Lloyds Banking Group PLC (LYG) 2010 Q2 法說會逐字稿

Welcome to the Lloyds Banking Group interim results conference call. Hosting the call will be Tim Tookey, Group Finance Director; Kate O'Neill, Managing Director, Investor Relations; and Michael Oliver, Director of Investor Relations. Following the formal comments, you will have the opportunity to ask questions. You may now begin.

Well, thank you for that, and, hello, everybody, and thank you for joining today's conference call. Now I'm aware that a number of you might have attended or listened into our results presentation this morning, but for the benefit of our US investors, I will cover all of the key issues on this call.

I'm very pleased to be presenting a robust set of results, which demonstrated the underlying momentum that we are delivering in our business, and I will provide details on the key numbers. On top of that, I want to share with you our views of the future shape of the Group, which will be supported by our increasing strength in the key disciplines of capital and funding.

In the first half, we demonstrated our core business is in good shape, with a strong trading performance against the backdrop of a stabilizing economy. The group delivered resilient revenues, a strong cost performance, and a significant reduction in impairments. In addition, we've continued to make excellent progress in the integration of HBOS. And all of this has contributed to the acceleration of the Group's return to profitability.

Looking at our business performance in a bit more detail, well we delivered good revenue growth of 5% driven by margin expansion, and excellent cost control with expenses down 5%. Impairment losses were half those of the same period last year and much lower than the charges in the second half of 2009, and this is significantly ahead of our February guidance. The reductions principally come from our Wholesale and Retail divisions, but all divisions are showing strong trends.

It's good to be back in profit, of course, and we are pleased with the profit before tax of GBP1.6 billion in the first half compared to the loss of nearly GBP4 billion last time.

Our core Tier 1 ratio has significantly increased to 9%, driven by benefits of lower risk-weighted assets, and the generation of core Tier 1 capital through a number of liability management transactions.

Looking at our margin, well the net interest margin rose strongly to 2.08% as higher asset pricing more than offset the impact of lower deposit margins and a 5% reduction in average interest earning assets. Asset margins benefited as pricing better reflected the real cost of funding and risk, and as funding spreads normalized. In all businesses, the continued returns for appropriate pricing for risk and lending duration, together with a more stable LIBOR to base rate spread, resulted in a strong increase in net interest margin.

We continue to see prospects for margin expansion in the future, alongside asset pricing gains, slow but steady base rate rises, which will eventually feed into wider liability margins, and of course, an assumption of stability in wholesale funding markets. And overall, we believe that the margin is likely to return to more than 2.5% by 2014.

Moving on to costs, well they're down 5% with strong cost management and integration delivery, and we've seen a continued improvement in cost efficiency with a further reduction of the Group's cost income ratio by 440 basis points to 43.5%, which is equivalent to 45.1% if I were to exclude liability management gains.

We're delighted with progress made on cost synergies, and we are firmly on track to deliver GBP2 billion per annum of cost synergies and other operating efficiencies by the end of next year. With further cost savings for the integration programs to come through and further improvements in efficiency thereafter, we're working towards operating at a cost income ratio of about 40% by 2014.

Now, let me update you on impairments. Well, impairment losses have halved since the first half of last year, and they are materially lower than the charges in the second half of 2009. And as we all know, these reductions are significantly ahead of our February guidance.

In Retail, impairment losses were materially down, particularly reflecting prudent risk management, stabilizing house prices, and the benefit of continued low interest rates.

We saw an improvement in credit performance, both in the secured and unsecured portfolios. And these improvements have come through somewhat quicker than we had expected at the year end.

The Wholesale charge from impairment losses also fell significantly, to just under GBP3 billion. And the decrease reflects the stabilizing economic environment with particular reductions in commercial real estate losses and the material slowdown in the value and volume of newly impaired loans.

In Wealth and International, impairment charges were down 15% on the charge in the second half of last year, but the level of losses continues to be dominated by the economic environment in Ireland.

So let me just talk briefly about what these things look like going forwards. Well, we expect to see modest improvements in retail impairment charges in the second half of 2010 compared to the first half. And next year, and as the UK economic environment gradually improves, further improvements will be delivered, but at a significantly slower rate than this year.

In Wholesale, we expect the volume of underlying impairment losses from traditional trading and manufacturing businesses to increase this year, as the full effect of slower economic growth filters into business insolvencies and asset values. However, the effects of this are significantly less than the benefits of lower absolute impairments from the commercial real estate and real estate-related portfolios that we saw last year.

For Wealth and International, we continue to believe that the impairment charge peaked in the second half of last year, although economic conditions continue to be monitored closely. Overall, therefore, we expect Group impairments to be moderately lower in the second half of this year, but, that they will continue to improve thereafter.

I'd now like to move on to talk about our balance sheet, the progress made in asset reduction, and the strengthening of our capital base.

Firstly, then, asset reduction, well, looking at the assets in our banking businesses, we've continued to book good progress on the reductions that we achieved last year. In this half, we've achieved a GBP23 billion reduction in assets whilst maintaining our support for core businesses and core customers, while overall asset levels were flat as new lending fully offset customer repayments.

Last year, we set out our strategy to reduce non-relationship assets by some GBP200 billion by the end of 2014. And it continues to be our intention to manage these assets for value, and, given the current economic climate, our primary focus remains on running these assets down over time.

The overall balance sheet reduction will provide the group with increased optionality and flexibility for the resultant releases in both funding and capital. And over time, this will facilitate further reductions in Wholesale funding, the repayments of governments and central bank facilities, and, of course, provide substantial capacity for core business growth.

Let me move on now to risk weighted assets and capital. Well, risk weighted assets are reduced 6% as a consequence of the balance sheet reductions that I've just spoken about, but lower risk mix of the loan portfolio and the generally improving credit outlook. Over the medium term, we expect to see further reductions in risk weighted assets as a result of both balance sheet asset reductions and a positive post-cyclical impact from the expected improvement in the UK economic environment.

The Group's capital ratios have increased significantly with our total capital ratio at 13.4%, a Tier 1 ratio now at 10.3%, and perhaps most importantly these days, our core Tier 1 ratio of 9%.

The Group has a strong capital base and is in a solid position to deal with what are constantly changing regulatory capital requirements. But putting all our guidance together, we expect capital and capital ratios to strengthen materially over the medium term.

Let's now look at our funding and liquidity. We've successfully continued to reduce the absolute level of Wholesale funding and our reliance on short-term funding, whilst growing our base of high-quality, relationship-based customer deposits.

We're maintaining a substantial, high-quality primary liquid asset buffer, the majority of which is cash held at central banks, and we have substantially reduced our government and central bank funding support.

Drawing on a very diverse range of funding sources, we've successfully completed GBP18 billion of public term issuance this year against a plan of GBP20 billion to GBP25 billion for the year. And we are planning to continue to reduce our wholesale funding whilst reinvesting in our core business franchises. The flexibility that we have created is exactly in line with our previous guidance. And over the next four years, we expect to achieve further significant reductions in the Group's Wholesale funding requirements.

Our primary liquid asset buffer has been maintained at over GBP80 billion, with over GBP50 billion of this held as cash at central banks and some GBP30 billion in AAA-rated government securities, such as gilts and US Treasuries. So this makes it a high-quality, extremely liquid portfolio. It's these primary assets that are the main focus of our liquidity management, and, of course, for the FSA's new liquidity regime, which broadly mirrors the proposed Basel III liquidity requirements, and which we have been operating to for the last couple of months.

Now let me summarize our guidance for the financial performance that we expect to achieve over the next several years. We expect to deliver 6% to 7% income growth per annum from our core business through our focus on customer relationships. We expect to grow faster than the nominal rates of growth in GDP, but we believe the range we have set out is consistent with the more conservative risk appetite you would expect from Lloyd's and our desire for lower earnings volatility through the cycle.

The rate of revenue growth across the Group that I have set out will be partially offset as we continue to run down our non-relationship assets and meet our state-owed requirements.

We expect to see our margins return to above 2.5% by 2014, more in line with historical rates. And we expect to achieve market-leading efficiency with a cost income ratio of around 40% by delivering the integration savings and maintaining our focus on positive operating leverage. This will enable us to further invest to strengthen our proposition and support future growth.

On impairments, we will continue to apply our more conservative approach to risk, which is underpinned by unparalleled customer insight. And this should result in a portfolio that settles in at a consistent 50 to 60 basis points of impairments per annum. We expect impairments to be moderately lower in the second half of this year, but they will continue to improve thereafter.

We will continue to shrink the non-relationship part of our balance sheet so that we can focus our capital on supporting customer relationships. That will allow us to reduce our capital intensity and support a loans to deposit ratio of under 140%.

We're expecting returns on equity of over 15% in the medium to longer term. And given the regulatory uncertainty, we cannot be more specific on ROEs at this stage, but we expect that we will be in the top quartile of world-class banks, and we also expect to return to a more normal dividend policy in the future.

So in summary, we've delivered on all of our promises with higher income, higher margins, lower cost of impairments, and terrific progress on integration. The capital base is stronger and the funding position is further strengthened. We set out today a lot of guidance on how this management team will build on and deliver the earnings potential of the enlarged franchise. And the guidance given today covers target margins, income growth, efficiency potential, the benefits of reducing the capital intensity of the balance sheet, and the flexibility that we are creating for core business growth. It's a great combination. But I'm going to stop there, and I would now like to open the call to questions.

(Operator Instructions). Lisa Walker, BlackRock.

First of all, thank you so much for holding the call. I just wanted to verify that the 9% core Tier 1 ratio is what is the -- that's the same calculation for the ECN trigger at 5%. Is that correct?

Lisa, hi. Yes, that's absolutely correct.

Okay.

We are still calculating our ratios under exactly the same Basel II capital regime at the time of the ECN issuance, so they are -- you are comparing apples and apples.

Okay, great. And then, can you comment just on -- I know -- you have a slide in here on the Basel announcement that came out, and it seems to have softened some of the liquidity requirements, at least the timing of it. And so, where does that leave you in a world where you're complying with an FSA requirement, but a Basel environment being less onerous?

Well, you'll be glad to know, Lisa, that we are obviously complying with all of the regulatory requirements that are in existence today, including the very significant stress testing environment that's conducted every year in the UK.

The Basel III changes that were announced I guess some 10 days ago now did make a number of changes, particularly on the liquidity pieces that you are asking about. We, like other predominantly retail banks, will probably be beneficiaries or be the main beneficiaries of the changes in the leverage ratio and the composition of the next stable funding ratio.

What they've done here is a number of changed proposals, including more flexibility over the treatment and the weighting given to quality mortgage books, and obviously we have a very substantial and high-quality mortgage book. And they have also changed some of the weightings that are applied to some retail deposits that are part of the outflow side of the equation. So overall, we, being big in mortgages and retail deposits, we are a good beneficiary of the proposed changes. But of course, everybody will benefit from the implementation being deferred until 2018, which I think is a sensible reaction from regulators as they listen to what banks want to achieve, which is a continued strong level of support for economic recoveries across Europe. And, therefore, being flexible on this I think is a very sensible approach that they've taken, but we are a beneficiary.

And the main benefit is both treatment of the mortgage book and also the weighting to the Retail deposits. Is that right?

Yes. Yes, those are the two big items on the liquidity side that help us. Also, on the capital side though, Lisa, some of the proposed changes under the original [BAU] III proposal have been significantly mitigated or diluted or eased; and on the basis of that, we will also be a beneficiary of the changes that were announced some 10 days ago.

So we've always been supportive of the direction of travel that regulators want to take capital and liquidity to making for a stronger environment. I think what they're now doing is understanding that a balance needs to be got, both as to what they are trying to achieve and given that they've said they will revert in the [autumn 1] timing, they are also understanding some of the transition arrangements. But there's a good dialogue going on between banks and regulators and treasuries and the like. So all in all, good and positive developments for us in the last couple of weeks.

Great. And one last point on -- so your insurance business, the impact on capital, that wasn't changed. Is that correct? The same applies as what we saw in December?

No, Lisa, actually there are some changes there. What was proposed in December was a full deduction of insurance from core Tier 1 capital. Obviously, we've been factoring into our plans for many years now the anticipated 50% deduction that is already part of the way the Basel II regime has been and will operate here in the UK. So for us, the impact of BAU III was looking at that additional 50%.

What the new proposals do is turn that on its head, and they say that you have a maximum amount of contribution to your core Tier 1 bases, capped at 10% from (technical difficulty) a number of things which for us would basically mean the insurance company. So this is a significant improvement for us.

And on top of that, you may have seen in our detailed announcement today that in the first half of this year, we actually repatriated some GBP2 billion of core Tier 1 capital from the Insurance group into the Banking part of the Group, and that alone is a very material mitigant against what BAU III or BAU 3.5 may eventually deliver for us.

So if it's a 10%, what's the deduction then from core Tier 1 for it?

What we would be allowed to do is include within our core Tier 1, an amount that's capped at 10%, which would relate to one's investment in insurance companies. And obviously the larger your core Tier 1 base, the larger 10% is of that number. So what we're doing is we're comparing that 10% against the impact that we were expecting, so 10% of one number of equity, basically, against what we were expecting was 50% of the insurance deduction. And the two aren't many miles apart.

So, by the time we get to whenever this comes in, in place, we now don't expect this to be particularly adverse to us. It's one of the reasons on the detailed Basel III chart that's on our Investor Relations website, you might see that I've actually -- I'm now coding this as green in terms of where Basel III has taken the direction, whereas I had it as amber when we were analyzing it back in February.

Under the strict Tier 1 capital securities, the green?

Yes.

Yes, great. Okay, fantastic. Thank you.

(Operator Instructions). Christian Hantel, WestLB Mellon Asset Management.

Thanks for holding the call. I have a quick question on funding; I'm not too sure if you already touched on it, but because I joined in a bit later. But I would be curious on your funding plans, as you seem to be pretty much on track for the full year, you already did GBP18 billion in the first half, and an additional GBP8 billion in private placement; and I would like to know if you're still looking for coming to the market issuing some benchmark sized paper? And the second part of the question would be relating to private placements. You did a lot on that in the first half, and I would like to know if you see this trend to be continued in the next year as well. Thank you.

Christian, hi. Thanks for the question. And don't worry, you didn't miss a particular comment from me on this particularly in my prepared words. So I'm very happy to give you a full answer now.

You have rightly identified from the material that we've released today that we have completed GBP18 billion of public term issuance in the first six months and GBP8 billion of raised via private placements.

Our target or goal, if you like, or range of expected issuance for the full year on the public side remains in that GBP20 billion to GBP25 billion broad category. So, even if I compared GBP18 billion against the top end of that range of GBP25 billion, we've done some three quarters-odd of our expected public term issuance for the year at 30 June. I do expect that we will probably complete the full issuance levels that we set out earlier this year, but what we will do, Christian, is maintain the pattern that you've seen us do in the first half of this year, which is access a diverse range of investors and investor types across varied and multiple geographies in different currencies, and using quite widely different structures for the raising.

You know, we've done some secured, some unsecured. We've done a variety of asset-backed type issuance, including a fair amount of RMBS during the first half. So one thing I can assure you is that we will continue to maintain a diverse range of different funding instrument issuance. And of course, we are mindful of making sure that's done at benchmark pricing, as you indicated.

And regarding the private placements, do you see this year as an exceptional that you did a lot of private placements? Or are you trying to continue this trend as well for next year, for example?

Yes, I think the GBP8 billion that we've done so far is more than we've probably expected to have done by this time of year. But I think there will always be an aspect of private placement within our plans. I think by being able to access such a range, I think it ensures that we don't -- that we continue to operate as we have done in the first half by not tapping into markets -- individual markets too regularly. I think that's very important.

One of the reasons that of course the private issuance is as high as it is, is actually we've had a number of reverse inquiries during the first half of the year, which we have responded to. And it's tremendously reassuring to find this level of investor interest in the Lloyd's name and in our issuance and in the quality of assets that are available to back some of our term issuance.

Across everything that we done so far this year, we've had an average maturity profile at issue of 5.9 years, which really is a very satisfactory position to be in. And by making sure that we are paying the appropriate pricing, we are getting a very, very strong benefit and spreading of the maturity profile of our Wholesale funding, which means that we are just further enhancing the reasonably prudent maturity profile that we had already.

Okay. And maybe an add-on question if I may. The FSA mentioned in the financial stability report that especially UK banks need to lengthen their maturity profile, as you already mentioned. So can we expect if -- in case you come to the market -- that we should expect more or longer-dated issue going to the market?

That's a very good question, Christian. We've actually done quite a lot of maturity extension already. If I wind the clock back 18 months or so, we only had about 44% of our wholesale funding had a maturity of more than one year. By half year last year, we've moved that to 47%. By year end it was at 50%. And today we're pretty much in exactly the same space; we've got about 49% in terms of maturity profile.

If you look at the quantum that we have outstanding, the absolute quantum of Wholesale funding that we've got outstanding, in the less than one year maturity space, is some GBP32 billion lower than it was 18 months ago, at the time of the HBOS acquisition, whereas the quantum of more than one year funding we have is broadly flat.

So what you can see here is us managing very prudently the maturity profile as it marches towards us, almost under the laws of gravity, by maintaining strong issuance with a good spread of different term maturities, and I said the average is about 5.9 years. So that's the long answer.

The short answer would just be for me to say yes, you can expect us to be doing more and varied term issuance going forwards as we look to manage our overall maturity profile.

Okay. Thanks very much.

(Operator Instructions). Anne McDermott, New York Life Investments.

Good morning. I have a couple of detailed questions for you. First of all, in your loans and receivables, you have almost GBP29 billion of debt securities. Could you remind me, are those the ones that were reclassified under IAS 39?

Yes, and the last part of that would be exactly those things which were moved principally by HBOS prior to our acquisition of them. They were moved when the IAS 39 window was open in, was it November 2008.

Because, actually, you will find an analysis of those if you looked at -- if you pull down the slides off the website, you will find there's a slide in the appendix that actually breaks down all of our treasury asset portfolios and breaks them down between what's in loans and advances, what's in IFS and what's classified as fair value through P&L.

I hope that will help you because we've also got then further information on what they are in terms of what's mortgage-backed or what's a CDO together with the carrying values and the average marks. And there's quite a lot of information in there that I hope you will find useful then.

I will do that. The other thing is, in looking at the loans and advances to customers that declined from year end, how much of the decline would you say was non-relationship loans that rolled off?

Basically, at a headline level, the amount of our banking balance sheet that relates to our core business is flat over the six months. So we've basically got a situation where new loans and advances to customers have been effectively offset by repayments by other customers that we've got in there.

If I had a slide that showed the overall movement of our non-core business, and what that showed is we had a GBP23 billion reduction overall, of which GBP9 billion was from our so-called treasury assets, which was primarily from those debt securities that were in the first part of your question, the remaining reduction of GBP14 billion came from our non-relationship loans and advances to customers, although I should be clear that sadly, an element of that GBP14 billion of reduction was due to impairments.

Okay. And then the other question, you had a nice increase in customer deposits from year end, but a lot of it appears to be from savings; and I know that everyone seems to be chasing the same customer. Is there an element of a sort of deposit war in the UK at this point?

No, I certainly wouldn't classify it as a deposit war. I mean there is a degree of competition out there for deposits, but I mean, I guess the evidence is in the way our margin has moved. And in the last six months, we've only taken a negative 4 basis points impact on the overall Group margin from what's happened on deposits across the whole business.

What we have seen is a growth in our relationship deposits, which are up about GBP12 billion over the six months. Whereas we saw a slight reduction in the deposits that we get through our treasury and trading desk, which give you the reduction for the overall number that you can see from the balance sheet.

The treasury and trading deposit -- they tend to be particularly rate-sensitive, very, very short-term, often even only overnight deposits from customers. So, it's nice to be in such a strong position that we were able to stand back from some pricing for those deposits because of the strength of our underlying relationship customer deposit growth in the last six months.

If you looked in the detailed Retail division disclosures, you would see that in the 12 months to June, if you can just bear with me, and I'll give you a 12-month figure, 12-month figure to June, our retail savings and deposit balances were up 5.5%, and that's notwithstanding us letting go some of the more expensive heritage HBOS deposits that we talked about in February, which we let go in the second half of last year. So relationship deposits really are performing very well indeed.

Great. Thank you so much.

Thank you, Anne. Thanks for the questions.

Thank you. And management, there are no further questions in the queue. Please proceed.

Well, look. Thank you, everybody, for dialing in, and for taking time to hear us talk about the significant progress that we're making. As ever, if you have any further questions, then please do get in touch. You know, give Kate, Michael, or anyone on the team a call because we are here to help and we would love to talk to you. Thanks very much.

Ladies and gentlemen, this concludes the conference. You may now disconnect. Thank you for using ACT Teleconference.