Lloyds Banking Group PLC (LYG) 2017 Q4 法說會逐字稿

Thank you for standing by and welcome to the Lloyds Banking Group 2017 Results and Strategic Update Fixed Income Conference Call. (Operator Instructions) Douglas Radcliffe and Toby Rougier will outline the key highlights of the results and the strategic update, which will be followed by a question-and-answer session. (Operator Instructions) I must advise you that this conference is being recorded today.

I will now hand the conference over to Douglas Radcliffe. Please go ahead.

Good afternoon, everyone, and thank you for joining this debt-focused call on the group's full year results and our strategic update. As just indicated, my name is Douglas Radcliffe, and I'm the Group Investor Relations Director. And I'm joined by Toby Rougier, who's our Group Corporate Treasurer; and Richard Shrimpton, who's Group Capital Pensions and Issuance Director. A number of you may well have dialed in to the results call and strategy update this morning. And if you did, I'm afraid I'm going to run through many of the same points again. I'll cover both the financials and the strategy, and then hand over to Toby, who will cover the balance sheet in a bit more detail. We set aside some time at the end for Q&A.

So 2017 was a landmark year for the group, with the return to full private ownership in May. We made significant strategic progress in the year and completed the second phase of our strategic journey, making great progress in creating the best customer experience, becoming simpler and more efficient and delivering sustainable growth. We have, again, delivered a strong financial performance, with improved profit and returns on both a statutory and underlying basis. And this strong financial performance, along with the continued derisking of the balance sheet, enabled the group to deliver very strong capital generation of 245 basis points. This has allowed the board to recommend a total ordinary dividend of 3.05p per share, while the board also intends to implement a share buyback of up to GBP 1 billion over the next 12 months. In total, this represents a 46% increase on total returns to shareholders versus last year.

Turning to the financials in more detail. Net income is up 5% at GBP 17.5 billion, reflecting both higher NII and other income. Net interest income was GBP 12.3 billion and up 8% with lower funding and deposit costs, again more than offsetting asset pricing pressure. The net interest margin for the year was 286 basis points, up 15 basis points.

And going forward, while we expect asset pricing to remain competitive, particularly in mortgages, for 2018, we still expect NIM to be at around 290 basis points. Other income in 2017 was GBP 6.2 billion and up 2%, with a good contribution from Lex Autolease in retail and the robust performance in commercial, offset by reduced insurance income due mainly to lower bulk annuities.

Other income also benefited from the gain on sale of VocaLink. And as previously stated, we continue to be a seller of [gilt] and have realized asset gains of around GBP 270 million in the year. Operating jaws were a positive 4%, and the group's market-leading cost-income ratio has improved further to 46.8%. Total operating costs, excluding the impact of MBNA, fell 1% year-on-year to GBP 8 billion, and our Simplification program has delivered GBP 1.4 billion of run rate savings, in line with the enhanced target we set for the end of 2017.

In terms of asset quality, our gross AQR of 28 basis points is in line with the last 2 years, and this is after a large single corporate impairment in the third and fourth quarters and the consolidation of MBNA in the second half of the year, which adds around 2 basis points to the ratio. Our net AQR is 18 basis points and reflects the expected lower levels of releases and write-backs.

Statutory profit after tax is up 41% at GBP 3.5 billion, reflecting the underlying higher profit, lower below the line charges and a lower effective tax rate. Although below the line items fell in 2017, which at GBP 1.7 billion for PPI, of which GBP 600 million was in the fourth quarter, and we are now assuming 11,000 complaints a week until the end of the time bar.

Toby will cover the balance sheet later in the call, but before this, I also want to cover the strategy announcement from earlier today. Today, we announced more than GBP 3 billion of investment over the next 3 years, a 40% increase over the last plan to deliver the scale of transformation we believe that will be necessary for us to succeed in the digital world. We've identified 4 strategic priorities focused on the financial needs and behaviors of the customer of the future, further enhancing our leading customer experience; secondly, further digitizing the group; thirdly, maximizing group capabilities; and finally, transforming ways of working.

By enhancing our leading customer experience, we want to remain the #1 digital bank in the U.K., with open banking functionality. We'll invest in our data capabilities, while remaining committed to a multichannel model and investing in refocusing our branch network on more complex needs.

Under digitizing the group, we'll continue to simplify and modernize our IT architecture, scaling customer journey transformation to cover more than 70% of our cost base compared to 12% during GSR2.

Maximizing group capabilities will deliver targeted growth and we expect to see a GBP 6 billion increase in net lending to start-ups, SMEs and mid-market clients, over 1 million additional pension customers and GBP 50 billion of asset growth in our open book financial planning and retirement propositions.

We are making our biggest ever investment in people, increasing colleague training and development by 50% to 4.4 million hours per annum. We will also adopt agile methodologies, significantly improving productivity and responsiveness. These 4 strategic initiatives will drive our transformation into a digitized, simple, low-risk, customer-focused U.K. financial services provider. The strategy outlined today will enable the group to deliver strong statutory profit growth, supported by targeted asset growth in key segments, a resilient net interest margin, lower operating costs, strong asset quality and lower remediation costs, whilst delivering strong capital generation and sustainable and superior shareholder returns.

Costs will continue to be a competitive advantage as we deliver market-leading efficiency. We expect operating costs to be less than GBP 8 billion in 2020. We also expect to achieve a cost/income ratio in the low 40s as we exit 2020, including future remediation costs. We continue to expect improvements in the cost/income ratio every year.

Asset quality remains strong. And given our low-risk business model and the significant derisking in recent years, we now expect an asset quality ratio of around 35 basis points through the cycle and less than 30 basis points through the plan period. We expect an improved return on tangible equity of 14% to 15% from 2019 on a higher CET1 capital base of circa 13% plus a management buffer of around 1%.

Capital generation is expected to remain strong, with 170 to 200 basis points of capital generation per year, pre-dividend. And as a result, we expect to deliver progressive and sustainable ordinary dividends, whilst maintaining the flexibility to return surplus capital to shareholders.

I will now hand over to Toby, who will cover the balance sheet in more detail.

Thank you, Douglas. Good afternoon, everyone, and good morning to those dialing in from North America. As Douglas has provided an overview of the full year results and our strategic update, which we announced today, I'll provide some further detail on the group's balance sheet covering our capital funding and liquidity positions. I'll also outline the progress we have made on ring-fencing and, finally, I'll update you on our issuance plans for this year.

The group's balance sheet remains strong with steady growth in customer balances. Loans and advances increased by 1% to GBP 456 billion following the acquisition of MBNA and continued growth in our targeted segments. Customer deposits increased by a similar number to GBP 416 billion. The group continues to be strongly capitalized, with an improved CET1 ratio of 15.5% at year-end precapital distribution. The group also remained strongly capital generative, generating a net 245 basis points of CET1 in 2017.

To break this down a bit further, this comprised around 250 basis points of underlying generation, including the insurance dividend, with a further 80 basis points coming from a reduction in RWAs and 40 basis points from market and other movements including pensions. Against this, there was 120 basis points of conduct provisioning, which Douglas covered.

Looking ahead, we expect to remain highly capital generative, generating between 170 and 200 basis points of capital each year. We'll also provided an update on our capital requirements as part of our year-end results. In the light of the increase in our Pillar 2A requirements, the introduction of the U.K. countercyclical buffer later this year and the systemic risk buffer in 2019, the board's view of the level of CET1 capital required is now circa 13% plus a management buffer of around 1%.

On the leverage ratio, the group's U.K. leverage ratio at the year-end stood at 5.4% on a pro forma basis, which was broadly unchanged on the half year and well in excess of current minimum requirements. Our total capital ratio also remains strong at 21.2%, which provides a good basis from which to build our MREL buffer.

And so in summary, on capital, the group remains highly capital generative and continues to maintain healthy capital ratios.

Turning then to funding and liquidity. We continue to maintain a strong and prudent funding and liquidity profile. The group's LCR ratio was 127% at the year-end and the group continues to fund its balance sheet predominantly through customer deposits, with a loan-to-deposit ratio that has remained broadly stable at 110% during the year. We have around GBP 121 billion of LCR-eligible liquid assets, roughly the same as a year ago given the stability of our balance sheet.

To give this some context, our liquid assets represent over 8x our money market funding and exceed our total wholesale funding, providing the group with a substantial buffer in any stress scenario.

On wholesale funding, the volume of outstanding issuance decreased by about GBP 10 billion last year to around GBP 100 billion. This was, in part, a result of using the Bank of England's term funding scheme, and we had drawn our full allocation of TFS by the end of 2017. Over the course of 2017, we raised around GBP 10 billion in new wholesale funding across a variety of products and geographies. A significant proportion of this was eligible for inclusion in our MREL buffer, and our transitional MREL ratio at the year-end was just under 26%.

As a reminder, we expect our interim MREL requirement to be in the high 20s and are, therefore, well on track to meet this. We will continue to do this organically, mainly through refinancing opco debt as it matures.

For 2018, our wholesale funding requirement returns to a more normalized level and is in the region of GBP 15 billion to GBP 20 billion over the year. We've done about GBP 4 billion year-to-date, of which around GBP 3 billion is MREL-eligible. During the remainder of the year, we'll continue to maintain the diversity of our funding program, building MREL gradually and maintaining strong capital ratios.

As you have seen, the group's strong capital and funding position has been recognized by the rating agencies during 2017. Moody's upgraded the long-term rating of Lloyds Bank to AA3, and S&P improved the outlook for Lloyds Bank to positive to reflect the group's improved ALAC position.

And finally, some comments on our ring-fencing plans and preparations. Now the group's ring-fencing plans haven't changed. They continue to be relatively straightforward. So as a reminder, the vast majority, over 95%, of our customer lending will remain within our ring-fenced banking group, which will include Lloyds Bank PLC, HBOS PLC and Bank of Scotland PLC. The existing wholesale funding from these entities will remain within our ring-fenced bank.

Later this year, certain wholesale and international businesses will be transferred to the new non-ring-fenced bank, called Lloyds Bank Corporate Markets. LBCM will house over Commercial Banking finance and markets businesses, together with the business undertaken by our branches in the U.S. and Singapore. LBCM will also be the parent for our small subsidiaries and branches in Jersey and Gibraltar.

LBCM will be mainly funded with customer deposits and capital downstreamed from holdco. They won't have a significant wholesale funding requirement, although it will have access to money market programs and, in time, will probably establish a senior unsecured term funding program for the business, most likely in 2019. But again, any volumes will be relatively modest.

During 2017, LBCM was assigned strong preliminary credit rating A2 by Moody's, A- from S&P and A from Fitch, and these ratings will be finalized later in 2018.

Finally, on ring-fencing. In addition to the setup of LBCM, we will also move the insurance business, Scottish Widows Group, to become a direct subsidiary of the holding company, Lloyds Banking Group, in addition to some other minor intergroup transfers. All these transfers will take place during 2018. And so in summary, the balance sheet is stable and well capitalized, the group continues to maintain a robust funding and liquidity position and our business remains strongly capital generative.

Douglas, back to you.

Thanks, Toby. So in summary, our low-risk business, cost discipline and targeted growth continue to provide competitive advantage. We have delivered on our October 2014 strategy. And in 2017, we have achieved further significant improvements in profit and returns on both a statutory and underlying basis. We have set strong financial targets for 2018. We expect the net interest margin to be around 290, the cost/income ratio to improve further, the asset quality to be less than 30 basis points and we continue to expect ongoing capital generation of between 170 and 200 basis points. Given the significant strategic progress in recent years, we are well positioned to future growth and face the next stage of our strategic development with confidence.

That concludes today's presentation. And we are now available to take your questions.

(Operator Instructions) And your first question comes from the line of Lee Street of Citigroup.

A couple for me, please. Firstly, the one you've (inaudible) hold a buffer over and above a minimum amount of AT1 and (inaudible) issues. Is that something that you've considered, holding buffers in excess of your sort of AT1 and Tier 2 requirements at all? And secondly, on your management buffer of 100 basis points, can you just give us any insight into how you calibrated that and why is 100 basis points (inaudible) the appropriate number to be held? And finally, just on -- not on the results, just going back to the stress test from the U.K. last year. Obviously, when you look through the 5-year impairment losses, Lloyds sort of stands out for the size of losses that come from its mortgage book relative to its main peers. I was a little surprised by that. So I was just wondering if you can give us any help in understanding why Lloyds seems to fare so much worse from a sort of mortgage loss perspective relative to its peers in the stress test where, I guess, you all face the same types of stresses, that being my 3 questions.

Okay. Thank you, Lee. Sure -- well, I'll first start on those. Or why don't I start on sort of your management buffer question. So we updated the market on our -- the board's view of our requirements, and so the background here is that we believe our requirements are circa 13% plus a management buffer of around 1%. We think that's the appropriate level for our business. Although, I guess, in that we look at how the -- obviously, how the business performs. Ours is a low-risk business. The business performance is quite predictable. We have a sort of very low or very limited exposure to high-volatility business lines. So high degree of predictability around the business. The business is also very capital generative. Earlier, as we mentioned a few times today, we would expect ongoing generation of around 170 to 200 basis points. And whilst that's not strictly linear in a sort of -- on a monthly basis, that's circa 14 to 17 basis points sort of per month. So, those are the things that we think about as we think about the sort of management buffer. And we -- the board has concluded, for us, around 1 percentage is the right number. You then asked about, I think -- sorry I remember the first question was about buffers on -- if that's the management buffer for CET1, how do we think about AT1 and Tier 2s, if that's right? Is that right, Lee?

Yes, that's the question. And just would you -- are you looking at holding in excess of your minimum requirements?

No, no. So we do look at that. So clearly, we -- in terms of sizing Tier 1 and Tier 2 requirements, we obviously look at the minimum requirements. We look at the amount that we need for Pillar 2A. We look at some sort of FX volatility, that sort of stuff. And so we do tend to hold -- withhold a management buffer on top of the Pillar 1 and the Pillar 2A number. So roughly we would run with probably a 3% number -- 3% of RWA number for Tier 1 and that sort of 4% number for Tier 2, if you think about those numbers. Around those sort of those levels is where we think it's appropriate to run. And then stress tests was, I think, your last point. Do you want me to have a crack at that? And so you're right in your observation. And this actually came up in terms of -- came up this morning as well. So our stress delta -- certainly, the mortgage stress delta is driven a lot by -- it's still driven by some of the old portfolios that we have, particularly the specialist portfolio, which is a sort of run-off legacy portfolio. And we give some further information on that portfolio in the documents that we've published today. I should say that the stress, itself, is a very severe stress. So the specialist portfolio has an average LTV of, I think, high 40-ish percent in terms of LTVs. Clearly, the PRA stress test is a very severe stress test with peak-to-trough house price falls of -- in excess of 30% and that sort of thing. And so it tends to be that legacy portfolio that creates that stress delta, albeit, over time, that portfolio is becoming -- it is becoming better and better as it seasons for longer and it's also becoming smaller.

Yes. So the current level of that portfolio is about GBP 16 billion, I think it's reduced by a couple of billion in the last year.

Okay. I think that -- I guess it's kind of amazing to me that a GBP 16 billion portfolio can sort of cause sort of multiple times of losses for you than of the other peers. But I guess that must just be tied up in the dynamics of the stress test.

Your next question is from the line of Paul Fenner of Societe Generale.

I just wanted to know if you could give us some color on how you sort of net out the GBP 10 billion to GBP 15 billion -- sorry, GBP 15 billion to GBP 20 billion run rate for this year across holding company senior, Tier 2 and AT1. You've obviously been quite shy around issuing capital. You did a Tier 2 late last year. Just trying to get a sense of how you'd split those up. And if you can give us a sense of currency, I'm assuming that most of it's going to be European-based, but that would be helpful as well.

Yes, no, happy to do that, Paul. I'm not so sure I used quite the right term. But happy to do that. We haven't issued any capital certainly for a while. So as I mentioned, also on volumes for 2018, I think we'll return to a more -- what we think of as a more sort of normalized run rate for our business. So think about sort of GBP 15 billion to GBP 20 billion of new issuance, something in that sort of range. And then on products, we will certainly continue to issue senior holdco. You've seen us do that year-to-date, as we continue to build our MREL buffer. It's likely that we will -- we'll also do some covered and ABS type issuance. Again, we've done some of that year-to-date in order to sort of maintain those programs and to bring in a bit of funding. On the capital side, we haven't done -- we didn't do capital last year, but we are likely to look at doing capital this year, so we'd done the Tier 2 issue in January. And it's likely that we might look at doing a little bit more on an opportunistic basis. Our -- so Tier 1 and Tier 2 buckets are broadly full, if you look at our capital stack, but we have -- within that, we have some legacy securities, which are obviously subject to grandfathering. And so it's likely that we'll look to do a little bit more Tier 2 later this year, potentially with a small amount of AT1 as well depending on market conditions. As I mentioned, we look to maintain healthy total capital ratios. The level stays around sort of 21%. But we will look to maintain healthy total capital ratios going forward. I hope -- does that give you...

That's very helpful. I guess, what you didn't say was maybe currency. Given your balance sheet, I would imagine the next move will be something in euros or sterling. You might want to correct me on that?

No. So we're active in all currencies. Obviously, our -- the 3 main currencies but also a variety of minor currencies as well. And we look at it on a regular basis in terms of what's most attractive at any particular time. So I don't want to lead you down any particular path on currencies. We look at it sort of broadly across the 3 main currencies and across a variety of sort of minor currencies as well.

(Operator Instructions) And your next question is from the line of Robert Smalley of UBS.

One question on funding and one on strategy. In terms of TFS and FLS, you've got GBP 20 billion and GBP 25.1 billion, respectively. As that starts to roll-off, as you guys wrote, you're going to be doing more issuing in the market. Can you give us an idea of the maturity profile of those 2 programs over the next couple of years? Is there any lumpiness in there? And I think the comment was made in the earlier call that the wholesale benefits to the margin have a bit -- repricing wholesale funding has already been taken. So does this mean that improvements in the margin are really going to be pricing and interest rate-driven more than that? That's my first kind of question. Second question, just on the strategy. Looking at the strategy deck on Page 12, you've got, on the right-hand side, 3 different objectives. Digitizing the group seems to be the largest one. And then when I look at Page 27, and I see scaling up the transformation to digitize the group. I guess my question is, how much of this digitization is -- are things that need to be done? How much of this puts you on the front foot and puts more daylight between you and your competitors when that gets done in the next 3-plus years?

Okay. So let me pick up the first, and I'll -- I guess I'll give the second to Douglas. So on TFS and FLS, yes, your information is correct, Rob. We have about GBP 20 billion of TFS outstanding and about GBP 25 billion of FLS. The maturity profiles of that, they're both sort of full year programs, albeit there is no costs to early repayment. And we have factored that into -- we factor the outlook -- the repayment profile into our funding profile for the year. The older program, FLS matures more quickly, so that broadly matures over the next couple of years. In terms of the FLS, I think a small part of it runs -- if I remember right, a small part of it runs into 2020, but it broadly matures in the next couple of years. TFS will run out to 2021, from memory. So we drew down -- yes, we drew down a decent chunk in 2017, so that will run to 2021 in total. But as I say, we build all of that into our funding plan for the year. So it's all factored into that. I think you asked a question on how that plays through in terms of NIM as well. So there are attractively priced programs. And the delta between -- they are secured programs, so the delta between that and secured funding is not enormous in today's market. And so we would -- the refinancing of those programs and the additional wholesale funding that we might do is all factored into our -- into the NIM guidance that we've given today of around sort of 290. Douglas, do you want to pick up the (inaudible).

Yes. No, absolutely. I mean, you're absolutely spot on. I mean, clearly, we've announced a significant strategic investment today of more than GBP 3 billion in the business. And when you think about that, clearly a large part of that is going to be digitizing the group as indicated by that pie. I mean, at the moment, Lloyds, which is one of its significant competitive advantages is its efficiency and its cost/income position. We've currently got a, what, just beneath 47% cost/income ratio. And yes, that's the market-leading position as it stands at the moment. However, what you do find is actually having that efficiency, having those lower costs actually gives you the capacity to invest more. That efficiency is exactly why we're able to invest more than GBP 3 billion in strategic investment. And actually, this is an ongoing circle. This is an ongoing approach because essentially that strategic investment will then enable further efficiency savings going forward, particularly on the digitization stream. So from my perspective, this is a case of -- look, we've already got an advantage in this area. That additional investment will further enhance the advantage that we have. I think what's quite interesting today is the fact that we've put out a strategic investment target of GBP 3 billion over the next 3 years, but we've also indicated that our operating cost base will fall over the next 3 years. There are a very few companies that are actually able to make that sort of investment while still reducing their cost base and that comes from the efficiency that we have and we'll continue to have. And you can see in the presentation, the way that Zach and the team are trying to drive that. They're trying to put far more of the customer journeys through this transformation process. They want now more than 70% of the cost base to be covered by journey transformation. And then from a change resource perspective, increase the efficiency by 30%. So this is all about further enhancing the advantage.

Your next question is from the line of James Hyde of PGIM.

It's about risk-weighted asset inflation in your 170 to 200 bps generation -- capital generation before dividends and share buybacks. I know that from the morning, you did say you factored in IFRS 9. But what about the preliminary stages of the PRA on the point in time and et cetera, the sort of runway that they have to Basel IV or Basel III revised? Do you expect those to have a significant impact? I mean, I know that Basel III or IV is particularly harsh on asset-based finance, which you -- which is one of your expansion areas, and as well as on mortgages. So can you give us a feel for how it will have in the 2020 projections? And what in fact that will have? And may be talk about final impact for Basel IV as well?

So I think there's couple of questions there. So let me pick that up. So in terms of our 2017 capital generation, we obviously got a lot -- we got a significant benefit out of a reduction in RWAs, which contributed to the high level of capital -- of generation that we've seen in 2017 from -- some of it was from portfolio optimization and some of it was from model approvals and that sort of thing. Going forwards, we do see that we will continue to grow in our targeted segments. And so all other things being equal, that would lead to a modest increase in RWAs across the plan period. And that gets factored into our capital generation guidance of sort of 170 to 200 basis points on an ongoing basis. In addition to that, James you mentioned IFRS 9. That's also factored in there. So if we pre-transition IFRS 9, for us, is about a 30 basis point number. And so as that transition unwinds, that is also factored into our guidance as is actually increased pension deficit payments that we are likely to see over the 2018 to 2020 period. So that's what's in the guidance. In terms of what I'm encouraged to call Basel III finalization. So it was obviously good to have a little bit more clarity on those proposals following the agreement at the end of last year. There's still quite a lot that we don't know. We obviously don't know how it's going to be implemented in a U.K. context yet. What we are looking at, well, obviously, with our book, we're sensitive to things like IRB floors, we're sensitive to things like mortgage floors, maybe some of the up-risk stuff as well. But we are still a long way from having anything like clarity. And so it's too early to give sort of formal guidance on that yet. We also don't know, for example, how some things might be offset in other parts of the capital framework. So it's still a relatively long way off for us and there's still obviously a long transition period to it, particularly to the things like the IRB floor. So as it gets nearer, we'll be in a better position to give guidance on it. That said, I'd just reiterate, we remain a very capital-generative business, and so that provides substantial comfort for us going forward.

Right. Just sorry, I also had asked, how about the measures that are kind of on the way, like the PRAs trim equivalent measures, the point in time kind of things they're pushing (inaudible)?

So on those, there are -- yes, I know, as I sort of said, there are some things coming in on securitization. There are things coming in on mortgage risk weights on in terms of through the cycle versus point in time. We use through the cycle already, so that has a less -- had a smaller impact for us than for some others. And again, the things that we know about are factored into our guidance.

And just to confirm, your assumption of 13% has got a 1% of SII buffer in it, assumption, I guess?

So if I talk about the components of it, so clearly we saw an increase in our Pillar 2A, and that is absolutely factored into that. We are going to see -- this year, we're going to see the introduction of a countercyclical buffer on U.K. exposures and the vast majority of our book is obviously in the U.K. And so the introduction of that countercyclical buffer is factored into the guidance as is -- and the anticipated introduction in early 2019 of the domestic systemic risk buffer, which is applicable to ring-fenced banks. But given our ring-fenced bank is large in the context of our group affects the group's ratio as well. So those are the things that we are taking into consideration in terms of the board's view of the level of CET1 requirements.

You have no more questions.

That's very well. I'm happy to leave it there. Thank you very much for dialing in, everyone, and I look forward to talking next time.

Thank you very much indeed.

Thank you. Ladies and gentlemen, this concludes the Lloyds Banking Group 2017 Results and Strategic Update Fixed Income Conference Call. For those of you wishing to review this call, a replay facility can be accessed by dialing 0 (800) 032-9687 within the U.K., 1 (877) 482-6144 within the U.S. or alternatively use the standard international of 00 44 (207) 136-9233. The reservation number is 29946990. This information is also available on the Lloyds Banking Group website. Thank you for participating.