Lloyds Banking Group Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 3, 2023

There are 12 speakers on the call.

Operator

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

Operator

Please go ahead.

Speaker 1

Thank you, operator. Good morning, everybody, and thank you for joining our Q1 results call. Let me start with an overview of our key messages on Slide 2. The group has continued to deliver in Q1. As ever, and particularly in the current environment, our purpose of helping Britonprosta is central to how we operate.

Speaker 1

Our purpose driven business model enables the group to offer significant support to customers and colleagues as they navigate the increased cost of living. We've also continued to deliver against our strategic ambitions

Speaker 2

for the group.

Speaker 1

You'll hear more about this at the half year and in our deep dive sessions in H2. Underpinning this, we delivered a solid financial performance in Q1, including strong income growth and capital generation. Our confidence in the group's business model, strategy and continued financial performance reflected in our maintained guidance for 2023. In an environment of change, our commitments have remained constant. Let's turn to the financials on Slide 3.

Speaker 1

Lloyds Banking Group delivered a solid financial Net income of €4,700,000,000 is up 15% on the prior year, supported by a net interest margin of 3 22 basis points, growth in other income and a continued low operating lease appreciation charge. Operating costs of €2,200,000 were up 5% on the Q1 of 2022. This reflects our continued strategic investments alongside inflationary effects on the cost base. We remain committed to maintaining our market leading efficiency And are on target to achieve our guidance of circa $9,100,000,000 for 2023. Asset quality is resilient.

Speaker 1

The impairment charge of £243,000,000 is equivalent to an asset quality ratio of 22 basis points, supported by a small release relating to the improved macroeconomic outlook versus Q4. Consistent with recent periods, given the reporting changes we implemented a year ago, underlying and statutory profit before tax are now largely aligned. Statutory profit after tax for Q1 was €1,600,000,000 and the return on tangible equity was 19.1%. This drove strong capital generation of 52 basis points even after taking the full €800,000,000 fixed pension contribution. Alongside, TNAV is up 3.1p per share after the IFRS 17 restatement.

Speaker 1

I'll now turn to Slide 4 to look at our resilient customer franchise. Mortgage balances stand at €307,500,000,000 This is down €3,700,000,000 in the quarter, largely driven by the €2,500,000,000 legacy portfolio exit that we mentioned at the full year. Excluding this, the open mortgage book was down $600,000,000 in the quarter, reflecting lower activity levels across the market. Alongside, we continue to see modest growth in our other retail businesses with credit cards, loans and motor finance All showing progress. Likewise, we continue to take advantage of Strategic growth opportunities within the Corporate and Institutional business, delivering growth of €700,000,000 in balances in Q1.

Speaker 1

As in previous quarters, this is offset by repayments of government support scheme loans within SME and some lower underlying balances. Turning to the deposit side of the balance sheet. Total deposits are down €2,200,000,000 in the 1st quarter or roughly 0.5%. This includes a reduction of €4,300,000,000 in retail and growth of €2,700,000,000 in Commercial Banking. The retail balance development includes an outflow of €3,500,000,000 in current accounts.

Speaker 1

This reflects unusually high seasonal outflows, mainly tax payments, higher spend given inflation and rates and a more competitive market, including government NS and I offers and our own savings rates. Looking forward, it is likely that the higher customer spend levels, internal churn and market competition continue, but we do not expect to see the circa €2,000,000,000 of tax payments repeating this year. Savings balances in Q1 were essentially flat, albeit with some expected movement from variable fixed rate. In Commercial Banking, we saw modest SMB outflows due to spend increasing and corporate and institutional inflows. Some of these inflows were strategic, Some likely short term quarter end balances.

Speaker 1

Across deposits as a whole and acknowledging uncertainties, we expect balances in 2023 to be broadly flat on 2022. Alongside, we continue to see good organic growth in insurance, with circa $2,000,000,000 of net new money in the quarter. Moving on to Slide 5, on the group's strong income performance. Net income of €4,700,000,000 is up 15% year on year with higher NII and other income. Net interest income of €3,500,000,000 is 20% higher than the prior year, benefiting from a stronger net interest margin and higher average interest earning assets.

Speaker 1

The Q1 margin of 3 22 basis points is up 54 basis points year on year but stable on Q4 as we had expected. As set out at the full year, we've seen continued pressure on asset margins, broadly offset by tailwinds from base rates and benefits from the reinvestment of the structural hedge. Mortgage completion margins were around 50 basis points in the quarter. This average included slightly higher new business margins and slightly lower product transfer margins. As you can see, the nominal balance for the structural hedge remains at $255,000,000,000 The weighted average life also remains around 3.5 years.

Speaker 1

Given an average yield of around 1.2% and currently providing swap rates, reinvestment of hedge maturities is expected to continue providing a healthy tailwind in the coming quarters. Looking forward and as outlined in February, we continue to expect the net interest margin to reduce in Q2 before stabilizing in the second half of the year. Overall, a base rate rise beyond our initial expectations has been offset by tighter product margins. We therefore continue to expect a full year margin in excess of 3 0 5 basis And alongside, we continue to expect broadly stable AIEAs in 2023. Turning briefly to other income.

Speaker 1

OI of CHF 1,300,000,000 in the quarter is up 6% year on year And up 11% on Q4. We continue to see activity build and benefits from investment, providing underlying growth. In addition, Q1 also benefited from benign weather in insurance compared to Q4 and a profit on sale of the legacy mortgage book. We continue to expect other income to build gradually supported by customer activity, our ongoing strategic investments and releasing the store of insurance earnings within our CSM liability. A brief word on operating lease appreciation.

Speaker 1

The charge of €140,000,000 in the quarter is higher than previous periods. The Lex car fleet grew and we recognized lower gains on sales in As new vehicle supply constraints eased. Augmented by Tasca, we expect this trend to continue through 2023 and therefore, to see the operating lease depreciation charge grow through the year. Now looking at costs on Slide 6. Operating costs of €2,200,000,000 are up 5% year on year.

Speaker 1

As you know, the increase is driven by our planned strategic investments, the costs associated with our new businesses and inflationary effects on the cost base. The costincome ratio of 47.1 percent or 46.6 percent excluding remediation continues to be competitive. Looking forward, we will maintain our rigorous cost discipline and remain on track to deliver operating costs of circa €9,100,000,000 in 2023. Remediation was very low in Q1 at 19,000,000 There is no charge in respect of HBOS rating, although as ever, uncertainties on this remain. We continue to have a base case remediation charges of around €200,000,000 to €300,000,000 per year.

Speaker 1

Let me now move on to asset quality On Slide 7. Asset quality continues to show resilience across the group. Our retail businesses are performing well with arrears at or below pre pandemic levels. Meanwhile, commercial performance is strong with the Q1 charges largely relating to cases that were already in Stage 3. The net impairment charge for Q1 was €243,000,000 equivalent to an asset quality ratio of 22 basis points.

Speaker 1

This includes a €322,000,000 charge before the updated economic scenarios, roughly consistent with Q4 an equivalent to an AQR of 28 basis points. As you can see, there's a small release in respect of the updated macroeconomic scenarios. Stemming from reduced energy prices and a looser fiscal constraint, The base case represents a modestly improved outlook. As usual, the detail of our scenarios is in the appendix. The stock of the ECL on the balance sheet is marginally lower in the quarter at €5,200,000,000 with coverage levels remaining very strong.

Speaker 1

And given everything we can see, we continue to expect the net asset quality ratio to be around 30 basis points for 2023. Turning to Slide 8 and looking across our portfolios. Retail performance is resilient. We're seeing a modest increase in neutral arrears in some portfolios, but from a very low base. Movements are within or in some cases better than our expectations.

Speaker 1

Mortgage book is very high quality. The average loan to value is 42% and 93% of the book is below 80%. We have seen a small uptick in arrears in the variable rate legacy books from 2006 to 2,008, but the rest of the portfolio shows no noticeable movement. The unsecured book, meanwhile, is performing better than we had expected. In the commercial business, we continue to see stable SME overdraft and RCF utilization trends.

Speaker 1

Watchlist and business support unit levels are stable to modestly down on year end. Our commercial portfolio is very high quality. Around 90% of SME lending is secured, whilst more than 75% of commercial exposure is to investment grade clients. Within the commercial business, our net real estate exposure after significant risk transfers is €11,000,000,000 and has been significantly derisked in recent years. Lending is focused on cash flows, with 84% having interest cover of 2x or more.

Speaker 1

The average LTV of the portfolio is 44%, while 95% have an LTV below 70%. The portfolio is also well diversified and subject to sector caps and limits. Our exposure to offices is around 14% of the portfolio, 10% to retail and 11% to industrial assets. Across our businesses, we feel very comfortable on asset quality. Let me now move on to Slide 9 on the group's liquidity position.

Speaker 1

Given recent events, it would be remiss not to spend a moment on deposits and liquidity. The group continues to have a very well diversified deposit base and a very strong liquidity position. The net stable funding ratio at 129% and loans ratio of 96% demonstrate the strength of the group's funding. We benefit from a predominantly retail focused deposit base with around 3 quarters of deposits coming from retail and a well diversified portfolio of SMEs. Over 90% of the deposit increase of circa €60,000,000,000 since the end of 2019 has been in the retail franchise.

Speaker 1

A very significant proportion of our customer deposits are insured, with over 80% of retail customer balances and 57% of total deposits protected by insurance schemes such as the FSCS. The liquidity coverage ratio 143% is stable and is well above both regulatory requirements and our internal risk appetite. Group's liquidity remained robust throughout the recent volatility with all liquidity measures well above internal thresholds at all times. Our liquidity pool of around €140,000,000,000 is held in high quality liquid assets, the majority held in cash and government bonds. The entire portfolio is hedged for interest rate risk with only credit risk driving limited movements in fair value through other comprehensive income.

Speaker 1

And this was negligible both in 2022 and in Q1. Together with Central Bank facilities, this provides over 210,000,000,000 of available liquidity, a very strong position. Now moving on, let's look at TNAV and capital on Slide 10. Tangible net assets per share are 49.6p, up 3.1p in the quarter after the IFRS 17 restatement. This is largely driven by attributable profit, but also benefits from the cash flow hedge reserve movement and pension surplus build.

Speaker 1

Liquidated assets of 211,000,000 Flat in Q1 as we continue to benefit from portfolio optimization. We saw no impact from credit migration. We expect to receive an update on CID4 models later this year and for this to result in an increase in risk weighted assets. Having said that, this will still be consistent with our 2024 RWA guidance of 220,000,000 to 125,000,000,000 Capital build remains strong at 52 basis points. Within this, we've now taken the full €800,000,000 fixed pension contribution for the year.

Speaker 1

The CET1 capital ratio is stable in the quarter at 14.1%. This is after the impact of regulatory change, the acquisition of Tuscar and accruing for the dividend. We remain comfortably ahead of the Board's ongoing target of circa 12.5%, buffer management buffer of circa 1%. Looking forward and including the strong performance in Q1, we continue to expect 2023 capital generation to be circa 175 basis points. Turning to Slide 11 to wrap up.

Speaker 1

In sum, the group has delivered a solid financial performance in the 1st quarter, supporting strong income growth and capital generation. We are committed to supporting our customers. Our franchise and portfolios are demonstrating resilience. Looking forward, we're maintaining our guidance for 2023. We continue to expect net interest margin for 2023 to Greater than 305 basis points.

Speaker 1

Operating costs to be circa 9,100,000,000 The asset quality ratio to be about 30 basis points. Return on tangible equity to be circa 13% And capital generation to be about 175 basis points. You can see that in an environment of change, Group's commitments remain constant. We remain well positioned for the future. That concludes my remarks for this morning.

Speaker 1

So thank you very much for I'll now hand back to the operator for Q and A.

Operator

Thank you. There will be a brief pause while questions are being registered. The first question comes from the line of Raul Sinha from JPMorgan. Please go ahead.

Speaker 3

Thanks so much. Good morning, William. Maybe two questions from my side to start with. Given the margin seems to be behaving exactly as you predicted last quarter, I was wondering if I could ask you about the extent of the margin decline in the And in particular, I guess, if we were to assume a base rate hike for the main MPC, Should we still expect it to be down? Or would you then expect it to be flattish?

Speaker 3

And then my second question is around The other income line, which obviously was a very good outcome this quarter. I'm just trying to get a sense of The new underlying run rate, if there is one, I mean, how big was the mortgage loan book sale gains? And it looks to me like the annualized run rate Might be closer to €4,950,000,000 almost. Would you agree with that? Thanks so much.

Speaker 1

Yes. Thanks, Charles, for those questions. First of all, in terms of the margin development in Q2, You saw in Q1 that our margin was 3.22%, which as you say was pretty much as we had expected when we gave our full year results announcement. There are a combination of factors that play there, including the benefit of base rate changes, somewhat offset by the mortgage headwind. Those are the 2 main factors, together with some Run through of the hedge maturities in Q4.

Speaker 1

When we look forward into Q2, we do continue to expect a step down in the margin Just as we highlighted the full year results. That is going to be driven by a variety of factors, but the principal factor in terms of the headwinds into the margin in Q2 Around the bank base rate changes combined with the churn and pricing impact on the deposit side. So it's really around the evolution of the deposit base and the pass through of some of the pricing changes that we've seen into deposits into Q2. And that has a preponderant effect in terms of The evolution of the margin going into the quarter. We do not have any structural hedge maturities into Q2, so that's an absence, if Like a tailwind that we'd expect to see playing through later on in the year.

Speaker 1

And then further as we go into the year, the mortgage headwind starts to evolve. So in Q3, Q4, You see more or less the offsetting impact of the structural hedge maturities on the one hand against a kind of maturation, if you like, of the mortgage refinancing headwind on the But for Q2, it's largely around that churn and deposit pricing impact. You asked about the effect of the bank base rate on that In Q2. And if we do see rather a further bank base rate change, what effect might that have? It is, as you know, normally the case The bank base rate changes will help our margin.

Speaker 1

That is off the back of leads and lags and to an extent any positive widening that you might liability widening that you might see. Having said that, we are seeing a competitive deposit market. And so the question will be in Q2, Raoul, if we do see a bank base rate change, How much of that feeds through into deposit pricing in the market as a whole? And how much do we see it as appropriate to ensure that our deposit base is as Resilient and robust and competitive as we've seen it in Q1. So those are the dynamics.

Speaker 1

I think overall, even if we do see a base rate change And even if that does benefit the margin slightly in Q2, I would still expect to see a step down in the Q2 margin. That is not going to change. Your second question, Raul, on OI. OI, as you say, was a pleasing performance in Q1, €1,257,000,000 That was up, as said, 11 percent of about €130,000,000 off the back of Q4, €1,128,000,000 or thereabouts. What's going on there?

Speaker 1

There's a couple of different factors going on. In each of our business areas, we've seen some positive developments. So in retail, for example, we've seen some positive underlying developments in Lex business growing likewise in terms of cars related activity. Within commercial, we've had a strong Q1 as we normally do, but it's been particularly marked And then in insurance pensions and investments, we've seen 2 benefits really. One is the absence of weather that we saw in Q4, So the absence of a negative there.

Speaker 1

But then more importantly, we've also seen the roll up in the contractual service margin off the back of the IFRS 17 changes in 2022 Start to then rollout off the liability into Q1 of this year. When we look forward, there are, as you say, a couple of one off benefits. We talked about the legacy mortgage book. I've just talked about weather or the absence of weather, let's say, in insurance. Those 2 will clearly have a way, but their place will start to be taken by kind of activity led growth by some of our strategic investments, both organic and inorganic, and they will play into the OI looking forward.

Speaker 1

So I think off the back of this kind of 1.25 number that we produced at Q1, you should expect to see that consolidate over the course of the remainder of this year. As you know, we don't predict OI, so I won't go into that precisely now. But I think that 1.25 number is likely to be a kind of roughly consistent type of run rate that we'd expect

Speaker 3

That's very helpful, Liam. Thank you.

Speaker 1

Thanks, John.

Operator

One moment please for the next question. The next question comes from the line of Benjamin Thomas from RBC. Please go ahead.

Speaker 4

Good morning, William. Thank you for taking my questions. First one is on cost. If I take the Q1 and multiply by 4 and then add in something like €150,000,000 to the bank levy, I think I'm a bit below Your guidance for

Speaker 5

the full year, so is it best

Speaker 4

to say that costs will step up slightly in the coming quarters? And then secondly, a question just in response to news So around pre funding a deposit guarantee scheme in the UK, have you had any discussions with the regulator in respect of this? And do you have any thoughts you can share with us on it?

Speaker 1

Yes. Thanks, Ben. In relation to costs, I think the most important point in costs is that we're sticking with our guidance of €9,100,000,000 for the full year. That is going to be the bottom line for the full year. We will deliver on that guidance just as we always do.

Speaker 1

In respect to Q1, as you say, we got 2.17 for operating costs in Q1. There are some factors that play themselves out in the late part of the year. Bank levy, you mentioned, There's a bit of a pattern to the overall investment spend and associated charges with that. There's a bit of a pattern to inflationary pressures over the course of the year, including things like pay settlements and so forth. And so that combination, Ben, is going to produce a pattern of costs, which will vary a little bit quarter by quarter.

Speaker 1

But again, I would focus on the bottom line of the 9.1% guidance that we'll deliver. In terms of The protection schemes that may or may not come to pass as a result of the recent volatility within the banking sector, we have not had any discussions so far with the regulator About what may happen there, whether that's a focus on deposit insurance, whether it's a focus on liquidity. And indeed, to the extent that it's a former, how would it be funded? It is, in its current form at least, going to be a funding mechanism, which should have a relatively modest impact on our overall earnings going forward simply because of the way in which the funding mechanism feeds through into our P and L. So absent some Very significant change in the way in the quantum of insurance or alternatively the way in which it's funded.

Speaker 1

We see this as If it does change, having a relatively modest impact on the P and L, that gives you some indication of bottom line expectation.

Operator

One moment please for the next question. The next question comes from the line of Martin Leitgeb from Goldman Sachs. Please go ahead.

Speaker 2

Yes, good morning. Thank you for taking my question. I just had 2 questions, please, relating to And the margin outlook. And the first one, I was just wondering if you could comment on the evolution of product Margins, you have called out product margins earlier, obviously, having an impact in 1Q. Completion margins up 50 basis On the mortgages, could you just highlight what you have seen recently and whether application margins have started to It's higher.

Speaker 2

And secondly, I was just wondering in terms of deposit composition going forward, How should we think about the shift from current accounts, retail and retail to other pockets of deposits going forward? There's a, I believe, a 3% decline, quarterly decline in current accounts in retail. Would you expect this phase

Speaker 1

Yes. Thank you, Martin, for the questions. First question on product margins. What have we seen? As said, we've seen product margins tighten slightly over the course of the quarter.

Speaker 1

It's been relatively competitive markets, Both in deposits and in mortgages. Taking each of those, there are 2 effects really within the deposit market. 1 is the pricing offers that you make to customers. Obviously, some of that attracts new money, some of that also generates internal movements. And as you have that internal movement, that increases your deposit cost By virtue of deposits moving from interest free in the context of PCAs into interest bearing in the context of, let's say, fixed term deposits, for example.

Speaker 1

So some tightening up. We have some good offers out there in the market just as others do. And that overall is leading to deposit costs, which are increasing on a quarterly basis. Within mortgages, we highlighted a completion margin of 50 basis points. As I said in my comments earlier on, that 50 basis points is composed of 2 elements.

Speaker 1

1 is the product transfer or retention part of the market, which is actually marginally below 50 basis points. Why are we comfortable with that? It's because we know the customer. It's because we're building the relationship. And so we see an attractive return profile for that type of mortgage even if the headline pricing or spread is slightly lower.

Speaker 1

The other component is new business margins. New business margins are in fact higher than the 50 basis points that we gave. We haven't put a number on it, But we've seen new business margins anywhere between 60 to 80 basis points through the duration of the quarter depending upon a particular point in time that you look at. So those are higher. The challenge is that the volumes of new business in the current market is relatively modest.

Speaker 1

And so that overall produces a blended margin of the 50 basis points that we've given you. That's the completion margin for Q1. As we look forward, Our expectation is that the mortgage market will continue to be relatively muted and therefore retention will continue to be a significant component of our overall completion margin within the mortgage business. That in turn, I don't want to be too kind of predictive at But that in turn leads us to think that completion margins in Q2 will probably not be terribly different to what we've seen in Q1. We'll see how that evolves, but that's our base case right now.

Speaker 1

It's worth saying at the margin as well sorry to give the pun. It's worth saying in other products as well, Unsecured, for example, we've seen slightly higher funding costs there, while pricing has stayed more or less stable. So there's a little bit of margin compression going on there. But all of these developments, deposits, mortgages, unsecured and indeed the commercial book, are all contained in our greater than $305,000,000 margin guidance. And as per the comments that I made to Raul's question earlier on, if we see base rate changes and not all those base rate changes get competed away, Then indeed, one might expect to see a little bit of upside in our margin develop over the course of Q2 and indeed into the remainder of this year.

Speaker 1

I I think we just have to see how that plays through. But again, if we do see more base rate changes, perhaps that's where it ends up, but it does depend upon how the liability markets move. In terms of movement in the overall book, we have seen some movement from PCAs into fixed rate and also That we call limited withdrawal, which gives customers slightly better rates in turn for sacrificing instant access on a, As the name implies, slightly more limited basis. We've seen money flow out of PCAs. About 25% of that $3,500,000,000 outflow of PCAs has actually been recaptured in our fixed rate and limited withdrawal products.

Speaker 1

We've also seen within the savings book a little bit of movement from variable rate into fixed rate Likewise, limited withdrawal. And then we've also seen new money from outside of the bank come into that fixed rate limited withdrawal product. So that overall is leading to the types of changes in composition of the book. You look at it on a quarterly basis and the overall changes are pretty modest on a quarter by quarter basis. But of course, that's what we saw in Q1.

Speaker 1

I would expect a little bit more of that to continue going into Q2. And again, that's all contained in our overall margin guidance of greater than $305,000,000 for the year.

Speaker 2

Thank you very much.

Speaker 1

Thanks,

Operator

One moment please for the next question. The next question comes from the line of Jonathan Pierce from Numis. Please go ahead.

Speaker 6

Yes, good morning everybody. A couple of questions please. The first is on net interest income. The margin was slightly better than people thought in the interest earning assets, likewise, but the headline NII was a touch lower. And it's this non banking interest expense that has moved up quite sharply in the quarter.

Speaker 6

I just want to understand what that is. Is this the equivalent to what some other banks For trading book funding costs and is there an offset there going through non interest income? And If so, should we be looking at that sort of run rate, €75,000,000 or so a quarter now, as long as base rate stays up Where we are. The second question is on the scale of the risk weighted asset increase you might be looking at later this year On the CRD4 clarification, could you give us a sense as to how large that is and which particular area it's coming from? And Just sorry, an additional in relation to that.

Speaker 6

I think when CRD 4 changes came through early last year, it was not only some increase in RWAs, But there was an increase in some capital deductions as well. So can you just tell us whether this clarification may affect both The numerator and the denominator or it's just a risk weighted asset issue. Thanks very much.

Speaker 1

Yes. Thanks, Jonathan. First of all, on the net interest income and impact on net interest margin of non banking interest income. When you look at the progression of net interest income quarter 4 into quarter 1, And as you point out, Jonathan, you look at the margin, it's basically the same. You look at the AIA and it's basically the same.

Speaker 1

To your point, what's going on there? Two things. One is there is a day count issue. There are fewer days in quarter 1 than there are in quarter 4. That's about half of the impact.

Speaker 1

And then the second one, as you point out, is the non banking interest income, for want of a better word, which If you look at our disclosures at the back of the interim statement is an expense, and it's an expense of about $76,000,000 in quarter 1. That is up a little from quarter 4. And on a year on year basis, it's up about $55,000,000 or thereabouts $56,000,000 I think to be precise. As you look forward, that is a run rate number. And the reason to explain kind of what's behind it is that it is basically funding the non banking Businesses, the noninterest income driven businesses for want of a better word.

Speaker 1

You described it as kind of trading expense in other institutions. There's a bit of that with us Sure. There's also things like NEX, for example. These are businesses which are not driven by virtue of interest bearing balances. And that, in turn, drives the non banking interest income expense, which is essentially a funding expense for those businesses.

Speaker 1

Now to a degree, as those businesses grow, you would expect to see some benefit from that coming through other operating income. A Lex business increasing in size, for example, benefits other operating income. Likewise, some of the trading activities. But actually, the main factor driving it alongside of that, let's say, is the increased funding cost, the increased interest rate environment that we're in. And that's what you see playing through into Q1.

Speaker 1

And as I said, you should expect a run rate not dissimilar really to what you saw in Q1 for the remainder of this year. When we calculate our interest margin of 3.22%, we exclude that component. And that's how you can reconcile that plus a new data point to the run rate net interest income from Q4 against Q1. You also have CRD IV, Jonathan. CRD IV, as said in my script, we do expect to receive further news on from the PRA over the course of this year.

Speaker 1

And it is likely, we think, that, that will lead to a modest increase in RWAs. Just to sort of track back and give some history on that, when we set out our CRD IV expectations on January 1, 'twenty two, which you referred to in your question, We saw at that point about €16,000,000,000 increase in RWAs, €14,500,000,000 of that was in relation to mortgages. We said at the time, the CRD4 component for mortgages was a best estimate, if you like. It was a place marker based upon the fact that the discussions of the PRA and the models were not totally finished business. As we roll forward, since that time, we've learned more on the PRA technical We've learned more about their approach to historical data and to a degree, their approach to cyclical sensitivity.

Speaker 1

And so off the back of that, we expect a Modest increase in RWA to be informed to it, if you like, by the PRA later on in the year. I think the most important point there, Jonathan, is that that increase, I won't put a number on it precisely, but that increase is within our circa 175 basis points capital guidance And also within our 2024 RWA guidance of $220,000,000 to $225,000,000 which tracking back at the year end, I said it was Yes, broadly speaking, a kind of linear trajectory, 23 going through into 2024. So that's how that CRD4 expectations in the PRA is Factored into our numbers, if you like. Specifically, on your point about is this a sorry, a numerator and a denominator issue? No is the answer.

Speaker 1

This is likely just to be RWAs, which in turn is a denominator issue,

Operator

The next question comes from the line of Chris Can from Autonomous. Please go ahead.

Speaker 7

Good morning. Thanks for taking my questions. I think it comes Just a couple of follow ups around NII and your thinking there going forward. In terms of the mortgage piece, Could you give us an update on where the back book mortgage spreads are on the non SVR component of the book just so we can understand the sort of degree of Ed, when that kind of 50 minute level I'd like you to present, then thinking about structural hedge, obviously, you've seen some current account outflows. You expect the deposit market competition to expect in some of those trends outside of the tax impacts to persist.

Speaker 7

So How are you thinking now about your structural hedge size prospectively? You previously said you were very, very comfortable maintaining it, given offers, etcetera. But if you're now expecting to see some persistent current account outflows, even if they're relatively modest, how does that then to feed into your thinking on the size of the bank awards.

Speaker 1

Yes. Thank you, Chris, just taking each of those. On the mortgage book, first of all, I won't give you price of split that you won, but I'll give you a few numbers that hopefully will Help you reconcile some analysis. When we look at mortgages in terms of the yield this year, The yield on the mortgage book this year, we expect to be about €135,000,000 To give you some idea as to the effect of refinancing this year, we've probably got about €56,000,000,000 rolling off from the fixed rate book during the course of this year. That stock of refinancing fixed rate mortgages is at around 1.8%.

Speaker 1

And as you know from our comments around completions, that is rolling back on or that part of which we retain is rolling back on An average completion margin of around 50 basis points. So quite a significant headwind this year. I know it's not the split SVR versus You're asking for, but it hopefully gives you some idea that will allow you to get to that answer. Having said that, the headwind from that refinancing next year Starts to dampen down because the maturities or the price of the maturities at which they are rolling off starts to get significantly less. So it's well below the 1000000 that we're going to see this year.

Speaker 1

I won't put a number on it, but it's well below the 1000000 and therefore, it's much less of a squeeze in terms of the headwind that it causes. That means, in turn, as we said before, that the bulk of the mortgage headwind is addressed and dealt with by the time we get to the back end of 2024. You asked about structural hedge size. Structural hedge size is currently €255,000,000,000 That's the size that we feel very comfortable with today. We have a buffer, which is about €19,000,000,000 In the past, we've always operated with a buffer, which is around 5% of the structural hedge.

Speaker 1

Dollars 19,000,000,000 is more like around 7.5% of the $255,000,000 that we've got in the structural hedge today. So the buffer of €19,000,000,000 is probably in excess of the types of levels that we would seek to carry going forward. Now having said that, as you say, deposit churn, we believe, will continue. We think that we will continue to see a little bit of outflows Within the PCA, why is that? Well, it's because spend is clearly greater in an inflationary environment than it was before.

Speaker 1

People are paying higher interest bills for various Financing other products than they did before. We will not clearly see a repeat of the tax issue within January that we and other banks saw having said all of that. But that means we may see a little bit more PCA flow. Likewise, PCAs will also be attracted into the savings book, including, as I mentioned earlier on, our own. Within the savings book, we would expect to see a little bit more out of variable rate and into fixed term deposits and limited withdrawal.

Speaker 1

As said, people are prepared So I think we expect to see that continue to a degree going into Q2. That clearly has an impact on the structural hedge in terms of the balances that are available to be put within there. But at the same time, we have 2 or 3 tools to manage that. We have the size of the buffer, as said, dollars 19,000,000,000 probably in excess of what we choose to run with. We also have upcoming maturities.

Speaker 1

Can you play, if you like, a slight lower buffer off the back of a significant volume of upcoming maturities? Yes. They're tools that interact with each other. Thirdly, you have the weighted average life. Can you slightly shorten elements of the structural hedge, bring the weighted average life in, again, as a further tool to manage?

Speaker 1

And then finally, we have very conservative pass on assumptions within the structural hedge. So those in turn give us a further degree of security, if you like, As we look at the overall structural hedge. So I think in sum, Chris, where we are with that is that size is currently 255. We feel comfortable with where it is today. We are also conscious of the fact or aware of the fact that we are in an evolving environment.

Speaker 1

We have not been in the rate cycle for, let's say, 15 years. And it's not entirely clear how that plays out and the pace at which it plays out. And so we are where we are today. We feel comfortable with it, But we monitor the position and we'll keep an eye on it going forward.

Speaker 7

Thank you.

Speaker 1

Thanks, Chris.

Operator

One moment please for the next question. The next question comes from the line of Aman Raka from Barclays. Please go ahead.

Speaker 8

Good morning, William. I just wanted to touch upon deposits Again, if I could. I'm sure we can kind of piece it together, various business disclosure that you could give us. Could you just confirm what proportion of your deposit base is a non interest bearing current account currently? And also what proportion of your deposit basis term deposits as things stand?

Speaker 8

And then secondly, could you Maybe just give us some indication of what deposit mix you've assumed in your NIM guide. Alternatively, could you help us kind of understand some kind of sensitivity that might Posed a risk to your outlook for NIM or NII. So if there's It's actually more migration of current accounts to term deposits. Kind of what's that threshold in your mind where we should

Speaker 1

Yes. Thanks, Aman. Couple of questions there. One is the split between interest bearing and non interest bearing within the deposit book and then the second around sensitivity to the margin We do not formally disclose the split between interest bearing and non interest bearing within the deposit book. I'm going to give you a couple of numbers that will enable you Make some assumptions and get there.

Speaker 1

First of all, you can see the PCA volume in our retail book. That's disclosed on our balance sheet every IMS. So I'll leave you to Look at that. 2nd of all, the commercial book is, roughly speaking, 28% or thereabouts non interest bearing. So that's giving you a very precise number.

Speaker 1

But 25% to 30%, it will go up and down on a quarter by quarter basis. But if you combine that together as a PCA, you've got a pretty good idea, I think, as to the noninterest bearing component of our overall deposit book. The second question is around how do we see the flows within our deposit book and to what extent might those cause Sensitivity to the interest margin. In short, in quarter 1, we saw within our deposit book overall Combination of variable rate to fixed rate, PCA into fixed rate term and limited withdrawal and indeed our wealth deposits into Limited withdrawal and fixed rate, that number in total was about $8,000,000,000 or $9,000,000,000 thereabouts, that type of movement. That type of movement is probably not totally unrealistic to project forward into Q2.

Speaker 1

But then as we see bank base rates Start to steady off, I. E, fewer bank base rates thereafter. We think you're going to see less movement thereafter because there's less reason to move, if you like. You've got less change in rates. You'll still see some playing out of a higher interest rate picture, to be clear, but less movement.

Speaker 1

So those are the types of flows that we've seen in Q1. Those are the types of flows that we might expect See in Q2. But as you can imagine, we built a degree of cushion, if you like, within our overall interest rate expectations to ensure that we are able to give you guidance that we can achieve and beat. And I would add to that, if we see the bank base rate environment play out in a way that was being discussed earlier on in the call, To the extent that is not fully passed on or competed away in the deposit market, that probably causes a degree of upside to our overall margin expectations. Again, still expect that step down into Q2 and leveling off in the remainder of the year, but at all points greater than 300 basis points.

Speaker 1

And again, there may be that benefit. It depends on how the bank based rate and deposit margins play out.

Speaker 8

Thanks very much, William. Can I just clarify your the amount of term deposits that you have as part of your overall mix? I think you refer To it in some places in the disclosure, I'm never quite sure if you're exactly referring to fixed rate term deposits. Could you confirm that number for us, please?

Speaker 1

I don't think we do disclose that, Amman. I mean you can see on our slides, Page 9, I think it is, the retail savings and wealth components. You can see in our In my comments earlier on, the amount of flows that we saw in the context of Q1 and The split that we've given on the balance sheet analysis in the IMS is probably about as far as we go, I think, in terms of disclosures. So sorry, we're not going to get back to you precisely on that.

Speaker 8

Okay. Thank you very much. Really appreciate it. Thanks, Ram.

Operator

One moment, please, for the next Question? The next question comes from the line of Andrew Coombs at Citi. Please go ahead.

Speaker 5

Good morning. One numbers question and one more question, I guess. Numbers question is on the AT1. You did a large issuance in March. I think you said you're going to call another at the end of June.

Speaker 5

Just any thoughts on the £81 And hold on the coupon cost over the remaining quarters of the year. And then on strategic question, wealth. Obviously, Nara, you focused On NERA, you've talked about growing as part of your non NII growth initiatives. I was just interested in Wealth, you've seen a 10% decline in deposits year end. That would be partly due to tax Issues you mentioned, but also it's a 15% year on year decline.

Speaker 5

So what's causing the Decline in wealth deposits through the time when you're trying to grow that business.

Speaker 1

Yes. Thanks, Andrew. Thanks for that. We did do an AT1 issue earlier on in the year. As you say, that was deliberately done in order to take advantage of market opportunities In the context of the year.

Speaker 1

And to a degree at least pre fund any upcoming activity that we might have in AT1. As you'll be aware, we've got a call out there for a small AT1 instrument right now. We are currently operating in excess of our regular AT1 Guidelines, if you like. I mean, we've got more AT1 than we would necessarily have on a run rate basis on the balance sheet. That's fine.

Speaker 1

We feel comfortable with that position. We have AT1 developments over the course of actually next year. And it's worth mentioning actually that we got our issuance away before the Disturbance within Switzerland and in turn that allowed us to deal with any AT1 requirements that we might have The remainder of this year. So we're done effectively for AT1. There is an AT1 instrument up for call next year.

Speaker 1

We'll obviously have a look at economic circumstances and other So as we approach that, but we're done for this year. You asked about wealth and what's going on within the deposit base there. In short, very similar things to what's going on elsewhere in the deposit base. So if I look at that, what's been factoring into the deposit base over the course of this year so far, As said, we've seen spend trends off the back of an inflationary environment. We've seen higher tax outtakes, if you like, in January.

Speaker 1

And we've seen some migration within instant access into savings books across the book and including wealth. And so in particular, if you look at that wealth number, a fair bit of that wealth output, if you like, outflow was actually captured in our savings products. So I mentioned earlier on The overall €9,000,000,000 that we've seen move around the deposit book, at least €1,000,000,000 of that, perhaps a touch more, was coming out of wealth and into those savings products. So we would see that as significantly a kind of build on that wealth relationship. You are offering a wealth customer who has an instant access Transaction based account, additional products to, if you like, benefit and tailor to their needs.

Speaker 1

As we look forward in 2023, that mass affluent, that wealth offering is going to build on asset products and liability products and indeed on the interaction with Investment Products. So the ambitions there, Andrew, are very much in the process of being achieved. There's nothing that we are stepping away from. It's very much business as usual.

Speaker 5

Thank you. And on the aggregate coupon cost on the AT1s?

Speaker 1

I don't think we disclosed the aggregate coupon costs. We were I mean, in short, Andrew, we were pleased with the Coupon costs relative to either our historical issuance or alternatively market benchmarks, I think we felt like we've got a good issue away.

Speaker 5

Okay. Thank you.

Operator

One moment please for the next question. The next question comes from the line of Guy Stebbings at Exane BNP Paribas. Please go ahead.

Speaker 9

Hi, good morning, William. Thanks for taking the question. I had one on interest earning assets and one on Capital or buyback. So on interest in the assets, dollars 454,000,000,000 in the quarter and ended the quarter, I think, at 455. I appreciate you have flat year over year guidance.

Speaker 9

Just think about that sort of exit rate and should we therefore be assuming some saw reduction to get to the guidance? If so, is that just the sort of closed mortgage book and slightly softer volume trends more broadly? Or am I reading sort of being too specific thinking about the guidance? And I mean, it's just A flattish outlook from here. And then on capital, I mean historically you've talked to excess capitalization being a decision For the full year, but you're sat at 14.1 percent, you sound as confident as ever on delivery of the capital generation targets even with the CRD4 changes to RWAs and some of the concerns around asset quality that may be receded.

Speaker 9

So I recognize you're still progressing a large buyback, but you are in a good position. So might a further buyback be announced Before full year results and also with the Bank of England stress test results in hand, which aren't too far away now? Or should we just expect to wait until later in the year? Thanks.

Speaker 1

Yes. Thanks, Guy. On AIA, the simple answer is just a flat outlook For the year as a whole. So that's a simple answer. I mean within that, there's 2 or 3 dynamics that are going on.

Speaker 1

One is, As you'll have seen from the Q1 results, the continued runoff of the closed mortgage book, we expect that to continue a little bit, although I suspect what will happen is it will flatten off as the year goes on You'll get to a stub of customers who are happy with what they've got, number 1. Number 2, government lending. We've indicated bounce loans getting repaid over the course of quarter 1. I think that will continue over the course of quarter 2 and beyond. And then number 3, as you'll be aware, we've had a Sale of legacy mortgage book, which in turn is actually in AIA, but not in terms of but not in lending.

Speaker 1

So you got a slight discrepancy going on there. Those are the factors that play into AAAs. And then alongside of that, clearly, there's a regular asset growth patterns. Now what we've seen so far this year is relatively muted asset growth in many of our major markets. Broadly speaking, we've seen a little bit of Outflow, if want of a better word, in the open mortgage book, if you exclude the legacy sale, that's about negative €600,000,000 So it's kind of negligible, but It's modest in terms of the outlook for that business, I.

Speaker 1

E, we have expected to grow a little, but not very much. We've actually seen some growth in our unsecured books and motor Within the retail business still, which is pleasing to see. I think that will flatten off during the remainder of this year. And then maybe C and I continues to grow a little bit and SME impacted by the points that I just made. So overall, I think a flat AIA picture over the year with those component parts moving in the way that I've just described them.

Speaker 1

On capital, your second question, as said, we had a very strong performance on capital in Q1, 52 basis points. We stand, as you pointed out, on a 14.1 percent CET1 level, which feels pretty robust, particularly in the context of us having Front loaded the pension payments of €800,000,000 There are 1 or 2 factors at play for the remainder of the year. We talked a little bit about the CRD IV Increase, if you like, from mortgages expected later on in this year. That asset growth that I indicated, it will be modest, but on the other hand, it will grow RWAs a little bit with it. And so overall, the capital growth for the remainder of this year, it's probably not going to be as strong as 52 basis points.

Speaker 1

And I'll just point you to the 175 Annual guidance or Circle 175 annual guidance for capital growth for the year as a whole. Coming to your question, Guy, what does that mean in terms of our statements around Buybacks capital distribution for the remainder of this year. As you know, we put in place a healthy a progressive and sustainable dividend off the back of 2022 That hopefully will get confirmed by the AGM and therefore allow us to pay that out. I'm sure that we'll look at the interim dividend at the half year And recommit, if you like, to our progressive and sustainable dividend in that context. Our buyback is underway right now.

Speaker 1

The number that we've produced at Q4 sorry, Q1 has been supplemented by ongoing progress in the buyback, and I think it's publicly available. But we've probably bought back about £700,000,000 £750,000,000 worth of stock right now, which will help us in terms of building TNAV per share and indeed EPS per share looking So there's a lot of capital activity and distribution going on right now, dividends and buybacks included. I don't think, Guy, that with all of that going on, We're going to move from our standard practice of looking at capital in the form of buyback and finally a dividend at the year end. My guidance to you would be to say That will be a year end board decision this year, just as it always has been.

Speaker 2

Okay. Thank you.

Speaker 1

Thanks, Greg.

Operator

One moment please for the next question. The next question comes from the line of Rohit Chandranarajan from Bank of America. Please Go ahead.

Speaker 10

Hi, good morning, William. Thank you. I've got a couple please also on margin. Apologies, you probably thought You were done with that, but hopefully they're relatively quick. So the first one is on the mortgage completion spread, the 50 basis points in Q1.

Speaker 10

It sounds from your earlier comments like you thought that was probably around the number that you will see in Q2 as well. I was so firstly, I wanted to check that. And then I guess as we progress through the year in terms of looking at where Spreads are in new offers in the market today that would probably not complete till Q3. They're starting to look a little bit better. So I was wondering if those in terms of either pricing or mix, how you think that would Progress particularly through the second half of the year in terms of the new mortgage spreads.

Speaker 10

And then the second one, Just on deposits, you talked a lot about mix, which is helpful. Thank you. What can I ask what the pass through is on the latest The rate hikes that will impact the NII in Q2, please, so the most recent 25 basis point hike? Thank you.

Speaker 1

Yes. Thanks, Rohit. In terms of mortgages, overall, as I said, we saw 50 basis points completion in Q1. It's a little early to comment on Q2, but our expectation is that it will not be significantly different, let's say, in the context of Q2. And as we saw in Q1, I would expect that to be composed of 2 inputs, that is to say, product transfer below 50, new business above 50.

Speaker 1

We have seen new business materially above 50 at the times during the course of So your point around new business margins, I think, is a fair one. But a couple of points to add to that. One is that we've also seen quite significant swap volatility, And that hasn't really gone away. And so at any moment in time, our new business margins are impacted by where swaps stand. And with them going up and down so much on a kind of daily, weekly basis, That is driving quite a lot of volatility in new business spreads with it.

Speaker 1

It's not clear to me whether that will go away or not, but I think you'll only really get a sense as to equilibrium new business spreads in an environment where you have more swap stability than we've seen for the last quarter. I would be hopeful that over time that equilibrium new business pricing steers itself back towards the kind of traditional 75 to 100 basis points guidance that we've given you before. But I think as a composite, based upon retention plus new business, even if it does, I would expect our completion margins to be south of that 75 to 100 basis points for the remainder of this year. And indeed, that is what is in our planning assumptions. That is what is in our greater than $305,000,000 interest margin guidance, I.

Speaker 1

E, the number being less on a composite basis than the 75 to 100 corridor. In terms of your second question, Rohit, on mix and pass through, The pass through that we saw off the back of the February March interest rate rises was around the 40% mark. So that gives you some idea. And what you're seeing there is effectively the pass through moving up over time. And we're not done yet.

Speaker 1

I think as we go Through the remainder of this year and into next, we'll see that pass through continue to gravitate towards slightly higher levels. So 40% is the most recent experience off the back of the combined February and March freight rises. You also see, to be clear, some further effective pass through that's not often described as such Because of the overall churn within the book, that is to say, every time a deposit migrates from PCA into fixed term deposit, That in a sense is another form of pass through whereby the customer gets the benefit of the rate increase. But 40% is your headline number for the February March Interest rate rises. I would expect our pass through or at least our interest rates to depositors to continue to mature second half of twenty twenty three And then 2024.

Speaker 1

And again, all of that is contained within the interest rate guidance or sorry, margin guidance that we've given you.

Speaker 10

Thank you. Could I just Come back very quickly on the mortgage spread. Are you seeing any initial signs of change in mix Between internal transfers and new to bankers, there seems to be some green shoots, at least in terms of the mortgage and housing market?

Speaker 1

Yes. I mean, there are some green shoots. It's looking a little bit stronger than we had previously thought. I think it's a general comment Actually, Rohit, and this applies not just to mortgages, but more broadly across the business. The economics are looking a little bit more favorable than we Describe them at the end of Q1.

Speaker 1

And there's all the factors that you're aware of going into that. But that's leading perhaps to a slightly more robust picture than we have previously thought. That in turn may play through over the course of the year. We have to see it. It's too early to call that.

Speaker 1

But that's the direction of things, I suppose, since we struck numbers. In terms of competition with the mortgage market, a little bit slightly better picture, perhaps fed by some of the points I've just made. But again, Rohit, I would be a bit cautious about over interpreting at this stage. We have to see how the remainder of the or rather the coming weeks fare before we're making a call on it. Okay.

Operator

Thank you.

Speaker 1

Thanks, Rohit.

Operator

As you know, the call is scheduled for 1 hour and we have now reached the end of the allotted time. So this is the last question we have time for this morning. If you have any further questions, please contact the Lloyd's Investor Relations team. One moment please for the questions. Last question comes from the line of Joseph Dickerson from Jefferies.

Operator

Please go ahead.

Speaker 11

Hi, good morning, gentlemen. Can you just clarify, I think this needs to be clarified, your Comment on your non banking NII of annualizing this 76,000,000 A headwind. Does this reflect the other side as we've seen at pretty much every other bank, Higher non interest income. So is this a more of a broadly neutral Matter, if you will, for total income. If you could just address that, if this is like the kind of trading book funding cost and so forth, where there is A corresponding benefit to the noninterest income line.

Speaker 11

Thanks.

Speaker 1

Yes. Thanks, Let me take another stab at that. The non banking net interest income is really driven by 2 things. One is interest rate rises because it is effectively a funding cost from non banking activities. I mentioned Lex Earlier on, but you also mentioned trading activities there.

Speaker 1

Same sort of thing. You're funding those activities as interest rates go up, So the cost of funding those activities go up, and that is a factor in non banking net interest income or non banking net interest expense as it is at the moment. The second thing that's going on is that as the size and scale of those activities increase, whether it's in commercial banking, consistent with some of our objectives within corporate institutional, for example, Whether it's in Lex, e. G, we've now got the Lex car fleet size growing once again. That will also increase Non banking net interest expense.

Speaker 1

And again, that's simply because the volume of what you're funding is going up. And so the twin effects of rate increases, number 1, Joe, And activity increases, number 2, or scale of activity increases, number 2, is what is driving that non banking net interest expense. I think if you're annualizing what we saw in Q1, you're not going to be far off for the year, and it's a reflection of those 2 underlying activities. And finally, Joe, to the point you were making, therefore, a component part of that non banking interest expense is playing itself through in terms of the benefits that you see in other operating income, commercial, Lex being good examples. So you do see a part of that playing through and benefiting other Operating income.

Speaker 1

And part of that was at play in our 1.257, part of it will continue to be playing that line through the year.

Speaker 11

So there is the short answer is there is because of some increased activity, there is some corresponding benefit to Other income?

Speaker 1

That's right, Jay. Yes. That's a short answer.

Speaker 11

Okay. Because you know what the market is going to do. I mean, you've already been asked if you just take your costs and annualize them And add the bank levy. I think what the concern of investors is, are you annualizing the $76,000,000 and taking it off of your revenue estimate? It sounds like that would be the wrong conclusion to draw here.

Speaker 1

I think on a total basis, that's right. There's a netting off in terms of ROI that you expect to see. But Just referring you back to the OI comments that I gave earlier on the question there, and that gives you a good sense as to where we expect OI to be.

Speaker 11

Fantastic. Thank you.

Speaker 1

Thanks, Joanne. I think we are concluding on

Speaker 8

the call for today.

Speaker 1

So I just want to say thank you very much indeed to everybody for taking the time for your interest in the story, and we look forward to continued dialogue. Thanks very much indeed.

Operator

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

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Earnings Conference Call
Lloyds Banking Group Q1 2023
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