Lloyds Banking Group PLC (LYG) 2019 Q2 法說會逐字稿

Thank you for standing by, and welcome to the Lloyds Banking Group 2019 Half Year results Fixed Income Conference Call. (Operator Instructions) Douglas Ratliff and Toby Rougier will outline the key highlights of the results, 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 2019 half year results. As you've just been indicated, my name is Douglas Radcliffe, and I'm group Investor Relations Director; and I'm joined by Toby Rougier, our Group Corporate Treasurer; and Richard Shrimpton, who's Group Capital Pensions and Issuance Director.

A number of you may well have dialed-in for the results call this morning, and if you did, I'm afraid, as per previous years, I will run through many of the same points again. I'll cover the strategic highlights and the half year results, and then hand over to Toby, who will cover the balance sheet in a bit more detail. We've also set aside some time at the end for Q&A.

So we've delivered strong strategic progress and a good financial performance in the first half with market-leading efficiency and returns. Together, this has enabled the Board to announce an interim dividend of 1.12p per share, an increase of 5% on last year. Looking briefly at the group's strong strategic progress. We are now halfway through this ambitious strategic plan responding to the changing environment and transforming the group for success in a digital world. We are already delivering a number of tangible customer and business outcomes against each of our strategic priorities supported by GBP 1.5 billion of strategic investment to date. These successes reinforce our existing competitive advantages and create new ones, equipping us to compete more effectively both today and in the future.

As I have mentioned previously, this investment is enabled by our unique business model and market-leading efficiency. These allow us to continually increase investments in the business, delivering improved processes and further productivity enhancements as well as tangible improvements to our customer experience, while generating sustainable and superior returns for our shareholders. We see this as an additional key competitive advantage.

Over the last few years, we've delivered prudent growth in targeted segments, while reducing costs and increasing investment in the business. The economy remains resilient. Although, as we said at Q1, economic uncertainty persists and this is now leading to some additional softness in business confidence, while we also observed some weakening in international market indicators. In this environment, our balanced approach, progressing our strategic transformation while being watchful and responsive to short-term risks remains the right one.

So looking at financial performance. We've delivered a good result with statutory profit after tax of GBP 2.2 billion, a strong return on tangible equity of 11.5% and underlying profits of GBP 4.2 billion. Within this, NII is GBP 6.1 billion and down 3% due to a GBP 3 billion reduction in average interest-earning assets and a margin in line with guidance at 290 basis points and 3 points down on prior year. On the margin, we have again seen a reduction in asset margins, offset by improved liabilities. And I would expect this to continue in the second 6 months and for the full year margin to be in line with guidance at around 290 basis points.

Other income is GBP 3.1 billion and in line with recent years, although, Q2 is down on the equivalent period last year due to higher levels of financial markets activity in commercial and higher central gains in 2018. In terms of divisional performance, there's been excellent progress made in Insurance and Wealth, which is up 21% led by new business in workplace planning and retirement, which is up nearly 50%, and a much improved general insurance result. And any of you that were on the call this morning will have heard Antonio Lorenzo talk specifically about the strong performance in the Insurance division. Elsewhere, other income in Retail was down 4% to GBP 1 billion, with higher current account fee income offset by lower Lex Autolease fleet volumes.

Commercial fee income was disappointing and down 13% as a result of the depressed markets activity and the strong performance in Q2 last year. And finally, operating lease depreciation is down 5% on prior year, although, marginally up in Q2 due to a slight reduction in used car prices.

Turning to costs. Our relentless focus on costs is a significant competitive advantage for the group and particularly so in the current operating environment. Total costs in the first half were GBP 4 billion and down 5%, with a 3% reduction in operating costs and a 44% reduction in remediation.

The lower operating costs is driven by a 5% reduction in BAU costs with lower property, marketing and staff costs, offset by a 3% increase in investment-related spend as we continue to invest in the business. Going forward, there are further opportunities to reduce costs, and we continue to expect operating costs to be below GBP 8 billion this year, and for the cost-income ratio including remediation to be in the low 40s as we exit 2020. On credit. Credit quality remains strong reflecting the group's ongoing prudent approach to risk and provisioning and a high-quality low-risk loan portfolio, which is well over 75% secured. And for the full year, we continue to expect the net AQR to be less than 30 basis points. On balances and coverage, statutory balances are in line with the start of the year at 1.9% of the portfolio, while coverage fell slightly to 23%, largely due to some balances in commercial entering Stage 3, where we do not expect to incur significant net losses.

Stage 3 balances and coverage within the mortgage portfolio are both in line with year-end at 14.8% and 1.7%, respectively, while the other products in Retail have seen Stage 3 come down slightly to 1.8% for balances, and with coverage maintained above 50%.

And across the group, we have maintained the total balance sheet provision of GBP 4.4 billion, which compares with an expected normalized cash flow for the full year of around GBP 1.2 billion, again unchanged from the last couple of full years.

Looking next at statutory profit. Restructuring costs were GBP 182 million in the half and mostly comprised severance, completion of the MBNA integration and non-branch property costs and are down over 50% on prior year due mainly to the completion of the ring-fencing program and lower MBNA spend. Volatility and other items are GBP 465 million and include the costs associated with changing asset management provider, fair value and amortization costs of GBP 169 million as well as GBP 85 million of negative banking volatility compared with a GBP 250 million gain last year.

The PPI charge of GBP 650 million includes GBP 550 million in the second quarter and is driven by a significant increase in policy information requests in the second quarter. Previously, we had received around 70,000 PIRs a week, of which, around 9,000 or 13% eventually resulted in a complaint. In Q2, the number of PIRs increased to around 150,000 per week and is now running at 190,000 partially offset by deterioration in quality and a lower conversion rate to complaints of around 10%. In our numbers, we have assumed that PIRs stay at this elevated level of around 190,000 per week and a slightly lower quality through to the industry line at the end of August, just 4 weeks away. The impacts of these additional volumes equates to around 200,000 extra complaints over and above our previous assumptions.

This accounts for almost 3 quarters of the GBP 550 million increase with the balance comprising slightly higher cost per complaint and higher customer originated complaints. The effective tax rate is 23% from slightly lower than our expected longer-term effective rate of around 25%. And this is despite the PPI charge and due to the one-off release of GBP 158 million prior year deferred tax liability in the second quarter.

Finally, our statutory return on tangible equity of 11.5% is a strong return but is clearly being impacted by the unexpected below the line charges, and we now expect the return on tangible equity for the full year to be around 12% and below our original guidance.

With that, I'll hand over to Toby, who will cover the balance sheet in a bit more detail.

Thank you, Douglas, and good afternoon, everyone. Douglas has talked you through the group's first half results and some of the key themes from Antonio's and George's presentations this morning. I'll also provide an update on the group's balance sheet and our capital funding and liquidity positions. And I'll start with the balance sheet.

The group's customer loans and advances were stable on Q1 at GBP 441 billion. We've seen continued growth in targeted segments such as SME and Motor Finance, and the open mortgage book also returned to growth in the second quarter. This was balanced by continued run off in the closed mortgage books. Customer deposits grew slightly to GBP 418 billion with continued growth in quality current account balances and a further reduction in our taxable retail deposits. The loan-to-deposit ratio was stable at 106%.

Turning to capital. The group has built 20 basis points of free capital over the first 6 months of the year, reporting a pro forma CET1 ratio of 14.6% pre-dividend accrual. This compares to 13.9% at the end of 2018. The CET1 ratio was 14% post the ordinary dividend accrual. The increase in CET1 capital included 97 basis points from underlying capital build primarily driven by underlying profits and 5 basis points from the interim insurance dividend. This was partly offset by 33 basis points of PPI and 11 basis points from the one-off impacts of IFRS 16. We continue to guide to 170 to 200 basis points of CET1 build per annum. Although, due to the below the line charges in the first half, we expect to be at the lower end of this range in 2019.

All of you heard at Q1, we have now received our Systemic Risk Buffer requirement from the PRA, this is 200 basis points at the ring-fenced subgroup level, equating to around 170 basis points at group level. This was lower than originally anticipated following action taken to manage the balance sheet of the ring-fenced bank.

Comprised of the reduction in our 2018 Pillar 2A requirement from 3% to 2.7%, the Board has revised our CET1 targets down to around 13% to around 12.5% with a management buffer of around 1%. We expect to be notified of our 2019 Pillar 2A requirement during the third quarter.

Our total capital remained strong at around 22% on a pro forma basis, and our U.K. leverage ratio is a healthy 5.1%. And then final on capital, we're well progressed towards meeting our MREL requirements with an MREL ratio of around 32% on a transitional basis. We expect to be fully compliant with the Bank of England's interim MREL requirements by the 1st of January 2020.

Moving on to funding and liquidity. We continue to manage liquidity prudently with the group's liquidity position -- and the group's liquidity position remains strong with an average LCR ratio of 130% over the 12 months to end June. LCR eligible liquid assets at the end of June were roughly GBP 130 billion, and we continue to have a large amount of secondary liquidity available at central banks. On funding, we have been active in the market so far this year, raising GBP 8.5 billion equivalent, just under GBP 6 billion of this was funding for Lloyds Bank, our ring-fenced bank, with just under GBP 1 billion of funding raised for LBCM, which is our non-ring-fenced bank.

This included the first senior unsecured public benchmark issue for LBCM in July. We've also raised just under GBP 2 billion of capital on MREL for the holdco Lloyds Banking Group. This included $500 million of AT1 in June, which satisfies our AT1 requirements for this year. The funding rates so far this year together with the movements in the customer balance sheet has enabled us to repay GBP 12 billion of FLS funding in the first half.

We now have GBP 1 billion of FLS outstanding, together with around GBP 20 billion of TFS, all of which is factored into our issuance plans for the coming years. Looking at funding for the rest of the year, our guidance remains a steady-state requirement of GBP 15 billion to GBP 20 billion per annum. Although, we are likely to be at the lower end of this range this year. We have some more funding to do for both Lloyds Bank and LBCM but don't currently anticipate the need to issue any more senior unsecured or capital from the holdco. However, we will keep this under review and may bring forward issuance if markets are attractive. And so in summary, the customer balance sheet is broadly stable with growth in targeted segments offset by reductions in closed or tactical portfolios. We continue to maintain strong capital funding and liquidity positions, and our low-risk business model continues to be highly capital generative.

Douglas, back to you.

Thanks, Toby. So to conclude, in the first half of 2019, we've made strong strategic progress, delivered good financial performance and increased the interim dividend by 5%. In the current environment, our strategy remains the right one and you see this in the resilience of our results in our 2019 guidance. We continue to expect the margin to be around 290 basis points, operating cost to be below GBP 8 billion and the net asset quality ratio to be less than 30 basis points. Significant below the line charges mean that, in 2019, we expect capital build to be at the lower end of the 170 to 200 basis points range and for the return on tangible equity to be around 12% for this year.

At the same time, our longer-term guidance remains unchanged. Although, clearly continued economic uncertainty could impact the outlook. However, we remain well placed to continue supporting customers, helping Britain prosper and deliver sustainable and superior returns to our shareholders. That concludes the presentation, and we can now go to Q&A.

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

I've got 3 for you, please. Just firstly, in terms of changes in terms of -- that are impacting RWAs, there's key things happening next year. Can you just break out what's known and what impacts you expect there to be from each of those, would be the first one? Secondly, I see the U.K. economic data is weakening in the outlook, it's looking a bit weaker. Are you able to give us any commentary or color on potential IFRS 9 volatility and how that may impact the provisioning line if the U.K. were to enter a recession, et cetera, et cetera? What we potentially might see there? And finally, just a quick one on Scottish Widows. Just in terms of its capital structure, just any thoughts around that? Do you think the current capital structure is efficient? And is there anything more to do with soft debt there? Just any thoughts around that? That would be my 3 questions.

Okay, Lee, let me have a stab at it. When I run out of stuff, I'll hand it over to Douglas. So let me start, again, on Scottish Widows, that is -- the capital structure is broadly where we want it to be. I think the FCR at the half year was 149%, which is roughly where we expected it to be. We tend to fund that sort of in equal measure between debt and sort of non -- sorry, between sort of equity and non-equity. And I don't have the numbers to behind that. I think it's broadly at that level today in terms of both the internal and the external and debt and the equity. But we do have some of the internal debt coming up next year. So if it does require tweaking, we have a sort of an opportunity to do it there. But it's broadly where we would expect it to be. And we said in the context of it being a subsidiary, and clearly, we do hold -- we hold equity buffers and we hold equity -- tend to hold equity buffers at group level rather than our subsidiary levels in our structure. And you then asked something about RWAs. Yes, there's a bit happening on RWAs at the moment. So in terms of the stuff that is coming through next year, there's a number of things still being finalized, but we do expect to see an RWA increase in sort of 2020, 2021 time period. And it's likely to be at the top-end of the previous guidance that we've given, which was a range of between sort of GBP 6 billion to GBP 10 billion of RWAs. And that includes -- so that will include the securitization changes that are coming through as well as the sort of PRA mortgage risk weight changes as well as some of the sort of EBA [repair] program type of proposals. So things like definition, just typical changes, moving to a hybrid (inaudible), those sort of things. But we are still working through the detail on that, so we're still working through the modeling on it. But as I mentioned, it's likely to be at the higher end of the sort of GBP 6 billion to GBP 10 billion guidance that we gave. And there may be things like -- I heard recently, there may be things like transitional arrangements in terms of default definitions and that sort of stuff. So we need a little bit more clarity on those. But hopefully that gives you something to work with. [Further other words] there is, of course, the finalization of [File] 3. And we're not giving any guidance on that as yet. There's still quite a long way to go in terms of seeing that finalize and seeing that turned into legislation. And as that becomes clearer, then we can guide it as it becomes clearer. Within that, given the makeup of our business, it's the mortgage flaw that's likely to make -- to be most sensitive item in there. Again, it's subject from a transition arrangement. So as that becomes clearer, I think we can provide some better guidance at sort of a later date. And then I forget what the last one was, Lee?

The middle question was one about IFRS 9. Which actually, I think Lee, in some respects I'm going to disappoint you because you're really looking for, I suppose, a sensitivity in case of different scenarios. Now essentially, as we highlighted on the call this morning, I mean, our assumption at the moment is that it will be an orderly exit that seems to be the general assumption not for us but for the market as a whole. Given that, the impact on our scenarios and our IFRS 9 modeling has been relatively limited to date. We don't give any specific scenarios if it wasn't the case, what the potential impact on IFRS 9 would be. But clearly what I would say is that, as part of the IFRS 9 modeling, we already include a 10% chance of a -- almost like a severe outcome.

Okay. I get, that makes sense. The one thing I guess always interests me on IFRS 9 is, ignoring the Brexit outcome, is more just if the U.K. were just to enter a recession in the ordinary course of business, just how we're supposed to try and look and understand that? Because, obviously, we looked at the stress tests from the last year, that's pretty -- it looks pretty extreme (inaudible) seems that the book ends that that's probably a discussion for another time. So thanks for your answers.

Okay. Fair enough.

So your next question comes from the line of Robert Smalley.

Thank you very much for doing this call in U.S. time. Funny that Lee should finish on that point because that's exactly where I wanted to pick up. In terms of the call that you did earlier this morning, you talked about the central scenario being an orderly withdrawal. But could you give us an idea of what kind of indicators you're looking at, even away from the stress test, which Governor Carney is pointing at? When you look at business conditions, what are -- as we look from the outside, what are some of the early warning signs that you're looking at that might not have been picked up in the stress test or any of the other commentary? That's my first question.

Secondly, in terms of AT1s, with an increase in RWAs, do you think that you'll be more than replacing calls with the AT1 issuance down the road? And third question, you addressed it a bit on the ring-fenced bank. You've done GBP 1 billion, a couple of trades to pretty concentrated blocks. Are you happy with that? Or are you going to try and build a broader investment base for that paper going forward?

Sorry, Robert, what was the first one because I just missed that?

On the -- you talked about LBCM and you had done some senior unsecured issuances in July. My understanding is you've got a couple of large blocks that you did going forward. Are you going to look to try and diversify that investor base a bit more?

Yes, okay. So if I'll touch just briefly on the stress test, Toby, you might want to add something to this as well. But I think what I would flag was the significant amount of almost like stress scenario work that we've done both for the ICAP and also for the PRA annual cyclical stress test. Really, I suppose demonstrates that Lloyds has both a robust capital and, indeed, liquidity levels. Even in extremely severe economic environments. Now when you were specifically requesting that this was metrics that we look at, what I would say is that Lloyds, as a business, is predominantly a consumer-focused business. And therefore, the sort of metrics that are going to be most relevant for us as a business are going to be those that are related to consumer behavior. I mean, and frankly when you start looking at performance to date, actually consumer activity has remained actually remarkably resilient. Employment continues to grow, real wages are rising at more than 1% per year, consumption remains strong supporting GDP growth. And so it's a fact, when you're looking at it from a retail side, those are the primary indicators that are going to influence the business. Anything else you would add to that, Toby?

No, I think -- I guess slightly more broadly, Rob, we have been very prudent in terms of the way that we manage our business. We are a low-risk business. In terms of the underlying core loan book, I mean, that actually hasn't grown much in the last few years, and we have continued to derisk the business in things like the sale of the Irish -- the closed Irish mortgage portfolio and that sort of stuff. So we are -- we have been very prudent in terms of how we have managed the business over the last few years. We aren't seeing anything currently in terms of underlying -- different terms and different trends in terms of underlying credit performance. The credit quality still remains -- of our book still remains very strong. We're seeing no different trends there to call out either on the retail side or on the commercial side of our business. And we've reiterated today our credit guidance in terms of being less than 30 basis points of AQR this year, having been 36 basis points at the half year. So as I would say, we're seeing nothing currently in that. We're just -- certainly on the consumer side, it's not that surprising given what Douglas was saying in terms of very high level of employment, good levels of real wage growth and low interest rates. Clearly, we do a lot of stress testing on our business in terms of the whole bunch of different scenarios, not just the PRA stress tests that gets reported, but we do a number of sort of internal stress tests on our business. And again that all gets fed into how we set things like risk appetite around capital and liquidity and other bits and pieces. And you can see where we are in terms of our current thoughts on loans in terms of the sort of guidance that we've given in terms of Target CET1 levels and that sort of stuff. So as I say, underlying, we're not seeing anything in the credit portfolios that would give us cause call out different trends currently. And I think, your first question was on LBCM. We've raised just under GBP 1 billion for LBCM this year. We're very pleased with the reception that, that new entity has got from investors. We would look to do roughly the same or maybe a little bit more again in the second half for that entity in terms of broadening its funding base and broadening its investor base. And so it's that sort of level. And then I think your first question Robert, was on AT1s?

Yes.

Of which, we did a small issuance this year, June or July of this year in terms of our AT1 [recounts]. That broadly satisfies the requirement for this year, and so we don't have any current intentions to issue anymore AT1 this year. We need to work through next year in terms of what that looks like as we got through our planning process.

And no other need for other subordinated debt either, I can assume.

So this year, no, there wouldn't be any need for that. We've got a few maturities coming up next year. But we'll think about that in the context of the business [theme] and sort of form our plans around that. And then we can give you guidance on that as we go into next year. But no need for any form of AT1 or Tier 2 this year.

Your next question comes from the line of Corinne Cunningham.

I think most of mine have been answered, most of them were really about Brexit. But let me -- one question on LIBOR and how your preparations are going there in terms of altering documentation and interaction you're having with clients and the -- your own issues. So if you could give us an update on what's happening behind the scenes there that would be very handy.

Yes, we've been very happy with the [afternoon]. It's a big topic and a big piece of work for us in terms of transitioning onto new risk-free rates. We are -- we're very engaged with regulators and well advanced now in terms of our own internal processes. But I tend to think about it in sort of different buckets. And so, on the issuance side, on the securities side. From a front-loaded perspective, we won't be doing anymore LIBOR-based issuance post 2021. We've already taken that decision internally. Then we have to think through what that means for the backlog in terms of the sterling and non-sterling issuances, we're working through that. Different on the derivative side, we're engaged with (inaudible) and various sort of parties there in terms of fallback protocols and that sort of stuff. We'll see where that gets to and then we'll have to take action in the light of that. I suspect the slightly -- the heart of it will be on the loan side, which tends to be more bilateral. It's mainly an issue -- it's not really an issue for us in the Retail business. It's mainly an issue for us in the Commercial business. And we are sort of working our way through that in terms of how we work with customers and with those clients to transition them from what they have today onto something that is based more around risk-free rates. So I think we're engaged with the right people. We're engaged with the right regulators. We are hoping for regulatory coordination across the different jurisdictions on this. But I think we are reasonably well advanced in our planning.

Any cost on how much the whole transition is going to set you back? Or how long you think it will take to actually work your way through it at all?

No, we haven't. Because, in part, it's still quite uncertain depending on how the regulation progresses. But yes, like many of these activities, it won't be cheap. I suspect it will be quite expensive to do. But we're focused on doing what is required effectively.

There are no questions currently at this time. (Operator Instructions)

I think we've probably exhausted the questions, which we -- probably is something a record for us. But -- should we wrap the call up there? Thank you very much for everyone who has dialed-in. We'll close it there.

Yes. Thank you very much indeed.

Ladies and gentlemen, this concludes the Lloyds Banking Group 2019 Half Year results Fixed Income Conference Call. For those of you wishing to review this call, the 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 on 0044 20 7136 9233, the reservation number is 85881056. This information is also available on the Lloyds Banking Group website. Thank you for participating.