Lloyds Banking Group Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 25, 2024

There are 12 speakers on the call.

Operator

Banking Group 2024 Half Year Results Call. At this time, all participants are in a listen only mode. There'll be presentations from Charlie Lunn and William Chalmers followed by a question and answer session. If you wish to ask a question, please press star 1 on your telephone. Please note this call is scheduled for 90 minutes and is being recorded.

Operator

I will now hand over to Charlie Nunn. Please go ahead.

Speaker 1

Thank you, operator, and good morning, everyone, and thank you for joining our 2024 half year results presentation. As usual, I'll start by providing a short overview of the group's financial and strategic performance. William will then run through the financials in detail. Following a brief summary, we'll have plenty of time to take your questions. Let me begin on Slide 3.

Speaker 1

I'm pleased to say that we're continuing to make strong progress on delivering in line with our purpose, driving positive outcomes for customers, colleagues and shareholders. I'll cover this in more detail on the following pages. But to start, I'd like to highlight the following 3 key messages. Firstly, we're now halfway through our 5 year strategic transformation. We remain on track to deliver our interim 2024 targeted outcomes, delivering meaningful change for our customers and creating value for the group.

Speaker 1

Secondly, we've delivered a robust financial performance in the first half, in line with the expectations we laid out of the full year. This is driving strong capital generation and enabling consistent growth in shareholder distribution. And finally, we are reaffirming our guidance for 2024 and remain confident of delivering higher, more sustainable returns in 2026. Turning now to our purpose on Slide 4. Delivering in line with our clear, long standing purpose of helping Britain prosper ensures that we drive outcomes that benefit all stakeholders.

Speaker 1

During the first half, we continue to provide extensive support to our customers to help them meet their life cycle financial needs, such as supporting their savings goals through our strong ISA proposition. Our 19% share of cash ISA flows has enabled an additional £6,000,000,000 of tax free savings for our customers. We also helped more than 50,000 small businesses and charities start a new banking relationship with us. We remain focused on contributing to an inclusive society and supporting the transition to a low carbon economy, with these also representing new opportunities for growth. Since the beginning of 2022, we provided around £38,000,000,000 of sustainable financing.

Speaker 1

Looking ahead, we welcome the emphasis that's been placed on sustainable economic growth by the new government. Businesses like ours have a vital role to play in working in partnership with the government to address national priorities and help communities across the U. K. Prosper. We are well positioned in this regard and believe we can make a meaningful contribution across key focus areas such as sustainable infrastructure, housing and financial planning.

Speaker 1

On Slide 5, I'll provide a brief overview of our financial performance. Our robust financial performance in the second quarter and across the first half was consistent with our expectations and guidance. Our Q2 NIM has remained resilient, whilst we continue to deliver strong momentum in other income with our strategic initiatives supporting this growth. Net income was lower, reflecting an increase in operating lease depreciation, an area that William will cover in more detail shortly. Elsewhere on the P and L, costs are tracking in line with guidance and asset quality remains strong.

Speaker 1

We've also grown the balance sheet in the quarter with broad based lending growth of £5,000,000,000 excluding a Q2 securitization, whilst deposits were up £6,000,000,000 with growth in both retail and commercial banking. Our return on tangible equity was 13.5% for the first half. This translates into strong capital generation of 87 basis points with 47 basis points in Q2. In line with our intention to deliver attractive shareholder distributions, we today announced a 15% increase in the interim ordinary dividend to 1.06p per share. Our financial performance is supported by our strategic progress as we realize the benefits of our investments.

Speaker 1

I'll provide an update on this over the coming slides, starting with Slide 6. We're now halfway through our 5 year strategic transformation and nearing the end of the first phase. Through our investor seminar, we provided you with increased detail on our plan and progress across our main business areas. To reiterate, the key messages from these sessions were: we're building upon the strong foundation, including our significant scale, digital leadership and broad offerings. We've increased investment in the business with circa £3,000,000,000 incremental investment out to 2024.

Speaker 1

We're building momentum across our businesses, delivering growth in priority areas whilst investing in our enablers to improve operating leverage and enhance capabilities. And finally, we remain on track to meet our financial targets for both 2024 and 2026. Bringing this to life on Slide 7, I'll provide some examples of our progress in the first half. We're addressing a variety of growth opportunities, meeting more of our customers' needs, focusing on higher value segments and leveraging the unique breadth of the group's businesses. Building upon our existing scale, we're focused on deepening relationships right across the group.

Speaker 1

We're extending our digital leadership position with new features and propositions that increase engagement. For example, we launched InvestWise, a new mobile first investment proposition for 18 to 25 year olds, which has supported a doubling of customers in this segment. Additionally, we're delivering strong growth in our CIB market business, deepening our share of wallet and diversifying revenues, with CIB other income up 30% compared to the first half of twenty twenty one. Our strategy is also focused on building our offering with high value customer groups that have a greater number of needs. The development of our mass affluent proposition is a key example of this.

Speaker 1

We've scaled the number of customers with access to Lloyds Bank 360, 10x since launch with early benefits such as higher investment portfolio sizes for these customers. We expect these benefits to grow as we scale further with a larger addressable customer base. Finally, we're better connecting our businesses to address our customers' financial need. This includes increasing the penetration of our IP and I product within our consumer and commercial franchises. For example, we've seen a marked improvement in protection uptake rate and have reclaimed the number one share in new home insurance policies.

Speaker 1

Importantly, these outcomes are translating into financial benefits. We remain on track to deliver circa £700,000,000 of additional revenues from strategic initiatives by the end of the year with this growing to £1,500,000,000 per annum by 2026. Let me now cover our enablers on Slide 8. Complementary to our growth focus, we're investing in our enablers to enhance our capabilities and drive operating leverage. By digitizing end to end and modernizing our technology estate, we're increasing efficiency benefits as we scale.

Speaker 1

For example, we've now digitized around 45% of servicing journeys within BCB. By digitizing the journey to change a business address, for example, we've reduced unit costs in this area by 60%. We're also transforming our physical footprint. Our new leagues offices are the most energy efficient in the region. And later this year, we'll be moving to our new head office in London as we improve and consolidate our estate.

Speaker 1

Since the end of 2021, we've reduced our office footprint by more than 20%. These activities have contributed to the delivery of circa £900,000,000 of gross cost savings to date, leaving us on track to deliver circa £1,200,000,000 by the end of the year. At the same time, we've continued to demonstrate discipline with regards to capital efficiency, growing in capital light areas and undertaking securitization activities. We've now relied around £15,000,000,000 of RWA savings from optimization since the end of 2021. Finally, our people remain critical to our future success, and we're taking action to build capability in key areas.

Speaker 1

For example, we've recruited another 1500 technology and data specialists in the first half, taking the total to more than 4,000 over the past 2.5 years. Turning now to Slide 9, where I will close with our financial outlook. As you've heard, we're making strong strategic progress in all areas and are on track to deliver our targeted outcomes. We're also on track to deliver our interim 2024 financial targets and remain confident in the outlook for 2026. This includes a return on tangible equity of greater than 15% and capital generation in excess of 200 basis points.

Speaker 1

These higher, more sustainable returns and capital generation represent a highly attractive proposition for shareholders. Thanks for listening. I'll now hand over to William for the financials.

Speaker 2

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, Lloyds Banking Group delivered a robust financial performance in H1 and in Q2. Tax free cash flow plus tax for the first half was 2,400,000,000 dollars return on tangible equity at 13.5%.

Speaker 2

In H1, net income of $8,400,000,000 was down 9% year on year. This was built upon a resilient banking net interest margin of 2.94%, including a Q2 net interest margin of 2.93%, 2 basis points lower than in Q1. Operating costs of $7,000,000 were up 7% year on year, in line with our expectations. Including the impact of the sector wide Bank of England levy in Q1, H1 operating costs were up 4% on the prior year. We continue to see strong asset quality.

Speaker 2

The H1 impairment charge of $101,000,000 equates to an asset quality ratio of 5 basis points. Excluding MES benefits totaling 324,000,000 dollars the asset quality ratio was a still low 19 basis points. After the impact of shareholder distributions, TNAV per share is now 49.6p down 1.2p in H1 given distributions and rate developments. Our performance resulted in strong capital generation of 87 basis points in the first half after the impact of regulatory headwinds. This supports our 15% increase in the interim dividend.

Speaker 2

I'll now turn to Slide 12, look at the customer franchise. Our business grew in the 1st 6 months of the year across the lending and deposit franchise. Group lending balances of $452,000,000 were up $3,900,000,000 or 1% in Q2. This is led by growth across the retail business. The mortgage book balances were up $3,200,000,000 in Q2, excluding the $900,000,000 legacy mortgage securitization or $2,300,000 after that transaction.

Speaker 2

Higher mortgage balances reflect the increase in application volumes observed at the start of the year as we mentioned in Q1. Elsewhere in the Retail business, we saw continued growth across cars, motor finance and unsecured loans. Commercial lending balances were also up slightly in Q2 by $300,000,000 Within this, we saw modest growth in corporate and institutional, partly offset by net repayments in small and medium businesses, including €400,000,000 of government backed lending balances. Let's look at the liability franchise. It's also been a good performance in deposits, which now stand at $475,000,000,000 up £5,500,000,000 or 1% in Q2.

Speaker 2

We saw growth of £3,600,000,000 in retail with savings accounts up $5,000,000,000 driven by inflows, limited withdrawal and fixed term products in a successful lighter season. Current accounts were $1,400,000,000 lower in the quarter, given the reversal of the bank holiday timing impact we saw at the end of Q1. This is probably a touch better than our expectations, driven by salary increases and lower spend. Commercial deposits were also up in Q2 by £1,900,000,000 In particular, we saw some stabilization of non interest bearing accounts and growth in targeted sectors within small and medium businesses. Alongside deposit developments, we continue to see steady liability growth in insurance pensions and investments with circa 2,700,000,000 of net new money in H1.

Speaker 2

Turning to net interest income on Slide 13. The group delivered a resilient performance in net interest income in the 1st 6 months of the year. Net interest income of $3,200,000 in Q2 was down 1% quarter on quarter. Alongside AIA's €449,000,000,000 was stable on Q1, driven by the weighting of customer lending growth towards the end of the quarter. As mentioned, the Q2 net interest margin of 2.93 basis points was down 2 basis points from the Q1, resulting in a first half net interest margin of 294 basis points.

Speaker 2

This general decline in the margin through the first half is consistent with our expectations as we outlined previously. Stage 1 non banking NII charge of $229,000,000 was driven by increased funding costs in the current rate environment and strategic growth in the growth of non banking businesses. The charge is tracking in line with the indication we gave previously for the full year of between €450,000,000 €500,000,000 Looking ahead, we continue to expect AIEAs for 2024 to be greater than £450,000,000,000 driven by current lending activity and expected further lending growth in the second half of the year. We also continue to expect net interest margin to be in excess of 2.90 basis points for 2024. Indeed, our confidence in this guidance is further reinforced by our performance in H1.

Speaker 2

Within the margin, mortgage refinancing and deposit churn development continue to evolve in line with our expectations. Forecasted bank base rate cuts will add to the deposit headwind in the second half. However, the structural hedge refinancing will also play a greater role as we progress through the year, helping offset these pressures. Putting all this together, and as we said at year end and at Q1, we continue to expect net interest margin to be on a positive trajectory before the end of the year. Looking at the mortgage portfolio on Slide 14.

Speaker 2

Mortgage book now stands at $307,000,000,000 This is up $1,600,000,000 in H1 and up $3,200,000,000 in Q2. That's excluding the $900,000,000 legacy portfolio securitization. In Q2, completion margins increased to around 70 basis points, albeit maturities in the book were around 110 basis points. As I said, the impact of the mortgage book refinancing on the group's margin is playing out more or less in line with our expectations. As Charlie mentioned, a key element of our strategy is to increase connectivity between businesses, meeting more of our customers' financial needs.

Speaker 2

As an example of this, we've now enhanced the integration of our protection insurance offering into the mortgage journey. This drove a 3 percentage point increase in protection take up in H1, albeit this is still below where we think it should be. The financial benefits gained by this partner across divisions reinforce the attractiveness of new mortgage lending from both a strategic and economic value perspective. Looking ahead, we expect the mortgage book to continue to grow through the remainder of this year. Let me now look at the other lending books on Slide 15.

Speaker 2

Consumer balances are performing well. Credit cards, loans and motor were collectively up 2,700,000,000 dollars in the first half of the year, including $1,400,000,000 in Q2. We continue to see credit card spend recovering Balance is up $500,000,000 in H1. Likewise, loan balances grew by $1,300,000,000 partly driven by lower repayments following the securitization in Q4 last year. Meanwhile, motor finance was also up £900,000,000 In commercial, lending was down £500,000,000 in the first half.

Speaker 2

Within this, corporate and institutional lending was up £100,000,000 including growth in strategic areas such as working capital and securitized products. In small and medium businesses, balances were down $1,500,000,000 slow customer demand continuing to impact performance alongside £800,000,000 of government backed lending repayments. Moving on to deposits on Slide 16. Our deposit franchise grew strongly in the first half of the year. Total deposits are up by 3,300,000,000 dollars or 1 percent to $475,000,000,000 Within this, retail deposits were up 4,900,000,000 dollars Continued growth in savings balances more than offset expected current account productions.

Speaker 2

Retail savings balances were up $6,700,000,000 in H1, supported by net new money inflows and strong retention activity. 2 points stand out. 1st, as Charlie mentioned, we had a strong ISA season, tracking significant cash ISA savings from new and existing customers in the half. 2nd, our limited withdrawal product continues to see strong demand, enabling us to retain a high proportion rate sensitive money within our own savings proposition. Current account balances reduced in the half by £1,000,000,000 Outflows were driven by seasonal tax payments and movements to savings products partly offset by wage inflation.

Speaker 2

Commercial deposits decreased by £1,600,000,000 in H1. Within this, small and medium businesses business balances increased due to growth in targeted sectors, particularly in Q2. Non interest bearing balances, meanwhile, showed early signs of stabilization. Elsewhere, outflows and corporate institutional balances reflect the group managing deposits for value. As you're aware, the performance of our deposit franchise supports the structural hedge, which I'll now update on.

Speaker 2

Our structural hedge is a significant tailwind to income. The hedge notional currently stands at 242,000,000,000 dollars down $5,000,000,000 in H1, including $2,000,000,000 in Q2. This is in line with our expectations for a modest notional reduction during 2024 linked to the deposit churn trends. In H1, we saw gross hedge income of 1,900,000, dollars 3,000,000,000 higher than last year. The average earnings rate on the hedge is now circa 1.6% with the reinvestment rates continuing to be significantly higher than this.

Speaker 2

Weighted average life of the hedge remained stable at around 3.5 years. Market rates over H1 have been slightly stronger than our expectations at the start of the year. Accordingly, looking ahead, we now expect the growth in 2024 hedge income to be slightly higher than the €700,000,000 that we mentioned in February. Moving on to other income on Slide 18. We continue to build momentum in other income across the franchise and linked to the successful execution of our strategic initiatives.

Speaker 2

Other income of $1,400,000,000 in Q2 was 9% higher than Q2 last year with H1 up 8% year on year. Pleasingly, this income is driven by growth across all of our business divisions. Within retail, we saw a growing contribution from our motor business, driven by an increased fleet size. And alongside, we saw quarter on quarter growth in banking fee activity. In commercial, the team drove a strong H1 performance in our markets business with growth supported by strategic investments as well as higher client activity.

Speaker 2

Insurance pensions investments delivered increased income within general insurance as well as workplace pensions. Looking forward, we continue to expect strategic initiatives across our business to drive further growth in other income. Turning to operating lease appreciation. The H1 charge of $679,000,000 included $396,000,000 in Q2. The increased depreciation in Q2 incorporates a circa $100,000,000 additional charge.

Speaker 2

This is caused by the half yearly fleet revaluation exercise recognizing used car price developments, particularly in electric vehicles. These are a material part of our leasing business. Looking forward, this charge will revert to something slightly higher than the Q1 run rate because of the revised appreciation schedules alongside business growth. Taking a step back, today's charge comes after a period of significant net benefits from used car price movements. Overall, we continue to see this business as an attractive and profitable growth opportunity.

Speaker 2

We launched costs on Slide 19. We remain on track to deliver our cost guidance in 2024. Operating cost of 2,300,000,000 dollars in Q2 was stable on the prior quarter, excluding the circa $100,000,000 Bank of England Levy in Q1. H1 operating costs were $4,700,000,000 up 7% on the prior year or up 4% excluding the levy. Costs include expected elevated and front loaded severance charges taken to facilitate cost efficiencies.

Speaker 2

Excluding the levy and the component of severance in excess of last year, costs were up 2% with inflationary pressures partially mitigated by continued cost efficiency. The cost to income ratio was 57% or 56%, excluding remediation. The group continues to maintain strong cost discipline in the context of inflationary pressures and strategic investments. As Chip mentioned earlier, we remain on track to deliver $1,200,000,000 of gross cost savings this year. Excluding the Bank of England levy, costs will be up in total by 7% over the 3 years from 2022, 2024 in the context of what was much higher CPI growth during that same period.

Speaker 2

As said, we continue to expect operating costs of circa $9,400,000,000 in 2024, including $1,000,000,000 Bank of England revenue. The remediation charge was £95,000,000 in H1, substantially in relation to pre existing programs. There's been no further charges relating to the FCA investigation into historical Motor Finance Commission arrangements. Let me move to asset quality on Slide 20. Asset quality remains very strong.

Speaker 2

Credit quality continued to improve in the quarter with either stable or reduced new to arrears seen across our portfolios. This reflects resilience of our prime customer base and our prudent approach to risk. Strong credit performance alongside MES adjustments resulted in a low Q2 impairment charge of $44,000,000 equivalent to an asset quality ratio of 5 basis points. On a pre MES basis, the asset quality ratio was still low 16 basis points in the quarter. This benefited from a modest underlying charge as well as the release of inflationary judgment in retail given the strong portfolio performance despite the environment.

Speaker 2

132,000,000 MES release in Q2 was primarily driven by a revised approach to our severe downside scenario. This now incorporates the more evenly balanced risks of supply side and demand side shocks with attendant CPI and bank base rate impacts. Our total ECLs on the balance sheet is now $3,800,000,000 This remains circa $500,000,000 above our base case and like for like higher than pre pandemic levels, driving strong coverage across our portfolio. We feel confident in our asset quality, considering the strength of the portfolio and performance year to date in the context of an improved economic outlook, we now expect the asset quality ratio to be less than 20 basis points for 2024. Let me briefly update on our latest economic assumptions.

Speaker 2

We've made modest changes to our forecast since Q1. We now forecast GDP to be slightly stronger than our previous expectations, 0.8% growth in 2024. Given sticky pay rises and inflation, we now assume 2 rather than 3 base rate cuts in 2024 starting in the Q3. This higher rate environment leads us to expect unemployment to rise a little earlier, peaking at 4.9% in 2025. Our assumptions for house prices, meanwhile, are broadly unchanged.

Speaker 2

Let me now move on to Slide 22 2 and address the below the line items in TNAV. The return on tangible equity of 13.5% in H1 represents a robust performance. Looking ahead to the full year, we continue to expect ROTE for 2024 to be circa 13%. Restructuring costs remain low at $15,000,000 for the first half. Volatility and other impacts of $158,000,000 in H1 was essentially driven by negative insurance volatility given the increase in long term rates.

Speaker 2

Charge also includes the usual fair value unwind. Total net assets per share at 49.6p were down 1.2p in H1, 1.6p in Q2. The decrease was driven by shareholder distributions, including the full year ordinary dividend payment in April and also by movements in the rate curve impacting the cash flow hedge reserve in Q1. As usual at this time, GNAV is also temporarily suppressed by an accrual for the share buyback over the H1 close period with no corresponding share count reduction. This 0.9p per share accrual impact will mechanically reverse in Q3.

Speaker 2

Looking ahead, we continue to expect TNAV per share to grow this year and indeed over the medium term from lending growth, buybacks and the unwind of headwinds. Inevitably, the growth trajectory may be influenced in the short term by rate volatility, just as we saw in the Q1 of this year. Turning now to capital generation on Slide 23. We have delivered strong capital generation in the first half. In H1, RWAs were up $2,900,000,000 ending at $222,000,000 Lending growth was offset by securitization and other capital optimization activities.

Speaker 2

In quarter, RWA developments were further impacted by the reversal of the temporary increase in market risk RWAs related to hedging we mentioned in Q1. We continue to expect risk weighted assets to be between $220,000,000,000 225,000,000 at the end of the year. This is led by expected lending growth in H2 with continued active balance sheet management to offset regulatory pressures. Capital generation of 87 basis points in the first half was, as said, a strong result. In this context, we continue to expect full year 2024 capital generation to be served at 175 basis points.

Speaker 2

This represents a healthy level of capital generation and what is a robust business performance. Closing CET1 ratio of 14.1 percent is after 48 basis points of ordinary dividend accrual. This is inclusive of the announced interim dividend increase of 15%. I'll now move on to talk further on capital distributions on Slide 24. The group's strong capital generation and CET1 position continues to support growth in shareholder distributions.

Speaker 2

Today, the Board announces an increased interim dividend of 1.06p per share, 15% growth from last year. As usual, we'll consider further capital distributions at the year end. Both the interim and final dividend per share have grown consistently over our strategic plan. The 2024 interim dividend per share announced today is around 60% higher than in 2021. This strong distribution growth is consistent with our guidance for progressive and sustainable dividends.

Speaker 2

Alongside this growth, we have undertaken consecutive and significant share buyback programs. These have reduced its group share count by around 12% since the end of 2021, supporting growth in value for our shareholders. We remain committed to growth We remain committed to growth in distributions and returning excess capital to shareholders alongside delivery of our strategy for the benefit of all stakeholders. I'll now move on to Slide 25 to wrap up the financials. In sum, the group is delivering in line with expectations.

Speaker 2

As Charlie said, our strategy is progressing well towards our ambition of generating higher, more sustainable returns for our shareholders. As part of this, we saw a robust financial performance over the 1st 6 months of the year with solid profitability, strong capital generation and an increased interim dividend. Looking forward, we reaffirm our 2024 guidance as set out in full on the slide, and we remain confident in our 2026 commitments. We remain very well positioned for the future. That concludes my comments this morning.

Speaker 2

Thank you for listening. I'll now hand back to Charlie for his closing remarks.

Speaker 1

Thank you, William. So to summarize, the group has once again delivered in line with the expectations we laid out, increasing our track record of consistent delivery. We've continued to deliver in line with our purpose of helping Britain prosper and see further opportunities to drive sustainable economic growth. We're continuing to execute against our strategic plan and are on track to deliver our interim 2024 outcomes. Our financial performance remains robust with strong capital generation supporting increasing shareholder distributions.

Speaker 1

We have today reaffirmed our guidance for 2024 and remain confident in the outlook of delivering higher, more sustainable returns and capital generation in 2026. Thanks for listening. That concludes our presentation. And we're now very happy to take your questions. Back to you, operator.

Operator

Thank you. There'll be a brief pause while questions are being registered. Thank you. Our next caller is Jason Napier from UBS. Your line is now unmuted.

Operator

Please go ahead.

Speaker 3

Good morning. Thank you for taking my questions. 2 on net interest margins, please, if I could. The walk on margins on a quarter on quarter basis, just focusing first on the 4 basis point headwind from mortgages. I wonder whether you could talk a little bit about the spreads that you achieved in the Q2, the pipeline for the Q3 and how that looks sort of persistence of the headwind is a particular focus for investors.

Speaker 3

How long you think that headwind will continue? And then secondly, the support in this quarter from funding capital and other, it looks to me like that's mostly about the Bank of England levy change. But if you could talk about whether we should consider that to be a plus or minus or neither in future periods, that would be most helpful. Thanks very much.

Speaker 2

Thanks, Jason. I'll perhaps take those two questions. Maybe that Charlie wants to add a little on the mortgage point in particular. On the mortgage question, 1st of all, in relation to NIM. As you say, we've seen a bit of a headwind during the course of quarter 2 in relation to mortgages, 4 basis points.

Speaker 2

That's very consistent with what we saw in quarter 1. And to your look forward point, Jason, it's consistent with what we would expect to see the remainder of this year. It's not playing out very much in line with expectations. What's going on behind that? As commented on in my comments, I think perhaps in Charlie's too, we've seen completion margins of around 70 basis points in the course of quarter 2.

Speaker 2

That's up a touch versus quarter 1, which I think was more like 65. That's good to see, but it's a gradual and obviously relatively modest progression, but it's progressed nonetheless. That is, however, as you know, in the context of maturing mortgages coming off the balance sheet around 110 basis points. And it's that combination that leads to that 4 basis points headwind in quarter 2. And as I say, I expect that pattern to be pretty consistent for the remainder of this year.

Speaker 2

As we go forward on that, today is not the day, obviously, to be making guidance or giving guidance for 2025. But as we go forward and consistent with the comments that we've made before, we expect that headwind to temper slightly during the course of 2025 and then get effectively eliminated during the first half of twenty twenty six, at which point you're taking on new mortgages at much the same rate as they're coming off. So it's that type of development looking forward, Jason, which hopefully is helpful to your question. In terms of the second question there, funding capital and other on the margin, as you say, we've had about a 3 basis point benefit from that. What's underneath that number?

Speaker 2

It's basically three things. You mentioned bank levy, which is quite right. That is certainly a feature of that. Alongside of that, we've seen some spread compression, which is helpful. And we've also seen lower quantities of wholesale issuance than we might otherwise have had, partly because of the deposit strength that we've seen on the balance sheet.

Speaker 2

So those things are coming together to help steer the margin in the context of our $293,000,000 for Q2, dollars 294,000,000 for the half as a whole. Looking forward, Jason, on that particular point, I would expect that to continue to be a bit of a tailwind going forward and ebb and flow a little bit. But overall, that bank levy benefit will continue to contribute through the course of the year. And likewise, maybe a bit of benefit from wholesale in the context of strong deposits. Charlie, I don't know if you want to talk a little bit about mortgage volumes.

Speaker 1

Yes. Thanks, William. Just on the mortgage market broadly, I think probably everyone will know, we saw a strong Q1 actually in terms of customers coming back and origination around mortgage volume. That was linked to obviously the lower swap curve that we saw in January February. And I think the good thing from our perspective is our strategy about being focused on our segments that we are the leader and maintaining and growing market share in those segments played out well and it played out at margins, as William said, that we're very much in line or slightly better than our guidance.

Speaker 1

Volumes in Q2 slightly dropped as the swap curves moved up, but it stayed healthy. And we'll have to see how the second half develops probably along with the rest of the market. We're not expecting huge volatility in the swap curves and therefore pricing. It remains a competitive market, but what we're pleased about is we're competing well within the segments we've seen and we've actually gained a bit of share in the first half. So let's see how the second half goes, but it's a good start to the year.

Speaker 1

And obviously, those balances will be supportive of our AIEAs in the second half and hopefully into 2025 and 2026.

Operator

Thank you. Our next caller is Aman Raka from Barclays. Your line is now unmuted. Please go ahead.

Speaker 4

Good morning, Charlie. Good morning, William. I guess I had a follow on question on the net interest margin. So you're kind of talking about a bit more mortgage margin pressure in the kind of coming quarters at a similar run rate to Q2. So there's quite a lot of heavy lifting that needs to be done by the deposit side of NIM here.

Speaker 4

I guess, could you kind of break out your expectations of the deposit margin sequentially from here? And in particular, the structural hedge. So do you think we're kind of at a level now where the structural hedge is stabilized? Should we expect that to be a pretty meaningful pickup from here? And I guess that's coming in the broader context of NIM, which to me I think is I think you are pointing to a weaker NIM profile in H2 than consensus is modeling.

Speaker 4

So I guess I'll attach, I guess, a second question to that is it's right to think of NIM down in Q3 and then some kind of pickup in Q4, but one that probably may not approximate consensus. Is there any chance you can comment on those points, please? Thank you.

Speaker 2

Thanks, Man. I'll take those questions on the margin generally in the direction going forward, Man. The guidance for the margin remains consistent with what we said at the beginning of the year and then again at Q1. So hopefully, that's helpful in a sense that it's consistent over the course of the year. What's going on behind that?

Speaker 2

As I mentioned in my comments earlier on, actually, the developments in half one that we have seen have given us, I suppose, or rather underlined our confidence in that guidance as we stand today. So it continues to be greater than $290,000,000 for the full year, underlying greater than, and it continues to be turning towards a positive inflection point before the end of the year. Behind that, what is going on is the principal headwinds and tailwinds that we discussed before, which is to say that we see the mortgage headwind developing in the way that I've just described, pretty consistent for the remainder of this year. We see the deposit churn evolving but actually slowing in the second half of the year. And there's some early signs of that happening, Aman, that we can that we have discussed in the context of Q2.

Speaker 2

So we expect to see that churn continue and the rates environment be natural to expect people to continue to put money into things like fixed term accounts, likewise, interest or withdrawal. But nonetheless, that pattern, we expect to slow in the second half. And as I said, some early signs of that in Q2. Alongside of that in deposits, that pressure is going to be slightly augmented by bank base rate reductions that we expect to see, which in turn, as you know, will lead to certain lags before we're able to pass those on to depositors in whatever shape or form we choose to pass them on. So that's the picture of the deposit headwind, which evolved in the patent described.

Speaker 2

At the same time, we commented earlier on that funding capital NERVA tailwind, which is helpful, but actually much more importantly in the second half is the structural hedge. And the structural hedge comes back in a significant way in the context of the second half to offset a number of those headwinds that I just described a second ago. So I'm not sure I would totally buy into the profile that you described in terms of the overall performance of the margin. We feel, as I say, very comfortable in the overall guidance of present in 2.90. And likewise, the guidance that we expect the margin to turn before the end of the year.

Speaker 2

In that context, I think it's also reasonable to expect net interest income to turn in advance of the margin turning. So as we see it today, based on the guidance that we have given you in respect to net interest margin, in respect to non banking net interest income, in respect to AIEAs, we expect modest progress in H2 NII over H1. So it gives you a bit of context, if you like, for the way in which you might view not just the margin but also the net interest income picture as a whole.

Speaker 4

That's excellent. Thank you so much. Appreciate it.

Operator

Thank you. Our next caller is Benjamin Thomas from RBC. The line is now unmuted. Please go ahead.

Speaker 5

Good morning, both. Thank you for taking my questions. The first one is on that structural hedge. And just to help with our modeling, can you just provide some color on to what extent you pre hedged your 2024, 2025 and 2016 swap maturities? Top curve has been a bit all over the place.

Speaker 5

So to the extent that you have pre hedged, when did you do the bulk of that pre hedging? Or to put it another way, how does the rate you've locked in at compare to swap rates today? And then secondly, on securitizations, it may be performed an SRT securitization. Some of your peers are utilizing this method more than you are relative to size of their loan books. Can you talk a bit around your ambitions around further securitizations, whether they're traditional or SRT?

Speaker 5

And maybe put some color around the economics on this type of transaction from an RoTE and capital perspective? Thank you.

Speaker 2

Thanks, Ben. Again, perhaps I'll go through those two questions. In relation to the structural hedge, consistent with the pattern that we described at Q1 and perhaps also in February, We have, as you know, a structural hedge, which is right now, dollars 242,000,000,000 invested that's come off a touch since quarter 1 about $2,000,000,000 That's pretty much tracking in line with our expectations for this year, which is to say that we expect a modest notional reduction, probably not unlike what we saw last year, which is about $8,000,000,000 Maybe the deposit performance that we've seen this year actually helps us out a little bit in that respect, but let's see how the rest of the year fares. As we look forward to your question, Ben, we do obviously try to ensure that the hedge is both a source of shareholder value but also stability in our earnings, which in turn means that we do look to lock in the hedge in a way that's not hugely different to what you would expect out of a 3.5 year average life and the kind of lock in associated with that as you roll it forward. So specifically, what do I mean by that?

Speaker 2

It means that within 2024, we are very largely locked in, as you would expect. We've only got 6 more months or in fact, 5 more months of the year to run. You would expect us to be largely locked into 2024. When we look forward into 2025, we're about 4 5ths locked in. If you were to if you like to extrapolate the hedge over the course of its 7 year total life, 3.5 year weighted average life, that's about what you would expect.

Speaker 2

And then in 2026, we're probably around 2 thirds locked in. Again, to extrapolate the heritage over its total life of roughly 7 years, average weighted average life of 3.5 years, pretty much what you would expect. So that gives you a sense as to our hedge position, Ben, as we roll forward. In terms of timing, I'm not going to address precisely your timing question. But I think it is safe to say that when we see the curve look advantageous, if you like, relative to our long term expectations, then we will incrementally take steps forward on that basis.

Speaker 2

I wouldn't take that too far though, Ben, because if you look at our hedge, it is more like a kind of conventional hedge that you would expect to roll forward in a pretty conventional way than anything else. But occasionally, when rates are looking very favorable, then yes, we'll deploy a touch more than we would do in other less favorable circumstances. In respect of the SRTs and the like, Ben, as you know, optimization is a part of our balance sheet management strategy that we seek to pursue in a very net present value positive way for shareholders. There are a range of tools available at our disposal in respect to that optimization. Some of them are simply around making sure that we are efficient in our interpretations of how risk weighted assets should sit on the balance sheet.

Speaker 2

Some of them are around management with counterparties, for example, netting of collateral. Some of them, to your question, involve transactions. And to your particular point, yes, we do deploy SRTs. You'll see SRTs have been deployed in respect of our commercial business, including in respect of our commercial real estate business in particular. And so we do take advantage of SRTs.

Speaker 2

Likewise, we also take advantage of retail securitizations, particularly in the mortgage book. We did both the mortgage book actually and personal loans last year. The question that we ask ourselves every time we do an SRT or for that matter of retail securitization is, is this structure, is this transaction net present value positive? And if it is, then we see it as a useful source of shareholder value added. It is also, by the way, useful source of risk management, of course, on the balance sheet, talked about SRTs in the context of CRE just a second ago.

Speaker 2

But also over the course of quarter 2, we securitized about 900,000,000 dollars of Bank of Scotland Self certified mortgages. That combined with a transaction that we did in securitization space last year, similarly part of it relating to the legacy book, I've saved us about $200,000,000 in expected loss and therefore helped us in terms of the ECL management business going forward. So we're effectively risk managing in the context of some of these transactions as well as obviously managing risk weighted asset base that we seek to adhere to and target as you know for our year end. Thanks, Ben.

Speaker 1

Thank you.

Operator

Thank you. The next caller is Edward Firth from KBW. Your line is now unmuted. Please go ahead.

Speaker 6

Yes, good morning, everybody, and thanks so much for taking my question. I had two questions actually on a slightly different topic. Just going back to Charlie's comments about growth and the sort of labor imperative or the labor government's imperative for growth, because if I look at your full year 'twenty six target, that's sort of 15% -plus return target on a 13% core Tier 1. If you're going to generate 200 basis points of capital, that doesn't suggest there's much spare there for growth, if that's virtually nothing. So I'm just trying to think how important how much do you have to gear up your growth to actually get the economy going?

Speaker 6

And I'm particularly thinking of the commercial book. That's now been falling reasonably consistently for some time. And I'm just not clear in my own mind how the economy can really pick up if you, as one of the biggest players, can continue to decline that loan book. That was my first question. I've got another slightly different question.

Speaker 6

Should I give it to you now or wait until after that one?

Speaker 1

Yes. Just both at once and I'll take the first one in the second. But yes, please go with the second.

Speaker 6

Okay. Great. Yes. And the other one is completely different topic. When I look at the sort of regulatory papers that are coming out at the moment from the FSB and BIS and everybody else, there seems to be about 1 a week on artificial intelligence and the sort of potential in the banking sector for huge efficiencies and huge sort of transformations in the way you do your business.

Speaker 6

And I'm just welcome your thoughts on where you are at Lloyd's in your thinking. Is it potentially going to be a big game changer like sort of digital banking was perhaps 20 years ago? Should we be thinking about a lot of cost potentially to implement that? How where are the sort of big pluses and minuses for that sort of initiative?

Speaker 1

Great. Thanks, Ed. And thanks for giving me a question as well, Steve. This is great. So look, on the first one around growth and the imperative or the focus of the Labour government around growth.

Speaker 1

I think the starting point, as you've seen, is our forecast and the basis of our plan actually assumes the GDP this year, although we upgraded it slightly, is any 0.8% growth. And then we start heading towards 1.4%, 1.7% growth in 2025, 2026. That's not in line with the labor government's objective of getting to 2.5%. So we have laid out a growth plan we think is realistic based on the current government policy and the current fiscal policy. We'll have to see what plays out in terms of the labor government policies and whether that changes that trajectory.

Speaker 1

We think there is an opportunity, by the way, for a government to take a more proactive stance around blocking the supply side and encouraging investment in the U. K. That could enable that. It's not going to be in the 1st 6 or 12 months, it makes a difference obviously. But we do think there's an opportunity to beat that.

Speaker 1

But obviously, our forecast is based on what we can see today. In terms of our own growth and then balance sheet, I think about it in a couple of ways. The first thing is our baseline does have some core growth in AIA. We haven't given you specific guidance obviously beyond 2024. But I think what you've see this quarter around the kind of growth we can achieve when markets are returning to more stability is a good example of the trust we have in the VoIP Banking Group business and the broad based growth we can achieve.

Speaker 1

That was both across our CIB businesses and then our full consumer businesses. So we do have that growth built in and that is even with the capital return and the ROE that we're expecting in 20 26. If growth were to be faster, it does depend on where it comes from. And of course, as you know, when you talk about a lot of the investment in infrastructure growth the U. K.

Speaker 1

Needs, it's going to be in some of that longer term patient capital and it's going to be in areas like the energy transition, building out housing, infrastructure, etcetera. Some of that can be bank based lending. But we have some of the leading structures and especially ESG structuring teams in the UK focused on those sectors where most of the investment needs to go. And often we do that through, obviously, debt financing, debt capital markets. We're a leading structure on behalf of insurance companies.

Speaker 1

You've just seen the announcement this week around Oaktree. We are a source or a destination for private credit companies to come and say how can you help us use your expertise to originate assets. And so we see that as a really exciting area both for our CIB business, but also the right way to think about supporting some of this growth because it needs long term patient capital with the right cost of equity and the right liquidity profile underpinning that. And the great news is that we start as the leader in the U. K.

Speaker 1

On many of those sectors and we already have strong relationships. So I think if that's where the growth comes, it doesn't have to be just bank balance sheet based. In fact, I think if it were just bank balance sheet based, we wouldn't get the right return profiles for those sectors and for those industries. So that's a really important part of this. I suppose the third thing, and William you might have commented on this, but if we see our ability to grow our core retail and SME franchises faster than it is in our plan, they are accretive businesses and we'll always look to take economically positive growth for our shareholders if we can see it because we know that builds long term sustainable returns.

Speaker 1

And if we see that coming, we'll just give you guidance going through this period. Maybe your second point, and you all know me now, I feel like I'm about start a 2 hour lecture on AI because I'm very passionate about this topic. So maybe just a couple of thoughts. Look, the first thing is we're already a leader in the context of financial services. We have over 800 AI models.

Speaker 1

Most of them aren't generative AI, but they are AI models that we're using to make better decisions, optimize the efficiency of the way we manage the bank today, to manage risk better. And we've been doing that for a long period of time. And in the last two and a half years in the period of this strategy, William and I have been making sure we're now investing in and leapfrogging into some of the data and technology capabilities that really will enable us to use AI at the next level. So we're already a leader and it's already driving significant impact for shareholders, as I say, across things like risk management, efficiency, our ability to meet needs. And we definitely see that as part of the continued next 2 or 3 years.

Speaker 1

And that is part of the investment we've been making. I won't unless you want me to jump into about specific technologies. Generative AI is an additional opportunity for better services to customers, better risk management, better efficiency in terms of how we serve customers. We're already piloting those and we've had some good case studies and impact around bringing generative AI tools to support our colleagues and make better decisions faster and more efficiently. And we're seeing some good lift, right, in different areas, customer servicing, our own coding team.

Speaker 1

And we definitely think that provides additional opportunities over the next few years. One thing I'd say is, I think like all technologies, I've been 32 years doing this since the early 90s. And from day 1 been totally disrupting and building better efficiency around banking and financial services from day 1, started on the trading floors in the 1990s. All of these adoption curves don't happen overnight. It's going to take a few years for this to really be used generative AI that is on top of the existing AI tools.

Speaker 1

And I do think it provides an exciting opportunity for the industry over the 3 to 5 year time period. I think what you should be looking for and what I can give you confidence about is we're already a leader in AI and we're already leading on how do we deploy the new tools to get the best outcomes for the shareholders over the medium term. So we definitely see it as an opportunity. I think it's going to probably be more about 2026 plus It really starts to make a difference. But just have the confidence we're already working on it.

Speaker 1

And is it

Speaker 2

so just

Speaker 6

to come back, so just very quickly, is it do you see it as something that can provide a source of competitive advantage? Or is it something where it's just going to be good for the industry as a whole in terms of credit risk management and costs?

Speaker 1

So I've seen some of the comments from some of the U. S. CEOs around this who say if you're not using this service, you're no longer relevant to your customers. Look, I have always believed ultimately the way we use technology will be a source of competitive advantage. And that's why, for example, our digital capabilities and the differentiated position we have on customer engagement, use of digital and data is already differentiating.

Speaker 1

Just give you one tangible thing, why do I think we're doing better than other high street banks around our core deposits and our relationship banking? I think it's because of our digital engagement services and relevance of our services. So I think it is differentiating. How we use generative AI directly with customers needs a bit of development because there are risks about it. And obviously, the regulatory context is going to have to develop for how we use it.

Speaker 1

So I think the initial application of it will be around efficiency, making better risk decisions, which are guided by people and some enhancement around customer service. I think in that kind of 3 to 5 year time period, it could start to really improve how you serve customers and differentiate the service and therefore gain more market share, if you like, for the businesses that are winners in that segment. And we're obviously going to be thinking that way and are piloting things in that context. So short term, probably more about support for doing what we do to stay better, managing risk better and being more efficient. I do think that this medium term piece and maybe we've just done our full seminars.

Speaker 1

As we think about what we do next, we should just highlight some of those examples. I think around guided online advice in the wealth space, it's a really good example. So maybe we'll bring that back in one of the next set of seminars that we haven't yet committed to. So I'm looking at my team with a smile. If that's okay, we'll

Speaker 6

Perfect. Thanks very much.

Operator

Thank you. Our next caller is Joseph Dickerson from Jefferies. Your line is now unmuted. Please go

Speaker 7

ahead. Hi, thank you. Just back to the on the ground, Another question just on the margin outlook, I guess. I mean, one thing that's really stood out is that if you look at the your retail unsecured, the car, the motor finance, you've grown those 3 segments on the balance sheet by $2,700,000,000 and they're currently at a 5.50 basis points margin. You've had a neutral hedge impact in Q2 following the maturity yield issues that you flagged at Q1, but this looks like it's going to turn and you highlighted on Slide 17 that the contribution this year is going to be a little more than $700,000,000 plus you've got some funding benefits.

Speaker 7

So I guess if you're relatively consistent on the mortgage headwind and what's happening on deposits, is there any reason why the Q2 NIM won't be the lowest for the year? Thank you.

Speaker 2

Thanks for the question, Joe. Just to comment on what are 2 of those component parts you've been through there. Perhaps starting off before that with the overall reiteration really of the guidance greater than $290,000,000 for the full year and indeed the turn before the year end to a positive trajectory. I'll come back to that in just a second. You mentioned that consumer finance is the first of your component parts.

Speaker 2

And effectively, what we've seen within consumer finance is a couple of things going on. One is decent growth in balances. You've seen it's kind of circa $500,000,000 for the quarter to quarter 2 for the cards business, for the personal loans business and so forth. And those are in relatively high margin parts of the book, so that is net beneficial. At the same time, if you look at it over a temporal period, the margins have come in a little bit for 1 or 2 of those areas.

Speaker 2

And that's mainly because funding costs have been going up and we haven't passed on all of those funding costs to customers. So a little bit of margin compression there. But as we look forward, that is easing up a little bit. That is a source of pressure, is easing up a little bit on the margin going forward. So consumer finance is playing its part, in short, in the margin as we look forward.

Speaker 2

The second, the structural hedge, as you say, we were kind of in abeyance really for quarter 2. We flagged it at quarter 1. The quarter 2 contribution from the hedge would not be terribly much. That's simply a function of the impact of maturities within the hedge and the yield that the maturing hedges come off at as well as any pre hedging that we might have put on to manage duration and the yield of those. So that combination is what's led to the hedge being pretty static in Q2.

Speaker 2

But as I mentioned earlier on, our expectation is the hedge picks up significantly in the second half and goes, as I say, considerable way to offsetting the headwinds that I mentioned in respect to deposits and in respect of margin in respect of mortgages. So overall, the structural hedge makes a much more significant contribution in the second half of this year. You asked about timing in terms of the turn of the margin, Joe. I'd make 2 comments really. One is to revert to the earlier points where I went through the headwinds and the tailwinds as we see them for the second half of this year.

Speaker 2

I shall repeat that. The second is, clearly, you can see based on the flattening of the Q1 into Q2 margin, we are getting very close to the turn. Which precise day of the week the turn happens on is going to be a function of customer behavior, it's going to be a function of rates, it's going to be a function of competitive pricing and the like. But we have complete confidence as said in greater than 290 and indeed the turn before the year end. And again, in that context, I'll just repeat the earlier point that I made, which is in this context, it's reasonable to expect net interest income to turn before the margin.

Speaker 2

And that's based on all the guidance that you have out there as to net interest margin, as to AIA, that's the non banking net interest income. We would expect that modest progress in H2 NII. So the margin is going to turn. We're not calling the precise day of the week in which it happens right now because of the uncertainties that I mentioned just a second ago, Joe. But it is going to turn.

Speaker 2

And alongside of that, in fact, in advance of that, we expect LNI to turn.

Speaker 7

Thanks, thanks. Can I just confirm the full year guidance is still using a 4.5% base rate?

Speaker 2

The full year guidance is expecting 2 cuts in base rate this year, which takes it down to 4.75%, not 4.5%. 4.75%. Okay. Great. Thank you.

Speaker 2

Thanks.

Operator

Thank you. Our next caller is Guy Stebbings from Exane BNP. Your line is now unmuted. Please go ahead.

Speaker 8

Hi, morning. Thanks for taking the questions. The first one was on asset quality and really think about the impairment charge in the medium term. We can sense that it sat around 30 basis points, a figure you've talked to historically. You've improved the guidance this year to sub-twenty basis points.

Speaker 8

I recognize that change in part reflects the more one off changes during the first half. But then even excluding those model changes, we're still running below 20 basis points in terms of experience. And that comes at a time when households and corporates have really faced some pressures. So I'm just interested if your view on medium term cost of risk is perhaps lower than 30 basis points given the experience of the last 18 months or so in particular. And then my second question was really just a couple of brief ones on NIM.

Speaker 8

On the hedge, can you talk about maturities between Q3 and Q4, just given they are quite significant on those sort of quarter to quarter NIM dynamics? And related to Jason's earlier questions on mortgage rates, I don't suppose you could tell us what the average back book spread is now on the mortgage book. Thank you.

Speaker 2

Yes. Thanks. Thanks, Guy. A couple of different questions there. First of all, asset quality.

Speaker 2

2nd of all, the hedge and then 3rd of all, the back book mortgage spread. So I'll cover each of those in turn. In terms of the cost of risk, as you say, it's been a very benign experience over the course of both Q2 and also H1. We had a 5 basis points charge, dollars 44,000,000 for Q2. We've had a $101,000,000 charge, 5 basis points again ironically for the first half, coincidentally for the first half.

Speaker 2

So very benign experience. In each of the 2

Speaker 9

Ladies and gentlemen, apologies. Please remain on line. The main speakers will be rejoining us shortly. Thank you. Ladies and gentlemen, apologies.

Speaker 9

Please remain on line. The main speaker will be rejoining us shortly. Thank you. You've been reconnected. Thank you.

Speaker 2

That's great. Hi, Joe. Apologies or Guy, sorry, apologies for the drop in the line there. Can I just confirm that we are back online with you and you can hear us?

Speaker 1

We can hear you. Thanks.

Speaker 2

Thank you, Guy. And again, apologies for that. I think I'll just start out again in answering your question, if that's all right. So I'm not quite sure where I dropped in the response. So taking a step back, as I said, the impairment experience for Q2 and also for H1 has been extremely benign.

Speaker 2

Specifically within that, the Q2 impairment charge $44,000,000 as you know, 5 basis points. The H1 impairment charge, dollars 101,000,000 also coincidentally, 5 basis points. What's going on within that? Two things. One is the observed charge has been extremely low.

Speaker 2

The observed charge, as you know, relates to the customers going through default process, customers having difficulties. We are seeing those at extremely low levels. That is augmented by very benign write off picture, very few write offs, very few flows to default and indeed improving new to arrears pictures within most of our portfolios in Q2. So that's a very benign observed charge. So that is augmented within the still within the observed charge of $176 in Q2 by the withdrawal or release of some inflationary judgment.

Speaker 2

Why do we do that? It is because the inflation happened, but the defaults that we thought might be associated with that inflation did not happen, I. E, the credit quality of the customers was more resilient than we had expected. Therefore, the inflationary judgment is being withdrawn. The second component of the impairment charge in Q2 was NES revisions.

Speaker 2

And the NES revisions gave us a credit of £132,000,000 in Q2. That was principally because of a modest change in the way in which we model the severe scenario. The severe scenario within our IFRS nine provisioning is still pretty severe. You'll see it in the context of our economic assumptions and it produces a circa 7,000,000,000 ECL associated with it. But what we have done is in recognition of the kind of evolving economic environment around us is we now have a blended demand shop and supply shop in the context of our severe modeling.

Speaker 2

What does that mean? It means that a supply shop, which has been associated with very high inflation and very high interest rates, is balanced in our severe scenario with a demand shock, which is associated with the contra of that, I. E. Low inflation and low interest rates. And it's that modeling change, which is fed into our MES in quarter 2.

Speaker 2

And as I said, it's conditioned upon the evolving environment as we see it in terms of the outside world. So stepping back for a moment, Guy, on your first question. Asset quality continues to be very benign quarter 1 going into quarter 2. Now as we look forward, two points. One is, I'm not going to give guidance on 2025.

Speaker 2

But the second is we would expect, as you can tell from our AQR revision, to be below 20 basis points for the full year. And if you look at the underlying charges that we've seen within the first half, going back to my observed charge earlier on, we've seen an observed charge of around 25 basis points averaged over the first half as a whole. That is not a bad signpost to what you might expect to see in the context of the second half of this year and in turn helps inform our less than 20 basis points AQR guidance for 2024 as a whole. How that then progresses into 2025? As said, I'm not going to give guidance in 2025, but you can see that the underlying performance of the portfolio has been pretty robust.

Speaker 2

And at the moment, at least, we're not seeing any signs that is about to change. Second question, in terms of the Q3, Q4 structural hedge movements and the maturities and so forth in respect of that. I'll just give you some guidance for the second half of the year in respect to the structural hedge, which is that we're expecting about $20,000,000,000 of maturities. That obviously ticks up, it's more like €40,000,000,000 of maturities in the context of 2025, but it's €20,000,000,000 for the remainder of this year. The slight word of caution I would apply there, guys, as you interpret that, bear in mind that the maturities will be coming off and indeed the refinancing going on at various different yields at any given moment.

Speaker 2

So there's some numbers behind that that are required to build a full picture. But I think, bearing in mind my earlier comments, if you consider those, we do expect the structural hedge to play a much more significant part in development of the margin Q3 and Q4. And that's the right context to look at that $20,000,000,000 of maturities in. Final question, Guy, in respect to the mortgages. As I said earlier on, we've seen maturity yields on those mortgages are rolling off the balance sheet at 110.

Speaker 2

I know that's not exactly your question. Your question is about the yield on the back book. The yield on the back book as we stand today is around 1%. It's going to be about that on a going forward basis. And so hopefully that gives you the answer that you need in respect to the back book.

Speaker 2

That's all very helpful. Can I just check

Speaker 8

on that last one? Would that be ex SVR or including SVR, the 1%?

Speaker 2

That number that I've given you is the total book of mortgages, Guy. So it's 1% for the €307,000,000,000 of mortgages that we have based on where we are today. The SVR is obviously going to be marginally higher than that. I don't think we disclosed the SVR yield, but you can see it in the context of our publications and public information.

Speaker 1

And William, as you said earlier, as you said earlier, the mortgage headwind we think as we get towards 2026, the front book back book becomes no longer a headwind to us.

Speaker 2

Yes. Yes.

Speaker 1

And that guidance helps the back book from book pricing assumptions. Thanks, guys. Thank you.

Operator

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

Speaker 10

Good morning. Thanks for taking my questions. I just wanted to briefly a little bit on the full year guidance. I guess, firstly, with respect to NIM and second average interest earning assets. So on the NIM, just to follow-up on Joe's point earlier, you talk about mortgage and deposit trends being as expected.

Speaker 10

You've seen good growth in Metro and Card. Structural hedge is now expected to contribute more than 700 for around 700 and you're only assuming 2 cuts now rather than 3. So that all sounds quite positive and yet your full year guidance is unchanged on NIM. So what's the offsetting negative? And similarly on average in standing assets, you're at $449,000,000 Your guidance is greater than $450,000,000 for the full year.

Speaker 10

You've just done $5,000,000,000 Q on Q ex the securitization for 50, why has that been reiterated? Thank you.

Speaker 2

Thanks, Andrew. The I'll perhaps take each of those and then Charlie may wish to add, particularly in respect to AIA's. In respect of net interest margin, your question is effectively why are we not increasing guidance today. Let me just put a bit of context around that. The guidance today, as I said, is greater than 290, right?

Speaker 2

I just underline that point, greater than 290. We feel very comfortable. In fact, per my comments earlier on in my script, we feel more confident now around that guidance than we did at the start of the year. So we're feeling very comfortable with that. And again, great than $290,000,000 We also continue to feel very comfortable with the guidance around the turn of the margin before year end.

Speaker 2

We're just not calling out precisely which day the weekend is going to happen on. So why is that to your question, Andrew? When we look at the year as a whole and it's developed so far, we've clearly seen some things turn out pretty much as we expected. The macro more or less as we expected, the direction of deposit churn more or less as we expected, refinancing in mortgages, again, more or less as we expected. We've also, to your question, Andrew, seen some developments that are more positive, more constructive than we had expected.

Speaker 2

We talked a bit about PCA balances being a little bit better than expected in my comments earlier on. We talked about the rate environment that was in your question being a bit higher than expected. And likewise, we've had the bank levy change. At the same time, we consistently pointed out, including in Q1, there are 1 or 2 developments that have been more balanced, frankly. So, BCB, non interest bearing current accounts, for example, have been a touch more of a headwind than we have expected.

Speaker 2

To a degree, in the rate environment that we've seen, augmented by the prompts and customer retention that we paid, the SBR book in the mortgage business has come off perhaps a little bit more than we had expected, not huge, but perhaps a little bit more than expected. So those are the balancing factors, Andrew, in response to your question. But overall, where does that lead us? That leads us to feel, as I said, very comfortable, in fact, very confident with greater than 290 as the margin guidance, very confident in the point that I made earlier on is that we expect to see progress in H2 NII over H1 NII I'm very confident in the development of the margin on a positive trajectory before the end of the year, and we'll call out precisely when as we see the Q3 develop and obviously come back to you accordingly. Your second question, AIA, Andrew.

Speaker 2

We feel very comfortable actually with our guidance of greater than $450,000,000 for AIA. Why do we feel comfortable with that? Look at the lending developments over the course of quarter 2. We've had lending developments of £3,900,000,000 adding back the securitization, it's over £4,000,000,000 dollars of lending predominantly back end loaded. So if you look at our $449,400,000,000 I think it is, AIA in quarter 2, Those are not really being influenced by the lending that we saw in quarter 2, but of course, Q3 and Q4 will be.

Speaker 2

That's one reason. The second reason is we've seen not just those lending developments in Q2, but we expect to see continued positive lending developments in Q3 and Q4. And that will be across the business. It will be across the retail business, obviously mortgages, but also the unsecured books, likewise motor. It will also be across good parts of the commercial business.

Speaker 2

And so in that context, Andrew, our AIA view is very firmly in 4.50. Again, consistent with the guidance we've been giving all year, you don't see it so much in the AIA numbers of Q2. You should expect to see it in Q3 and Q4. Charlie, anything else you want to add on lending?

Speaker 1

Well, just on lending and actually on SME deposits. I think the other thing you can imagine we are very focused on is just understanding our market shares and whether customers are choosing to bank with us. On SME cash flows and deposits, what you've seen in the industry, as you know, is they have been smaller than actually we all expected. And in that context, we've actually grown our market share of SME deposits. So but it is a good indication of we can't get everything right in terms of our projections even when the market is smaller than we think.

Speaker 1

You can trust us to be really focused on whether customers are choosing us and whether we're competing well. And that's also true in mortgages. I think just stepping back on both of these, and I understand I think the question is really why didn't you take a positive upgrade on both of these? Our guidance, we're very comfortable with. The gray span is important in this context.

Speaker 1

And actually, you're just talking at a macro level here of, I think, a couple of basis points and a couple of 1,000,000,000 on numbers which we've given really quite clear guidance on. So as William said, we're comfortable with the guidance. I'm going to say very focused with William and the team on actually winning the trust of our customers in these businesses. We know there can be quite significant swings in the market and the volumes in the market. And from my perspective, it's good that we can stay committed to our guidance that we gave at the start of the year.

Speaker 1

Thanks, Andrew.

Speaker 10

Very clear message. Thank you.

Speaker 2

Thanks, Henry.

Operator

Thank you. Our next caller is Chris Cann from Autonomous. Your line is now unmuted. Please go ahead.

Speaker 11

Good morning, Bo. Thanks for taking my questions. I had one on NII, please, and then one on operating lease depreciation. On NII, obviously discussed very extensively this morning. I guess, cutting to the chase, you've indicated modest half on half growth.

Speaker 11

I think the current consensus is looking for about 3% half on half growth. Is that consistent with your view of what modest means in your own sort of lexicon, if it were? And then on operating lease depreciation, obviously, this has been a source of kind of ongoing misses for several quarters now. Just keen to get a bit more insight into actually the underlying dynamics here. So could you give us a bit more visibility on the composition of the current fleet?

Speaker 11

How much of the fleet is electric vehicles versus ICE? And what's the sort of sensitivity you would encourage us to think about in terms of potential further residual value provisions? So I think it's about 10% move in the first half. So is it sort of €100,000,000 if there's a further 10% fall, we should assume another top up or is that too simplistic? Thank you.

Speaker 2

Thanks, Chris. I'll take both of those two questions and hopefully address your queries. First of all, in respect of NII, you repeated my words obviously a modest tick up in NII in the second half over the first progress in that respect. I'm not going to comment on consensus numbers. So I'm going to answer your question directly in that respect.

Speaker 2

But hopefully, what we've given you in the context of the AIA debt interest margin and indeed non banking net interest income guidance, which is pretty comprehensive, gives you enough to work from. Op lease depreciation, Chris, it's an entirely fair question. When we look at Op Lease appreciation, it might be worth just stepping back for a moment and saying what do we do in the car finance area. First of all, as you know, car finance is an absolute part of the UK economy. Circa 85% of customers use car finance when they buy new cars.

Speaker 2

That means there is a significant market, which is going to grow as we look forward. We participate in that car finance business in 2 respects. 1 is a leasing business and 1 is a financing business. The financing business, 1st of all, as you know, trades under the Black Horse name. It's a conventional financing business.

Speaker 2

Income comes in through net interest income. Any impairments go through the impairments line. The leasing business, which is Lex Auto 1 and Tuskot 2, the income comes in through the other operating income line and the charge, if you like, or the depreciation comes through the op lease depreciation line. When we see when we execute on the leasing business, we have, as you know, the obligation to take the vehicle back at the end of the term, which means that we then set aside a residual value expectation against that vehicle and depreciate the automobile against that residual expectation. If the residual value expectation changes, so does our depreciation schedule.

Speaker 2

What that means is in times of used car strength, we will actually get some benefit from that and that has been the experience, as you know, since 2020. We've been significant net beneficiaries from strength in used car prices, which in turn has come through the P and L to the benefit of shareholders. From time to time, we see also see car price weakness. And over the last 6 months, we've seen weakness in particular in electric vehicles. And so that causes us to revise down the residual values to revise up the additional appreciation and accordingly take an adjustment of the type that we saw in quarter 2.

Speaker 2

Now a couple of questions a couple of points to follow on with there, Chris. In terms of the implications of that property depreciation going forward, the combination of fleet growth within the business plus the revised additional depreciation schedules that I just mentioned are going to mean that our lease depreciation in quarter 3 quarter 4 is going to be a touch above $300,000,000 While we're going to be above that, as said, so two factors that I just mentioned. And as you look forward, you should expect the business growth to contribute to that number growing over time. But that's what you would expect in the context of other income growth that comes with that. As you would expect, we hope for that business to grow.

Speaker 2

It's certainly an important part of our strategy. And likewise, charge and not lease depreciation will grow as other operating income grows. That's one point. 2nd point, you asked about sensitivity. The residual value exposure within the business across the Black Horse business and across Lex Auto and across Tuskar in total, and we disclosed this number, residual value is around $10,500,000,000 $10,400,000,000 to be precise.

Speaker 2

The operating lease part or component of that residual value is 4,700,000,000 dollars That's relating to Tuscar and it's relating to Lex. Now within the operating lease business, partly because a lot of it is company linked, that is a more electric vehicle heavy part of the business. So to give you some idea, just the 50% of the RV exposure within Lex and Tuskr is electric vehicle linked. To come to your question, what type of sensitivity do we have or exposure do we have for those electric vehicle prices going forward? The schedules for operating lease appreciation that I mentioned just a second ago, either touch about $300,000,000 or Q3 and beyond, they incorporate a further circa 7% reduction fall in electric vehicle prices over the course of 2024 and then a further 2% to 3% fall over the course of 2025.

Speaker 2

The internal combustion engine equivalent of that is around 2% to 3% for 2024 and a further 2% to 3% for 2025. So you can see in terms of the indications that we're giving for operating lease depreciation in quarter 3 and beyond, we are taking into account some further buffer for expected electric vehicle price reductions during that time. Final point, Chris, which I would emphasize is we are now seeing the operating costs of an internal combustion engine and electric vehicle engine basically come into equilibrium. In fact, it might even be cheaper to operate an electric vehicle today than it is to operate an internal combustion engine. That in turn should lead to some stability in prices.

Speaker 2

Let's see, I'm not forecasting it as such, but let's see. It should be an ingredient, if you like, for stability of prices. In that context, because of the residual value exposure within the leasing business, we are also exposed to the upside of that business. Now if we see it, that will obviously be of net benefit to shareholders. Again, I'm not forecasting it.

Speaker 2

It's not in our additional depreciation expectations, Chris, but it has happened before. It happened in the period between 2020 to 2023. So I just want to land on that or rather end on that point, if you like. This exposure goes both ways.

Speaker 1

Liam, I'm not going to jump in too much on that, but just one thought, Chris. Liam and I are highly aware that the volatility for this line isn't something that the shareholders have appreciated. So we are taking some actions at the moment. We're not going to give you specifics today on ways we can mitigate that volatility going forward. So we'll come forward back with some of the things we've done, but we are aware that the facility isn't really what you want to see and we're going to make sure we can see if there's any ways of mitigating that going forward.

Speaker 1

But the returns on this business are good. Thank you.

Operator

As you know, this call is scheduled for 90 minutes. We've now reached the end of the allotted time. So this will be the last question we have this morning. If you have any further questions, please contact the Lloyd's Investor Relations team. Our final caller is Amit Goel from Mediobanca.

Operator

Your line is now unmuted. Please go ahead.

Speaker 9

Hi. Thank you. And thanks for taking my question. So really just one clarification on NIM. I appreciate you don't really want to say exactly when you expect it to turn.

Speaker 9

But just wanted to get a sense of making sure I understand it correctly. So would you expect the Q4 NIM in aggregate to be better than the Q3 NIM? Or are we saying that you expect the exit rate at some point in this year to pick up? And then secondly, just a follow on the operating lease depreciation. Just maybe just the market is a bit different now, but just curious if you were to use depreciation curves from back in 2000, how different it looks now and what kind of order of impact could all of there be?

Speaker 9

Thank you.

Speaker 2

Thank you, Whit. Why don't I take those questions and maybe that Charlie wants to add before finishing up. In respect of your net interest margin question, as your question implies and hopefully as my comments have implied through the course of the session this morning, in short, we would expect the net interest margin to be better in Q4 than Q3. That is not predicting anything about the Q2 to Q3 shape, which I've obviously given you commentary on during the course of this call. But by its very nature, the evolution of the deposit churn picture, the evolution of the structural hedge picture, to a degree at least, the evolution of the mortgage picture, although I said that that will be stable through the course second half and I'll repeat that.

Speaker 2

But that combination naturally leads to the strengthening of the margin over the course of this year. So that's that question, Amit. The second question on lease depreciation. Depreciation curve has naturally changed since previous years. The one point that I would make there is a couple of things going on in our business.

Speaker 2

One is used car prices. We talked a bit about that. 2 is the evolution of car prices themselves. Car prices are up around 50% over the course of the last 5 years or so. So naturally, for any given size of fleet, you're going to get higher operating lease depreciation charge.

Speaker 2

And then the 3rd component is obviously the growth of our fleet itself. This, as I said earlier on, is a growth driver for the business, and we expect it to continue to be so. And that's a factor that leads into the Opdivis depreciation charge. But at the same time, I mean, there are 2 points to bear in mind there. One is that, that is a contributor.

Speaker 2

That business is a contributor to the significant growth that we have seen in other operating income, half on half other operating income as a whole, up 8% quarter on quarter, year on year that is, up 9%. So that's a significant driver of other operating income growth alongside businesses elsewhere in retail businesses and commercial businesses and IT and I. And the final point and it is just to underline the point that Charlie made. The Automobile Finance business is a very attractive, profitable and growing business. Charlie, anything you want to add?

Speaker 1

Well, just a couple of things because it's I'd love to talk about the business a bit more. As you said, William, the great thing here is we're operating at kind of 17% market share. So we just have a very, very extensive set of data across the whole industry, both on new cars and secondhand car prices. And when you look at the way you're talking about how was the depreciation curves changed since 2000, as William said at the aggregate level, we see a significant increase in the secondhand car prices, especially in ICE vehicles. It actually differs quite significantly by vehicle.

Speaker 1

And so we have a really distinctive competitive advantage around understanding around individual vehicles appreciation schedules, what customers do and don't want. And then every time we set prices for our operating leases, we can learn of what's happened in the previous weeks, quarters and months. So that's why it's hard for us to give you sensitivity as Chris asked because if we learn that a specific vehicle type is depreciating faster, we'll actually price the operating lease to incorporate that expectation. And we have the best leadership team in the market making those kinds of judgments and assessments, which is why I share confidence around the ability for us to manage this risk going forward.

Speaker 2

Thank you, Ernest. I think we are through with the call today. I'd just like to say thank you to everybody for taking the time to join. Your interest is much appreciated, and we wish you a good summer.

Speaker 1

Thanks, April.

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 Q2 2024
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