Lloyds Banking Group PLC (LYG) 2021 Q2 法說會逐字稿

Thank you for standing by, and welcome to the Lloyds Banking Group 2021 Half Year Results Fixed Income Conference Call. (Operator Instructions) Douglas Radcliffe and Toby Rougier will outline the key highlights of the results, which will be followed by a question-and-answer session. (Operator Instructions) Please note, this call is scheduled for 1 hour. I must advise you that this call is being recorded.

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

Good afternoon, everyone, and thank you for joining this debt-focused call on the group's 2021 half year results. My name is Douglas Radcliffe, and I'm the Group's Investor Relations Director. I'm joined by Toby Rougier, our Group Corporate Treasurer; and Richard Shrimpton, who's the Group's Treasury Markets Director.

A number of you may have dialed into the results call this morning. And if you did, I'm afraid I will run through many of the same points again. I'll cover the group's strategic progress and financial results. I'll then hand over to Toby, who will cover the balance sheet in more detail. As usual, we have also set some time aside at the end for Q&A.

First, looking briefly at the group's strategic progress in the half. We are making good progress on strategic review 2021, the current evolution of our strategy that sets out clear execution outcomes for the year, underpinned by long-term strategic vision. As you know, our purpose is to help Britain prosper. Within it in 2021, our focus on helping Britain recover has been on the areas where we can make the most difference.

We have delivered in the first half, and this morning, we were excited to announce the acquisition of Embark, a fast-growing investment and retirement platform business with assets under administration of around GBP 35 billion on behalf of circa 410,000 customers. This deal completes the group's wealth proposition by enhancing our capabilities in the attractive mass market and self-directed wealth segment, while also significantly strengthening our offering in accumulation and retirement, an important growth market.

Now turning to the financials. Financial performance has been solid in the first half, with Q2 consolidating trends established in Q1. Net income of GBP 7.6 billion is recovering, up 2% on prior year and up 8% on the second half of 2020. NII at GBP 5.4 billion is supported by higher average interest-earning assets of GBP 441 billion and a margin of 250 basis points, which has further strengthened in Q2.

Strong mortgage book growth was again the main driver of the AIEA growth. Looking forward, while we expect growth to moderate, we have a solid mortgage pipeline for Q3 and in line with our macroeconomic assumptions reflects a modest recovery in unsecured balances in H2. This means we continue to expect low single-digit percentage growth in average interest-earning assets in 2021.

The first half margin of 250 basis points was up 6 basis points on H2, while Q2 margin of 251 basis points was up 2 basis points in the quarter. In H1 2021 versus H2 2020, lower structural hedge income and the impact of lower card balances were more than offset by the benefit from continued optimization activity in the commercial book, strong deposit flows and liability management benefits.

Looking forward, the mortgage market remains attractive, but we are seeing pricing becoming more competitive, and we'll continue to be disciplined in our approach. We also expect increased structural hedge income, improved funding and capital costs. And a modest growth in unsecured lending, which I mentioned, support the group margin in the second half. All taken together, we now expect the net interest margin to be around 250 basis points for the full year.

On other income, other income of GBP 2.4 billion for the half includes GBP 1.3 billion in the second quarter. This is clearly ahead of our recent quarterly run rate, the performance benefit by just under GBP 100 million from gains in the equity investments business and minor assumption changes within insurance.

When you exclude these elements, whilst lockdown restrictions continue to impact, we are nonetheless seeing some very early signs of recovery in the second quarter. Retail, for example, delivered slightly higher levels of activity than other income in Q2. Likewise, insurance and wealth business saw a modest improvement in the quarter particularly in workplace pensions and particularly on a volume basis compared to the prior year.

Commercial Banking meanwhile was broadly in line with Q1 despite slightly softer markets related income. Looking forward, we do not assume the same level of equities and insurance gains, but we do expect underlying other income to gradually recover in the second half of the year, supported by increasing activity levels. We will also continue to invest organically in income diversification opportunities, which produce income over the medium term.

Net income also includes a GBP 271 million operating lease depreciation charge in the half, which is below our typical run rate but broadly in line with our expectations for the rest of the year given the continuing strength of the used car prices.

Now turning to costs. Our market-leading cost income ratio of 54.9% continues to provide competitive advantage and remains fundamental to our business model. Operating costs for the half came in at GBP 3.7 billion, which is slightly higher than last year, reflecting the accelerated rebuild of variable pay, given the stronger-than-expected financial performance in income and impairments. Our focus on efficiency and cost discipline is unchanged and enables continued investment in the long-term success of the business.

Looking forward, we now expect 2021 operating costs to be circa GBP 7.6 billion. This increase from previous guidance takes into account the variable pay adjustment. Excluding the impact of variable pay, operating costs are developing as expected at the start of the year. Remediation of GBP 425 million includes GBP 91 million in respect to the regulatory fine for historical insurance renewal, GBP 150 million for operating costs and redress for HBOS Reading as well as charges in relation to other ongoing legacy programs.

On HBOS Reading, we have now had the first view decisions from the independent panel re-review. As discussed previously, there could be further significant charges in coming periods, albeit the exact timing and flow of these is uncertain. These remediation charges are clearly very disappointing, but we are working hard to make things right and to put these issues behind us.

Looking at the impairment, asset quality remains strong and new to arrears remain low. While we continue to expect some deterioration consistent with our macroeconomic forecast, underlying charges are currently below pre-COVID levels. In this context, Commercial Banking has also benefited from improved restructuring outcomes and lower balances. The net impairment credit of GBP 656 million in the half is bolstered by an GBP 837 million release related to our improved economic outlook. We believe our economic assumptions remain prudent compared to market expectations. As a result of these changes, our stock of ECL has reduced to GBP 5.6 billion. It's still around GBP 1.4 billion above the closing 2019 level, and we have also maintained our COVID-related management judgments.

Indeed, these have increased in the second quarter to GBP 1.2 billion, including the GBP 400 million central overlay we took in Q4 relating to the significant uncertainty in the current environment. COVID-related management judgments also includes circa GBP 800 million held in retail and commercial, largely recognizing the potential delay in losses that we would have expected to see and support schemes not been in place during the pandemic.

Given the asset quality environment and improvements to our economic assumptions, we now expect the full year AQR to be below 10 basis points. Needless to say, uncertainty remains on the outlook.

Now turning briefly to the below-the-line items. Restructuring costs of GBP 255 million are significantly up on prior year and reflect the previously signaled higher levels of spend in technology R&D and in severance. We should see the benefits of this investment in our technology stack and financial performance over the coming years. We have previously talked about restructuring being higher in 2021 than in 2020, and that remains our expectation. The run rate is therefore expected to pick up in the second half.

Volatility and other items was favorable for the first half, benefiting from around GBP 250 million of market gains within banking and insurance volatility. Following the enactment of the increase in corporation tax, 25% in 2023, we recognized the P&L tax credit of circa GBP 1 billion relating to the revaluation of our deferred tax assets. As you know, the tax credit does not impact capital, but it is impacting profits and returns.

Given the improved outlook for both NIM and AQR and the updated operating cost guidance, we now expect the 2021 full year RoTE to be circa 10%. This excludes the circa 2.5 percentage points benefit from the tax credit just highlighted. Taken together, statutory profit after tax was GBP 3.9 billion, significantly higher than prior year and a solid recovery.

And with that, I'll hand over to Toby, who will cover the balance sheet in more detail.

Thank you, Douglas, and good afternoon, everyone. As Douglas noted, the first half of this year was characterized by an improving economic outlook, and this has supported our strong balance sheet, capital funding and liquidity position. I'll briefly talk through each in turn.

Looking first at the balance sheet. Customer loans and advances increased by 2% in the first half to GBP 448 million. This was primarily driven by continued strong growth in our open mortgage book, which has grown by around GBP 13 billion since the beginning of the year. On the liability side, we continue to see strong inflows of deposits, which have grown by GBP 24 billion in the first half to GBP 474 billion.

In aggregate, this means that we have seen GBP 63 billion of deposit growth since the end of 2019, resulting in a loan-to-deposit ratio of 49% and the reduction in our wholesale funding requirements, which I'll come to later.

Turning now to capital. The group's CET1 ratio increased by 50 basis points over the first half at 16.7%, reflecting strong pre-provision profits and a reduction in RWA. This outweighed the aggregate impacts of impairments net of transitional release, dividend accrual and the impacts of the pension scheme contribution. At 16.7%, we have headroom of 750 basis points above our MDA level of 9.2% and over 550 basis points above our regulatory requirements of around 11%, both of which are unchanged over the year.

Our 16.7% CET1 ratio includes around 50 basis points from the change in treatment of software intangibles that the PRA have stated they intend to remove on the first of January 2020 -- sorry, 2022. It also benefits from 78 basis points of IFRS 9 transitional release, which we expect to run down over the rest of this year and the early part of 2022. Excluding these 2 items, our CET1 ratio remains strong at 15.5%.

As far as our results this morning, William gave an update on our RWA. In summary, RWAs reduced by GBP 1.8 billion over the first half to GBP 201 billion. And we expect to end 2021 below GBP 200 billion. William also highlighted some expected headwinds, including GBP 12 billion to GBP 15 billion of RWA increases coming from CRD IV model changes and GBP 3 billion to GBP 5 billion relating to SA-CCR with standardized approach for counterparty credit risk. This gives a total of around GBP 15 billion to GBP 20 billion of expected regulatory inflation on the 1st of January 2022 in addition to the customer-driven balance sheet growth.

These amounts will be partially offset by our continued program of active RWA management, particularly in the commercial book, resulting in an expected end 2022 RWA number of around GBP 210 billion. Given our strong capital position and the regulator's removal of the dividend guardrail, the Board has recommended an interim ordinary dividend of 0.67p per share. The board's view of the ongoing level of CET1 capital required to grow the business meets regulatory requirements and cover uncertainties, remains unchanged at around 12.5%, plus a management buffer of around 1%. As in previous years, the Board will consider what to do with any excess capital at the end of the year.

Finally on capital ratios, our total capital ratio remains strong at 23.1%. Our U.K. leverage ratio also remains healthy at 5.8% as does our transitional MREL ratio, which is just over 36%.

Moving on to legacy capital. At the full year results, I said that there was only a limited amount that I could say, and that remains true today. But we're still in dialogue with the PRA on this topic. We continue to take action to reduce our legacy capital and announced the call of 1 of our legacy Tier 1 notes in April and 2 of our perpetual legacy tier notes last week.

We now have GBP 3.5 billion of legacy securities outstanding. In terms of the breakdown of this, around GBP 1 billion of preference shares issued out of the holding company, a further GBP 1.5 billion of legacy bonds, which are regulatory call features. And of the final GBP 1 billion, GBP 700 million has contractual redemption options or maturities before the end of 2025.

As we have said before, our decision to exercise call options is considered on an economic basis, taking into account a range of factors, such as the requirements of the business, regulatory developments, market conditions and any other legal or practical consideration. Again, as we've said before that there are sensible economic opportunities to optimize the overall legacy portfolio further. We will, of course, consider these. As always, details of all of our capital and MREL securities can be found in our Pillar 3 capital instruments report, which is available on our website.

Turning now to funding and liquidity. Our liquidity position remains strong. Our liquidity coverage ratio is 131% on a 12-month rolling average basis and continues to be comfortably in excess of our regulatory requirements and internal risk appetite. The average value of our liquid asset portfolio was GBP 139 billion, and we continue to have a significant amount of secondary liquidity available to us should we need it.

The strength of our liquidity position has meant that we repaid GBP 5 billion of TFSME funding in the first half, leaving GBP 8.7 billion outstanding. Since the end of the first half, we have repaid a further GBP 4 billion of TFSME. The TFSME scheme remains open to us until October and offers term funding at an attractive cost should we choose to use it further.

As a result of the deposit growth I talked about earlier, the availability of TFSME and our healthy capital ratios, our wholesale funding issuance in the first half was only GBP 2 billion. In terms of future funding plans, we expect only minimal additional wholesale funding over the rest of this year.

Finally, on IBOR transition, we continue to make good progress. We will continue to work to transition away from sterling LIBOR products by the end of 2021 and work with the industry more widely on the broader transition away from other currency LIBOR references.

And so in summary, our balance sheet, capital funding and liquidity positions all remain strong, helped by the improving economic outlook, allowing us to continue to support the U.K. funding.

Doug, back to you.

Thanks, Toby. To summarize, we have supported our customers throughout the pandemic, and we remain absolutely committed to helping bridge and recover. In the first half of 2021, we delivered good progress against our strategic priorities, continued business momentum and a solid financial performance. We have a strong capital position with a CET1 ratio of 16.7% after an interim dividend of 0.67p per share.

The group's solid financial performance in the first half as well as the improved macroeconomic assumptions have enabled us to enhance the group's 2021 guidance. This includes a strong [NIM] outlook for 2021 and a lower credit charge, in turn resulting in a slightly higher cost base as we accelerate the rebuild of variable pay.

Together, this leads to a return on tangible equity of circa 10% ahead of previous guidance. We also expect RWA to be below GBP 200 billion. In the medium term, we continue to target a return on tangible equity in excess of our cost of equity.

In summary, although the economic outlook remains uncertain, the group's business model and financial strength will ensure that it can continue to support its customers and help it to recover.

Thank you for listening. That concludes the presentation, and we can now take your questions.

(Operator Instructions) We will now take our first question from Lee Street from Citi Group.

I've got 3 for you, please. Firstly, this morning, William referenced the risk-based asset density actually increased. Is there sort of an illusion there that you might be changing your capital targets or management buffers as we look ahead as a function of that?

Secondly, you mentioned the 2 disco's that you called recently. Just any thoughts on the rationale with that? Was it economic? Is it more of a view to losing capital treatment at the year-end, becoming competent for resolutions? So any thoughts around that would be helpful.

And then a third one also on legacy. You mentioned you're still in dialogue with the PRA. Is that just an ongoing thing? Or is that in relation to the submission that you made at the end of March? And also have you heard back from the PRA on that submission from the end of March? Anything around that would be most helpful. That would be my 3 questions.

Thank you, Lee. Let me see if I can take that. So I'll just -- I'll do them in reverse order, and then maybe Richard can chip in if there's anything I forget to mention. So only on the legacy securities. Yes, look, we -- like everybody else, we submitted our plan to the PRA earlier this year. We have had some initial feedback from them, but the conversation there is very much ongoing. So there's not really anything I can add to that at the current time. But I would expect us to reach a conclusion sometime in the second half on that.

And clearly, if there's anything that is coming out of that, that we need to update investors on, we will do that at that time. So that's where we are on those conversations.

On the disco's, that was entirely in line with our usual process. So we do look at these things on an economic basis. You will have seen from our results that we've had a very strong inflow of deposits. And actually, we continue to see a very strong inflow on deposits, which are very attractively priced. And so whilst the disco's, they weren't a significant coupon. They were -- actually, on an economic basis, they were more expensive than other funding that we had. So that was the basis for the decision there, very much in line with how we look at our call options more generally.

And then your first question, if I remember, it was a question on RWA and capital targets. So we'll discuss that. So this did come up this morning. So our capital target currently remains unchanged at 12.5%, plus a management buffer of around 1% -- around 12.5%. There's a management buffer of around 1%. I mean the Board does review that on a regular basis in the light of circumstances. And when circumstances change, we would -- I know we would review that target. We did update this morning and in what I said earlier in terms of what we're seeing on the RWA side and RWA density. And that's 1 of a number of factors that we might take into consideration when we think about capital targets, along with the economic outlook and how that would play through to our business, along with our regulatory requirements and any updates in Pillar 2A or other components of the regulatory requirements that we have.

So it will be considered in the rounds, and we'll look at our -- we do look at our capital target on a regular basis. But currently, we're very comfortable with the target that we have set out of around 13.5%.

We will now take our next question from Robert Smalley from UBS Fixed Income.

A couple, one on asset quality. You've become a much more gas-driven company in the ways that you look at asset quality. This is a rather peculiar cycle, though. How are you looking at the data any differently at -- on the borrowers? Are the ones who are going to borrow first more likely to be better credits, worse credits? And how are you -- what are you looking at differently than you would look at before data-wise? That's my first question.

Second question, you did a subordinated debt deal in June. I didn't think that was in the plan in the beginning of the year. Could you talk about why you did it? Was there a specific reason, specific entity to be capitalized? And then if you want to talk about the 12s any more, feel free.

Thanks. I'll tell you what? I'll let Richard pick up on the 12. And actually, Richard, why don't you answer on the debt one too, and then I'll pick up the asset quality.

Yes. Absolutely. And I think we did the last reverse, we'll do in reverse order as well. So Rob, on 12s, nothing changed. You know and there's many times we've had a call on these if they cease to account as Tier 1. I think the market generally recognizes that. I mean if I look at cash price, that bond, it's around sort of GBP 106 million, GBP 107-ish million, which would ordinarily imply yield around 9.5% to 10% to the optional call date. So clearly, not pricing to that. It's pricing much sooner when our AT1s are yielding somewhere in the region of 3%. So that sort of tells you that the market is very aware of that. And as Toby said earlier on that, that regulatory call is an option that we would treat on an economic basis and view that very much on circumstances at the time.

On the Tier 2 in June, you're right. We don't have much in the way of Tier 2 appetite. And as Toby mentioned earlier on, we've got a very strong total capital ratio of 23%. But market conditions were very supportive. We looked at it in terms of where we might be in 6 to 12 months, where we might have Tier 2 needs next year and saw it very much as an opportunistic prefunding. And so that was the reason for the Tier 2 that we did in June. And I'll pass back to...

Can I do asset quality, Rob? So firstly let me make some general comments. We're not -- we are seeing strong underlying credit performance. So we're not seeing anything negative in the portfolio. That said, there is still a fair amount of uncertainty in the macro environment, and it's still obviously supported by government schemes. So we'll look to see how that evolves over the course of the second half. And as Douglas mentioned, we are continuing to hold our COVID management judgments, in fact, slightly increase them in the second half to GBP 1.2 billion. So as we get more clarity on that, on how the macro environment evolves, we will continue to reassess those net judgments.

But to reiterate, we're not seeing anything adverse currently in the credit portfolios. And indeed, we've adjusted our AQR guidance as part of our interim results to reflect that, and we're now guiding for 2021 to an AT1 level of less than 10 basis points.

In terms of data, you're right on the -- we're -- certainly on the retail side, we're quiet data driven. I mean on the -- as you move into the commercial side and the larger commercial side, there's more sort of judgmental elements of that and positive developments that support the quantitative assessment. But we haven't changed things much actually during the course of the last 18 months. The only thing I can think of is we have tightened our criteria slightly on the unsecured side as you would expect. I don't think that's a surprise given the environment that we have been in. But other than that, I don't think that we are doing anything fundamentally different. We're very pleased with the way that the credit portfolios have behaved. And I think that's a testament to our origination capability.

Absolutely, Toby. So to back up what you said there, I mean historically, as you know, as a group, we've always taken a very prudent approach to risk. And that's been shown through the crisis so far. So the key element is we are not seeing any deterioration at present. So it's quite difficult from a data side to indicate where that would come through post crisis, post COVID. But at the moment, we're not seeing that deterioration.

We will now take our next question from Alvaro Ruiz de Alda from Morgan Stanley.

Actually, they were all answered. And I just want to say thank you to be that clear with -- about Lloyd's 12%. And thank you for doing the call.

No problem, Alvaro.

(Operator Instructions) We will now take our next question from Daniel David from Autonomous.

First one is just a quick one on your mortgage book, noting kind of the strong growth that you've got on the slide. Do you see any impact there stamp-duty changes coming through?

The second one is on stress testing and just in relation to the changes in risk density and the future drawdowns that it might create. Should we potentially think of you being more leverage constrained going forward as a result of the changes in RWA density.

And then finally, just on ESG. I'm noting the targets in your slide pack. Would you consider issuing a sustainability-linked bond going forward? Is that's something that's potentially on the agenda?

Yes. Thank you for the questions. Let's take that in that order. Douglas, do you want to talk about the mortgage?

Yes. Absolutely. You know what, I can start off there. I mean as you rightly say, I mean we've seen really strong performance in the open mortgage book in the first half of the year. And we've seen growth of, what, GBP 12.6 billion in the half, GBP 6.6 billion in the second quarter. So yes, I mean, it's been really strong. Clearly, part of that has been driven by the stamp duty.

What I would say is that we've had -- we've got a solid pipeline for Q3 based on what's there. And we still expect open mortgage book growth in the second half. But frankly, I think although we expect the growth, we'd expect to see that significant growth that we've seen in the first half ease off a bit. One of the reasons behind that being because of the change to the tax treatment from stamp duty side. But clearly, there are going to be other elements that will support that more from a structural housing market perspective in the U.K. So I think that there will be some form of easing in the second half. But like I said, at the moment, we still think the pipeline for Q3 is still quite promising.

Thank you, Douglas. And I think the second question, if I remember correctly, was about stress testing and binding constraints. And so we look -- we do look -- we obviously look at both. We look at both -- we look at the things on a leverage basis and on an RWA basis. For us, today, the RWA basis tends to be the one that is binding for us certainly in terms of the ring-fenced bank. And -- but we don't anticipate that change. Most of the RWA increases that we referred to are related to the ring-fenced bank, and we don't really see the binding constraint changing from that -- from our current basis on that. And then on ESG, Richard, that comes on you. Do you want to pick that one up?

Sure. We've made a lot of progress on ESG. We've seen -- in the last 12 months, we've seen progress with MSCI analytics in terms of ratings. We've got a framework that allows us to do ESG issuance, which we've recently renewed. But fundamentally, we're always looking in the way of issuance plan. There's not much last year of this sort of green bond in the near future, unfortunately. But it's one of those things that's on our radar should the opportunity arise for sure.

Just to touch on the final framework (inaudible) and know more kind of (inaudible) work out whether there's a change in kind of feeling towards sustainability-linked bond?

No. It's normal sale of green bonds.

It appears there are no further questions at this time. I would like to turn the conference back to Mr. Radcliffe for any additional or closing remarks.

Excellent. Well, from my side, I'd just like to thank everyone for dialing into the call. I hope specifically running this debt-focused call in the afternoon is helpful. And we look forward to speaking to you again at some stage in the future. Thank you very much indeed.

This concludes today's call. Information for the replay is available on the Lloyds Banking Group website. Thank you for participating. You may now disconnect.