Legal & General Group Plc (LGEN) Earnings Call Transcript & Summary

Good morning, Americans, and good afternoon, Europeans. It's Oliver Steel from Deutsche Bank here. I'm delighted to welcome Jeff Davies, CFO of Legal & General to our fireside chat today. Jeff, I think you wanted to say a few words first, and then we can move to Q&A.

Yes. Thanks, Oliver. And yes, good morning, good afternoon. It's novel not doing this with jet lag, but in some way, it would be preferable to be there in New York, clearly. Yes, just to set that, if you will have seen our trading update alongside the debt rates that we've done with continued well in 2020 around the core businesses. For those of you that have the slides available on Slide 2, you can see some of that captured in one place. We continue to see demand for institutional PRT. I'm sure we'll talk about that in the Q&A. We announced another transaction, GBP 600 million today with 3I. So you can see there from both written and exclusive, we're looking at GBP 3 billion or so for H1 at the moment, which is a good position to be in, whilst actively managing our capital at the same time. Our ambitions stay the same. And again, we'll cover that further in the Q&A, I'm sure. Other business continues to flow. LTM had good external flows in Q1 as of the latest trading update. And so generally, in our retail businesses as well, LGRR and the term life business, we see good underlying demand for our products. And operationally, we've been in good shape to deliver those and to get the math to customers. And obviously, in LGC, that's pretty much dominated by CALA. So revenue income is only recognized -- profit recognized when we actually sell and complete the houses in there. That was stopped completely for a number of weeks, almost 2 months probably in total. They're now back up and running, and we're looking to get start completions on that business and start business flowing again. And obviously, we had a couple of months at the start of the year where we did secure income on that. But we have been busy, we've continued with planning permission. We continue to invest in our businesses like Later Living and Affordable Housing. And in some ways, it illustrates the diversification of our model that we're seeing opportunities arise in other parts of LGC. And the other big question, obviously, that comes up there, in which we can cover in more detail in Solvency and credit. The big high-level summary on that is something, too, has worked. It's moved in line with our sensitivities. We are happy with the position on that, the management actions we've been taking. And as credit unfolds, that will be the big question. We're very comfortable with the names that we're in. We have a A-rated portfolio. We have very, very little below BBB, just GBP 700 million going into this. And since then, our performance has been less than GBP 250 million that have been downgraded, downgrades within investment grade a very little impact on our balance sheet. So it is really looking at those BBB names and seeing where over the next sort of 18 months, there could be questions about downgrades. But because of the factors that we're in, we feel very happy with where we are with our portfolio. We may spend a little bit of money that we've accumulated through good trading at the most volatile time. And so -- and some of the new issuances to trim some of those BBBs just in case, but we feel comfortable with where we are overall and the same is true on the direct investment portfolio. So overall, we're in good shape. All the liquidity stress has passed at the most volatile time. We stood up to that very well. It was more of an operational challenge than anything else, and LGIM did a good job delivering on that as it's all collateral-related. So overall, we're looking forward to the sort of second half and the medium-term and really proving our model and continuing to deliver around our core businesses. So yes, back to you Oli.

Okay. Jeff, thank you for that. So we might start with the balance sheet, sort of the balance sheet impacts. And both from what you said today and your first quarter statements. I felt personally that it was pretty reassuring on the corporate bond holdings. But in recent weeks, what I found is a number of people have then been asking me specifically about the property-related investments, particularly in the light of one of your competitors putting in a 12% and 15% cut to their property values. I've also been asked about negative interest rates in the UK and I've also been asked about a renewed risk of no-deal breadth it. And I don't really want to ask them all as sort of 3 separate questions, but I wonder if you could just sort of address those 3 issues as far as you see them.

Yes. So yes, they're all there. They continue to be there. If we look at them, it probably come best to the property. That's the longest answer, if you like instead talking to the banks quite a lot. And perhaps while we haven't seen so much movement in markets and U.K. being disjointed, if you like, from others from the Brexit discussions is that even with the sort of hard or Brexit that potentially has been talked about if a extension, the transitions isn't asked for people don't actually see that as being that different from where the anticipated ending point was anyway. So at the moment, that isn't seen as a big problem. I mean it's fundamentally for us. Irrespective breadth of the same things hold as we were saying, when there was discussions around it before. The core macro drivers will exist, whether it means we get 1% or 0.5% less GDP growth over some x period. So U.K. is really neither here nor there for us that we will be aligned with climate change, the need for housing, continue to have the agent demographics, a lot of the stuff that's coming out of this now in terms of government spending, et cetera, will continue to play to what we've been doing. So that continues to be there. Negative interest rates, well, we reached 10 for a 10-year gilts in the middle of the volatility, and we're around about 20 now. So -- and actually have that much further to go for 10-years gilts.

So there's no cliff edge, which I stated the question, on that.

No, exactly. No, no, there is no cliff edge for that. I mean we could all debate at length whether the Bank of England is really using that to shift the perception of the lower band as opposed to actually thinking it will ever implement it. Andrew Bailey was please struggle at the Treasury Select Committee that whilst you have to consider it, he really doesn't like it. And there is a best mixed evidence to the effectiveness of it. So I think still most bankers will say they anticipate other tools being used around expansion of QE, et cetera. So it feels like it's a less resort tool for most people. And of course, you do have the interesting dynamic of -- it's the pressure with the amount of issuance that's happened and the pressure is in the other direction. And it's really that then the Bank of England come in and they're buying those bonds that are effectively being issued and is close to printing money as possible to control the yield curve, which suits them to effectively be whilst they're borrowing so much. But I think that control of it is very different to allowing it to go negative. So on the property side of things. Yes. I mean it gets thrown around about it, partly because we show lots of pictures of buildings. But in reality, most people who study our direct investment portfolio, which is where the vast majority of our exposure would be, is actually it's not the underlying property. It is the counterparty that is essential in this. So yes, whilst we will show pictures of regenerating Cardiff and Newcastle in other places, the exposure, the remaining exposure we have in Cardiff is to BBC and HMRC, [indiscernible] equate or government-backed yield. So it's all about the [indiscernible] and then continuing to pay their rent. And our recovery on the direct investment portfolio back in the annuity portfolio is market-leading to move. We probably were less than 1% difference in terms of income on that portfolio in April, May, compared to the sorts of figures into was talking about on its retail funds, for example. So we're pretty much close to 100% recovery on those. And it's all about rental of the counterparty's method to do with the underlying property. Obviously, there is some stress that we would apply to the lifetime mortgages, but these are very long assets, and they've built and designed and the securitization within Solvency II is designed to be able to withstand shocks of especially the sorts of numbers that Eva talked about as long as you have any sort of HPI assumption then for the remaining 20 years, then that isn't an issue for both the rating and the actual performance of the lifetime mortgages. So generally, we don't have a big exposure to property. You could see it in our sensitivities at the Solvency level. And interestingly, we haven't equally seen the sorts of revaluations that were being talked about. It will be interesting to see how those play out, but they really aren't the type of exposure we have. We only have retail, for example, we have one shopping center, which is actually the shareholder asset, similar to holding traded equity. We happen to have one shopping center in Bracknell and then a mixed-use in lead Thorpe Park, and that's it. And we certainly haven't seen revaluations at that level. You've sort of got to assume rental incomes on retail property is down 10%, 15% forever from where it was being marked. So until we start seeing trading on those portfolios, we need to be careful with the sort of emotional valuation versus the more realistic valuations.

Fair enough. Then I -- as we've got one question that's come in, which I'll ask now since it's sort of relevant for the moment. So on the bond portfolio, is the impact on Solvency II, the same for a downgrade from IG to below IG of 2 different assets? So the centrally question is, is it the same for A-rated corporate bond and an illiquid asset with a higher yield? Are they both treated in the same respect?

Yes. Insofar as the main impact of that downgrade is that the benefit you're allowed to take under Solvency II is capped at the BBB level. And so if it's moved to BB, you can't take any more benefit than if it had been BBB. So therefore, you lose the spread widening benefits of the BB, but you're losing the market value. So therefore, you need to put other assets to make-whole your MA in simplistic terms. And so the impact of that is the same. You were already getting the benefit for the DI at the BBB level, and you will have the same. There's no reason to believe that the spread rising at the BB level will be disproportionately higher or the market value loss would be disproportionately higher for the DI. The fact that I'd do, if anything, you might be a bit less because you've got -- it's easily higher collateralized and a better loss given default. So the lower down you're getting and the closer theoretically, you would get to a default, the better the security of the DI should come in. But that's -- and second order will depend on the individual assets. It'll be the variance and see what the people's views of traded creditors where you get the fallen angels because they will be the strongest of the strong in the BB. And it could be that the BB assets actually are very attractive going forward because you don't get the historic levels of default, and you've been over rewarded. So it will be an interesting dynamic for us if we will naturally get some. I mean we've had GBP 250 million. How and when we decide to trade out of those over time or whether we actually decide to the wholesome, we consider them being upgraded, or we just think there are quite a good investment.

Fair enough. And just sort of moving on, the dividend decision you took, I mean you were pretty overt in willingness to pay the final dividend. Can you just talk us through the assumptions you made at the time? And whether any of those assumptions or whether -- well, basically, how those assumptions might have changed since then, if at all?

Yes. I mean there definitely hasn't changed because I think I think we won't -- well, sorry, there was probably a higher probability placed on the fast B recovery. I don't know when it would have been we put our press release as the sort of March time more generally in the market. To be honest, we weren't really putting more weight on that than any sort of U or even a W. And so none of those will have changed because we really you want any clarity until, I don't know, let's call it, Q1 next year, at best. We should know them. We'll know them whether we've had a second wave or not going into the winter in the northern hemisphere, for example, but there's nothing that has changed there. There's, at the moment, conjecture, which seems to be different to the market view of the world at the moment around how slow a recovery may or may not be and how quickly items can be restored to the pre-2020 levels. And so we're really planning for more. What does it look like in the adverse rather than our best estimate scenarios? And it's our comfort around the amount of management actions, the flexibility we have and the capital buffers in the slightly more feasible adverse scenarios. So I don't know, for example, us and all our peers would have tested things like a 6% type downgrades from BBB to BB, which is of the order of what happened in 2008, and then you can go to a 14%, 16% type downgrades, which is what you saw in 2002. But don't forget, we would be modeling that on our own portfolio. So if we're experiencing roughly 1/3 of what the market implies, then the actual scenario is playing out is much worse if we're experiencing, let's call it, even 6% or 14% on the portfolio. So we also would have done the 19, 30 type and looked at what happens in those, where is the Solvency level. And clearly, it's really about how much PRT business who want to be writing in those scenarios and how many management action levers that we want to be pulling. You don't get to the point where you're even at 100% Solvency. You're not -- never at a point where policyholder protection is a question. They're going to get paid. So it is about optionality, what makes sense at that point in time, reacting as these things come. And I think what's very important for us is our conviction that given it's all about how the credit implications of what's happened play out, then to us, that will happen over an extended period, and we have a whole bunch of clever people in Eldon that are paid to manage this for us. We like the way our portfolio is positioned against that, and we'll continue to monitor it and take actions. It's not -- it will be slow and play out over time. So that gives us options rather than suddenly having a big impact that impacts our balance sheet overnight.

Can we -- let me move on to talk about sort of future growth. Let me ask a general question, first of all, which is do you think COVID has actually changed the outlook for growth at all?

I would say fundamentally, no. We will clearly have bits of our business, which are more or less related to GDP or housing demand, et cetera. But as I said, the 6 growth drivers that we have will still be there. There's no difference of that. And you can argue one of them well globalizations and then go backwards or someone yesterday said, will you get more local or regional cooperation. But no one can argue haven't seen everything that goes on, the globalization of asset markets isn't there, which is actually our driver, not globalization as such. So that will all continue. The things like derisking the pension schemes in PRT, that won't go away. Our ability to source good assets, whether that's direct investments through affordable build-to-rent. Okay, that will go away. And at the moment, we can do very well out of trade of credit. Clearly, selling pure term assurance, where it's linked to mortgage sales would be dependent on the house market. That's always ever been pretty robust, and we've seen that over the more than the last 10 years, where that's pretty robust and it wasn't one of our growth businesses. Whereas LGIM, the move to ESG, changes of asset classes, that's still positioned extremely well. We saw the inflows in Q1. DC pensions will still continue to grow. And so the growth prospects around our key businesses don't really go away. And actually now, there will be a [indiscernible] who is talking about some pretty new asset classes and products that we should be looking at. And we've certainly done quite a lot of work already looking at what sectors, areas, shifts cause winners and losers out to this and where should we be positioning ourselves.

The -- sort of moving away from COVID for a second. You've guided to GBP 8 million to GBP 10 billion a year of bulk annuities. And I noticed in one of your slides, you say that's the average over the last 4 years, but it's quite a long way below the average over the last 2 years, and it implies...

Yes. Yes.

Quite a -- I mean, the net inflow rate would still be pretty good. I mean my calculation is the net inflow rate would be 6% per annum instead of the sort of 11% or 12% per annum net inflow rate that we've seen over the last 2 years. But I mean, why -- do you think the market is just not big enough to go for a bigger number than that? Or are you actually sort of consciously just sort of trying to calm investors' expectations down? Because obviously, this is a lower growth rate than you have been achieving over the last couple of years.

Yes. I mean I'd say the biggest factor is that -- I imagine I was talking about this after the full year, we probably underestimated the growth of the market on 5 years ago when we put the plan together. And it has grown significantly over that period. We've gone from doing GBP 500 million deals to GBP 5 billion deals. And the market has grown from a, I guess, GBP 5 billion to GBP 10 billion market to a GBP 40 billion market. We don't see the market grow into an GBP 80 billion market. This is the U.K. market in the next 5 years. It's -- we see the sort of supply being steady. Now that will have peaks and troughs around that, and so the amount that we write. So that's the main driver is we would like to keep our market share, let's call it, 30% of the 1 billion-plus cases between as well say intake, for example, but we wouldn't, in some ways, want to be winning more than our fair share of that urban market that is roughly GBP 40 billion. And so therefore, that's the right sort of ambition. Now that doesn't mean that in 1 year, we won't write GBP 15 billion. And another year, we may not -- we may write GBP 7 million. But that's where we see it. We see growth coming from potentially the Canadian market and obviously grow in the U.S. as well, where we also think the U.S. market is more likely to grow a bit over that period because it is slightly more immature, same sort of scale that it hasn't done the number of large deals and complicated deals. I think the trustee has been quite at the same level of confidence and execution in the same way. So we do see those growth opportunities. So that's the main driver of it. We clearly look at it against what's available to we think will be there, capital use of trying to balance all of that. And to some extent, what you say is right. I think if we suddenly said we were going to write EUR 80 billion, we have a lot of people saying, well, how are you going to do that? You can't afford that doesn't make sense, et cetera. In reality, we will try and win at least our fair share of what we see there in the market. We have lots of recurring business from schemes where we have been doing -- been on a journey with them. And so we have a good line of sight of an underlying amount, and then we'll write business on top of that.

And you've also highlighted LGIM and U.S. protection as areas where my sense is you're looking to accelerate the growth. First of all, like, is that right that you're looking to accelerate the growth there? But also, how are you planning to do that? Because LGIM in particular, you've been attracting but these inflows, no doubt on that. The growth rate has obviously been sort of sapped by investment into the business and a little bit of margin pressure.

Yes. I mean, overall, across the business, we have big scope to internationalize it, but we need to be without adding too much risk and the investors need to remain confident that management know what they're doing on that and not Solvency tracks of others in the past. The term business is well established. The reason we see growth there, and actually, we're seeing it now, is that we are potentially in a very, very unfortunate event, we maybe had some very fortunate timing and maybe one of the winners and it's accelerated ambition there because we were, from the start of the year, really start to roll out our technology solution and we've just simply accelerated that. And we have seen a disproportionate amount of applications, therefore, coming through there. Brokers are really starting to understand what the new business model can do and the efficiency it gives. So we are hopeful that, that will really play through this year in volumes and service levels that we're able to provide. So that is where we see quite a growth for that U.S. term business. And yes, LGIM is very much around the international theme. I agree with you that we not only need to grow it into new markets. We need to also grow more profitable lines of business, but there is a huge potential around real assets. Interestingly, January, February, we were seeing a lot of increased interest in just purely U.K. real assets. There was more political stability, et cetera. And we were seeing overseas investors much more in planned to invest in that. Clearly, now, it will take time for real assets to play out people to find the pricing level, but there will equally be good investments available, and we'll be looking to drive that. Those areas plus multi-asset and more profitable lines, we will look to drive more and more activity, look to internationalize more of that. And at the same time, we will have to spend for a couple more years, as we've said, in the operator model to make that efficient. But when we're at GBP 2 million or GBP 3 trillion, then we'll have operations which were scalable that have meant that we are hugely efficient at those levels. And actually, the level of investment we make is not to be in comparison to the size of business. And it's very controlled. And I'd like -- hope to think as the CFO, we're getting pretty good bang for our buck on that in terms of unit cost reduction as a time. But that takes time, and we will continue to invest in those projects.

Okay. Now we're sort of getting close to the end. So if anybody has any more questions, please put them on the website. But before we get to that, can I just sort of -- I mean you talked there about IT costs at -- or not just IT costs, but investment costs generally at LGIM. But you've also been putting quite a lot of extra money generally into sort of IT and projects across the wider business over the last year or 2. How long should we expect that sort of elevated level of spending to continue? Or indeed, should we just expect it to continue?

Yes. Yes. That is the alternative, is it? No. We very much see or saw next year as a high-water mark on that. Now there's always regulatory projects. There's always difficulties when you list a hurdle. We do have the ongoing -- the journeys to the cloud as they like to call us term life business and in our main -- well, across the annuity business. Those are fundamental to the resilience, but also the service standards and the costs benefit, if you like, going forward. But those are continuing. They're ongoing. They were budgeted for they're not the biggest that contributed it was very much. As you said, fundamental investment into our IT platforms that was slowing, we invested a little bit more very quickly in a matter of weeks for COVID preparedness, but we would still see -- and hope over the next couple of years to see reductions in that. That's very much what we planned for. And so unless there's unforeseen usually regulatory-driven, et cetera, then we should be seeing a reduction when we fundamentally shifted our operating model, how much we outsource, how much we earned in-house, the way that we use data center mainframes versus the cloud. And actually, 12 months ago, we wouldn't have been able to get 7,000 people working from home within 2 weeks. And so it was money well spent because we've completely stayed out for business, we've made it, stayed on top of customer service. Obviously, it's not always quite at the levels we would aspire to, but it is at the levels that our customers have been comfortable with.

Jeff. I could ask one more question, but I feel we're going to overrun if I do that. So I'm going to go there. Thank you very much indeed for being with us today. And I hope have a good day.

Yes. No, thank you very much. Look forward to the conference. Thanks a lot.

Bye.

Cheers. Bye.