Lloyds Banking Group plc (LLOY) Earnings Call Transcript & Summary

Hello. I'm absolutely delighted to be joined today by António Horta-Osório, Chief Executive of Lloyds Banking Group, here at Hilton. António, tremendous thank you for being here with us today.

Thank you, Magdalena. It's a pleasure to be here with you and everyone on the...

And everybody watching, yes. We do have a brief strategic presentation available on the conference app. But here, we'll jump straight into questions.

And let's tackle the current environment head on, the both the kind of the economic disruption of the coronavirus is at the forefront of everybody's minds. And of course, it added to uncertainty on so many levels. We had a quick policy response, particularly in the U.K. with 50 basis points cut but, of course, the countercyclical buffer. But how do you, kind of yourself and the management team, react to that kind of really fast-evolving environment? And what's kind of incorporating in your business planning now?

Right. Well, very good question, obviously. So the way I look at this situation is this is, obviously, an unprecedented shock from -- an external shock from the virus. All experts and all governments are saying that if we take the right policies in a coordinated way, this should be a temporary shock. All the best advice is in that direction, but it requires taking the right policy response in a coordinated way. And we have a big role to play as banks, given this is not a crisis originated in the banking sector, like the last one. This is an external crisis, which will hit first the corporate sector. So this is not a run on the banks. This is a run on the corporates. And it requires strong, clear, immediate action to support, first, SMEs as the U.K. government has done, as you mentioned, Magdalena. So the scheme, the GBP 1.2 billion scheme with 80% government guarantee is clearly -- is very important. And we have had already communications from the government since it happened, saying this is just a first amount. As it is used, this amount will be increased, which is absolutely the right thing to do. Secondly, delaying tax payments is clearly very helpful to SMEs. Having the business rates decrease to 0 is very helpful. So I really think that the measures taken on the budget as a whole from the U.K. government and specifically to help SMEs are absolutely in the right direction. Secondly, they have been coordinated with the Bank of England with the basis rate decrease you mentioned, the FLS availability again, and the decrease of the countercyclical buffers. So that is positive as a whole, and it's really good to see a coordinated response with the Bank of England as well. And thirdly, all the banks have announced, like we did, that we have packages of additional lending to support SMEs. So this is what I mean by a fully coordinated response from government, from the Bank of England and from the banks, which have huge liquidity available, have huge capital cushions. So we are part of the solution now. And I -- fourthly, I would like to say I hear exactly the same from my friends as CEOs of other banks in Europe. Germany already announced a similar packages to support corporates. France is announcing a huge package today. Spain should announce it in the next few days. So this is absolutely being a coordinated action across Europe, which is exactly what must be done. If we believe this is a very significant shock, that given it is an external one and is a temporary one, what has to be done is coordinated action both on the fiscal front and monetary front to support corporates and businesses and also individuals to go through this temporary shock, where the economy progressively slows down as people have to go into self-isolation in order to minimize the impacts of the virus. What have we been doing in terms of planning and how do it change our planning, as you say? Well, it changes a lot. First, we are working mostly remote -- remotely. We have more than half the people working remotely in the bank and increasing that as the U.K. government steepens up the measures and asks for people to progressively completely self-isolate. We are very well prepared to do that. Secondly, our planning cycle has shortened significantly. So from a very long horizon, I am now running the bank with a much shorter horizon, and I'm having virtual meetings with my GEC members every 3 days to assess how things go, what has to be done? Are we seeing all the signs from our customers? Are we helping them as they need? Do we have enough people to support the call centers, to support customers that are calling us? So that's what we are doing. And thirdly, I'm very focused personally on helping and coordinating with the authorities and the government, the policy responses.

No, no, absolutely. What do you hear from the ground? What do you see -- what do you hear, particularly from your business bank in terms of what are the consumers ask -- consumers and the corporate is kind of asking for? It is the drawdown of the commitments? Is it the liquidity lines? What do you kind of -- yes, what do you see literally?

I hear a lot about liquidity lines from other banks and from papers. I know...

Yes. Yes, of course.

But it is not the case of Lloyds, because we have designed the bank to be absolutely focused in the real economy of the U.K., especially on households, small- and medium-sized businesses and insurance. And you have heard me say for many years now that I did not like the situation on the corporate -- large corporate sector. I did not like the risk-adjusted returns. I did not like the covenants. I did not like the huge amount of lines available and used at low returns. So we have gone away from that for a long time and, therefore, we have minimal requests in terms of using the lines immediately that is not significant for us at all. What I hear from the ground is very little on the retail sector. It's also early days. On the SME side where we are the largest lender to SMEs, I have asked already my teams to visit all customers, speak to them for 2 weeks now. And we have had some requests, but very small, less than 50 requests for support, but that is just early days. It is clear that the unfolding of the situation, as companies sell less or have their supply chains interrupted, they will need working capital support. That is absolutely clear. That's why what the U.K. government did was very important, and that's why we are doing our bit in terms of supporting our companies and supporting our corporate customers and being there for them. That's our purpose, to help Britain prosper. So we are absolutely committed to do it. We have ample liquidity. The decrease of the countercyclical buffer is really important for us because we are 90% ring-fenced, therefore, the impact on us is proportionally even larger than for other banks. And we absolutely intend to support our customers, of course, the valuable customers.

Yes, yes. Maybe kind of slightly more medium term. We've completed the second year of the kind of strategic plan. And it, of course, has been quite a challenging backdrop with the Brexit policy, with the changing rate outlook. When you look back, what do you consider the key milestones of the last, of the -- kind of the last of your strategic plans?

That's a great question. In a nutshell, which is the 2 slides that I have on the presentation that people can consult afterwards, in a nutshell, what we wanted to do in the third strategic plan was to build up a huge additional competitive advantage for Lloyds. And what was that competitive advantage? In my opinion, and we did a huge work together with GEC and Board in June 2016 before embarking on the third strategic plan. We thought that the world would evolve basically into higher, much higher technological competition from fintechs, narrow banks, large techs, and we could face lower interest rates for longer, which is now, I think, again, a reality. And we thought that in that scenario, only the banks that could significantly step up their investments for the benefit of customers, creating a huge digital platform to serve evolving customer needs, but at the same time, could relentlessly lower BAU costs in order to protect the appropriate returns for shareholders, would be the ones that would survive and have appropriate returns. So in the way I saw it, and I see it now with the hindsight of 2 years, customers will want, all the time, to access us more often, want more products cheaper, personalized, and that requires ever-growing digital investments. And in order to be able to amortize those digital investments, you need a large customer base, we are the largest retail bank in the U.K., and you need to lower BAU costs so that your total costs continue to go down. And as your total costs continue to go down and you improve your cost to income, as we have been doing, we have a huge difference of cost to income versus any other player in the U.K., then we can step up those investments, keeping our dividend policy and our desired returns for shareholders. We now are on the third year of the strategic plan, and that advantage is clear. Our cost to income, which is the lowest of the market by far, has again improved over the last 2 years versus the peers. Our investment was stepped up to GBP 3 billion discretionary investment, because our total investment is closer to around GBP 8 billion on the plan. And our dividends continue to increase as per our ordinary dividend policy. And our return on tangible equity has also increased, as the legacy issues fade out and PPI is now finished. So this is a huge competitive advantage, I repeat, because it enables us to invest massively to the benefit of our customers and to automate the bank further. That increases NPS scores and decreases BAU costs. The cost to income improves again. As it improves again, we can release more investments, and we can keep returns for shareholders. So it's a virtuous circle, which I believe is a huge competitive advantage. And now in the third year of the plan, I'm very confident that we are going to get to where we want because we are already there.

So in that position of strength, let's talk about the repercussions of the policy kind of changes. We've talked about kind of some, but let's delineate them.

Yes.

So of course, we've -- the Bank of England cut rates by kind of 50 basis points. How does that permeate into your business, into the margins that you have been kind of talking about kind of back in -- kind of back earlier in the year? How do you see that kind of sensitivity evolving from here?

Right. So we have to take the policy response as a whole. The 50 basis points decrease in margins is obviously negative for any retail commercial bank. I think you can assume the first 25 were not very impactful. The second 25 are because the cost of our deposits was already around that level, so we should not decrease them further. And that has an impact, which we gave guidance. I mean we gave guidance at year-end, and that guidance stands. You just have to apply where the curve is today. So we said, our swap rates for 5 years was assumed at 75 basis points. At the time it was 65, we gave you the sensitivity. Now it's around 55 because the curve steepened, as base rate went to 25 basis points. So we are now deploying part of the structural hedge, given that the curve has steepened and we had huge capacity to deploy. We are deploying part of the structural hedge. You should bear in mind that as rates go to 0, and we have more rating-sensitive deposits, and therefore, they will accrue to the structural hedge volume as a whole, which is positive. And also, we continue to grow our current account balances above the market, which shows the strength of the franchise, the trust that people have on the Lloyds brands, as we continue for 5 years in a row to increase our current account balances above the market with a multi-brand approach. So in a nutshell, 50 basis points negative for us. Like for other retail commercial banks, we gave you the sensitivity. On the other hand, the FLS is positive, because we can draw around 5% of our loans in FLS. We have around more than GBP 400 billion of loans. We will absolutely use FLS and draw it as quickly as possible to support our customers, but also to replace opco debt that we would be issuing at very high spreads now to no longer be necessary, and also to buy liquid assets of high quality for our liquids portfolio, where now credit spreads are very high. So we have been buying assets at very good spreads and very high quality, like covered bonds and others. So you have -- we have some offsets there in the FLS from the cost of the FLS, from replacing opco, from buying high-quality assets for our portfolio. And finally, the countercyclical buffer, which, as I said, is really important to us because we are 90% a ring-fenced bank. It's a huge impact. It decreases our capital requirements very significantly, which show that we are even more prepared, apart from the fact we started from 13.8% fully loaded CET1 ratio, we have now the capital requirements lowered. So we have absolute an enormous amount of capital to support our customers and to face the pro-cyclicality of IFRS 9, as depending on the scenarios that all banks will set up after Q1 and on the moving into stage 2, stage 3 works. And I also want to mention that I think the U.K. government and the regulators and the banks, we are all as well, in a coordinated way, looking exactly at the impacts of forbearance rules on moving into stage 2, stage 3 to minimize the impact of pro-cyclicality in terms of [ eating ] capital that has been released, on the other hand, from the lowering of the countercyclical buffers, which is a really important policy. To give you an example, the guarantee, the 80% loan guarantee from the government to small businesses has a huge impact on pro-cyclicality, because given it's 80% government guaranteed, you have only 20% of the pro-cyclicality going forward. So that's an example of the impact that the coordinated action to support SMEs and corporates can also have on the impact on the banks, if done properly, as the U.K. bank and the Bank of England and all the regulators are doing.

Yes. But of course, I think the market is really kind of struggling with the moving parts because of where we have the -- of course, we've got the help programs effectively assuming that the -- particularly, the provision of liquidity, the provisions kind of for lending to SMEs to commercial part of the economy is going to increase. So that's the underlying part. Of course, at the second time, as you've mentioned, IFRS 9 kind of pro-cyclicality, given its sensitivity to the economic parameters that we will kind of have to kind of put through, are still a little bit of a -- of course, not to you, but from an outside in, quite difficult to actually kind of measure. So is this how you see the countercyclical kind of buffer, either the ability to grow lending kind of short term temporarily as we -- as the banks are kind of fulfilling the liquidity needs? Or as an ability to cover the increase in provisions given the pro-cyclicality of the model?

So the way I look at it is the following. So you have, as you just said, several steps in that equation. In terms of the scenarios, I think we have to wait for the end of Q1, which is 10 days away, and see what's going to happen. But why is it important to wait a few more days? It's too early to tell. Because we have the impact of the virus, the economy will progressively slow down as every country, including the U.K., will go into lockdown, which is the right way to make the right balance between supporting the economy, building capacity in the NHS and saving people's lives. So that's exactly the right thing to do. But we are forgetting that it should be a temporary shock, therefore, scenarios have to see beyond the temporary shock. And secondly, I am absolutely confident we are going to see a massive government response and regulatory response, which has to be taken into consideration for those scenarios as well, as we were just discussing. So what Germany announced, what France is announcing today, what [ the chancellor ] will be announcing later on today and over the next few days, Spain probably over tomorrow or the day after. So all governments are going to do massive fiscal measures and guarantees to support the corporate sector and avoiding a run on corporates originated by an external factor to become a contagion into the financial sector. So we have to wait and incorporate all those actions, which are not ceteris paribus in our economic scenarios. And together with the fact that if the policy action is taken coordinated and in the proper direction, this will be a temporary phenomenon. First point. Second point, those scenarios, as you were saying, will then filter into pro-cyclicality through going to stage 2, stage 3 through the accounts of the banks. So we are also discussing our forbearance policies to protect our customers with the regulator and with the auditors. And I think we will have measures there, and we will also have the government guarantees, which immediately counter attack that pro-cyclicality, right? And thirdly, in the case of Lloyds, we are a 2/3 retail bank, 1/3 corporate bank. I have GBP 300 billion of mortgages, which is 2/3 of my loans, where I have a 46% average LTV and only 10% of my loans are above 80% LTV and practically 0 above 100%. Why? Because of the measures we have taken over the past 5 years in decreasing lending to large houses, London, Southeast, not growing the book, avoiding and decreasing buy to let. So we -- you have to understand that for a retail and commercial bank, what really matters is not what we do today, it's what we have done over the last 3 to 5 years because we are a stock bank, not a flow bank. A retail commercial bank is mostly a big stock of loans and deposits which we have to manage properly. And then you have a small amount of new business, which progressively changes the book. That's why it's so important to take measures well ahead of events. And I always said I wanted to build a safe, simple U.K.-focused retail and commercial bank. And my loan book as a whole, at GBP 440 billion, is exactly the same it was 8 years ago. That should give a lot of comfort to investors. I had large corporates, which I thought were excessive and not with the proper returns, which I decreased. I had mortgages which were excessive. I decreased them, deemphasized buy to let. And I have increased credit cards by buying a good seasoned prime book MBNA by increasing SMEs 2%, 3% a year, which is a great sector; and increasing car finance, where I only have 15% market share, and it's 80% secured. But the whole book is the same, and it's a very safe book as people will see. And it's GBP 300 billion, I repeat, 2/3 mortgages, 46% LTV, which means that we can give holiday payments to our retail customers, which is in place with us as with any other bank. People, normally, if they had a marriage in the family or if they had -- they lost their job and they were in between jobs, they could come to the bank, ask 2-month holiday repayment, which is automatically accrued to their balances that they earn. We have a huge capacity to do that as well now and the other banks for problems of the coronavirus on the retail sector. Our customers have GBP 700 billion of value in their houses with GBP 300 billion of loans. We can use that appropriately to help them mitigate and go through this temporary shock, and that's what we are here for, to support our customers responsibly in an appropriate way and fulfill our purpose, which is to help Britain prosper.

How do -- of course, let's talk about kind of mortgage market overall. Of course, we had a kind of a little bit of a bounce in the beginning of the year on, you can argue, kind of some at least election clarity. And how do you see the kind of competitive environment in kind of U.K. mortgages at the moment? So of course, we did have a start to a year in January and, of course, probably even mid-Feb.

Yes, that's right. I mean I said in the yearly results at the end of February that the competitive conditions which had eased in December had continued to be better in January. We had done substantially more mortgages, as I said then, in January that will help on the plan. I can tell you that it has continued in February, and the competitive conditions have stayed the same in February. And they have improved again in March because the swap curves went backwards and prices in the market, and most mortgages are fixed rates, did not decrease as much. I would expect it to continue because with the coronavirus and the flight to quality, I think people will be more risk-afraid in the banks, and therefore, they want -- they will want to protect margins and capital more. As we have been doing for a few years, I would expect the competitive environment to be better. And we have seen that since the decrease of rates again last week. We continued to perform better than we thought in terms of applications, which, by the way, will only convert into closing and they will go on the books after 3 months. So that's an impact you will see more in Q2 than in Q1. But on the other hand, as you say, given the coronavirus and the progressive lockdown of the U.K. and all countries, obviously, the new business will slow down. People don't visit houses so much anymore. They are more concerned. They will, therefore, ask for less mortgages. And therefore, there will be less new business. But again, we are a stock bank with a small new business inflow. And we have already been quite prudent in how we manage the mortgage portfolio by keeping it reasonably stable. And we bought a few assets like, as you know, the Tesco mortgage book, which was really good, prime book, GBP 3.6 billion in good economic conditions. If more portfolios like those comes to the market, we'll obviously look at them, given we have the liquidity and the capital to look at them. But I think there will be a slowdown in new business with the slowdown of the general economy.

Let me take a couple of questions from the web. So it's -- the first one is about kind of exposure. So I suppose that we've -- yes, we would -- we knew we're going to get there. Particularly, your -- how do you think about your exposures to energy, to the hospitality sectors?

Yes. Well, so those are some of the sectors that are more affected, obviously, oil and gas, on one hand; energy, as you say; on the other hand; airlines, travel agencies, hotels, restaurants. On oil and gas, you have heard me say as well for many years that we wanted to decrease our exposure there and also within the context of large corporates. We have disclosed in our annual report, we have less than -- we've got some GBP 1.5 billion exposure to oil and gas, very small exposures. In terms of hotels and airlines and hospitality in general, we also have small exposures. We are comfortable about that. Our main business, as I have said before, is 2/3 mortgages, and we have the consumer sector. Within corporates, we have GBP 35 billion of loans to SMEs, and we have GBP 20 billion to financial institutions and around GBP 40 billion between mid-sized corporates and large corporates. So it's a smaller part of our book. We are quite well diversified. Obviously, some companies will have difficulties. Again, we are here to support the companies that are our customers and that deserve our help with proper business plans and with a coordinated actions we discussed. We don't have any special concentration in those sectors like airlines.

Yes. But of course, your mix is very protective, particularly in this [ type of ] environment.

Especially with the mortgage. And we have not been growing, which is always a good thing on this type of circumstances.

Yes, absolutely. I've got a couple of more quick ones. How do you see the outlook for your fee generation in 2020? We broadly -- we touched upon NII and the impact of the ROI.

Yes. Well, I think it's logical that as the country goes progressively to lockdown and self-isolation, there will be less activity. And our fee income is very much generated by activity. While NII is very much generated by stock, ROI is very much generated by activity. So as there is a progressive lockdown, obviously, that will impact our ROI, in general, like the rest of the country.

Absolutely. There's a question about kind of the impact of IFRS, particularly in your consumer lending on the premise that you've grown the motor lending, as we have kind of -- we have discussed. And after MBNA, you've got, of course, much higher kind of market share in the credit card kind of market as well. So the question really is, how do you think those portfolios will respond in a current kind of scenario?

So we are very comfortable with -- about our credit card portfolio. It's absolutely a prime book. We don't do anything near sub-prime. And as you know, MBNA was a full prime book, and 20% of the customers were already our customers in the group in other products. It has been performing very well, has great risk-adjusted returns through the cycle. I had promised investors a 17% ROI post acquisition. It was actually 18% because we did it quicker and we got some revenue synergies both from MBNA into Lloyds cards and vice versa. Very pleased to have around 24% market share now, the largest in the country. Of course, a situation like this requires attention. We'll have to look at each customer. It will be its own case. And we'll look how best to support them. There is a higher AQR in cards than in other products, but there is also higher returns. Through the cycle, we are very comfortable about our credit cards. And in car finance, where we have a smaller 15% market share, 80% is guaranteed by the value of the car. You know that we have been always very prudent in terms of forward prices used on the residual value calculation. We have also generic provisions apart from that because we are generally a prudent bank in terms of provisioning. And we will also monitor -- each customer will be a case, and we will support our customers as appropriate. I mean we are a bank for the good and bad moments for customers. We are through-the-cycle bank, and we have, I repeat, all the liquidity, all the capital and very strong customer knowledge to support our customers as more appropriate for them to go through this extraordinary, but hopefully, temporary external shock.

Of course. Now just a follow-up from the kind of very strong capital, very strong liquidity kind of comment. Of course, one of the main kind of surprises in the 4Q was the capital -- was the capital print. And you have guided towards the 170, 200 basis points of organic capital generation. And of course, at the moment, visibility, particularly kind of short-term on the next, let's just say, the next kind of 3 months, is quite poor. But what do you -- how do you see that kind of target with kind of knowing what we know that effectively we are going into kind of lockdown over the next kind of couple of weeks? And it will, of course, have quite a significant effect on some of the revenue generation, particularly on kind of fees. Where -- knowing what we know, and I know it's February -- sorry, not February, it's March. I forgot. How do you think about that organic capital guidance? And I assume also, I think that when people think about your kind of profitability, should the impact on revenues be particularly ugly, what's the flex on your cost side?

Right. So I mean it's a bit early days, as we said, because the main impact that is more unknown, as we discussed, is the impact of IFRS 9 and pro-cyclicality in terms of provisions, as we discussed. And that is too early to say because we have to see the scenarios. Hopefully, given everybody thinks it's a temporary shock, you have to go through that. You have to see through that. And then we have to see forbearance policies impact on stage 2, stage 3. So there is uncertainty there, which will be clarified in the next few weeks. If you go to the revenue line, as we discussed, we have some impact on margin, as we just discussed, but we have some mitigation from FLS. We have, on the capital requirements, a significant decrease, 200 basis points countercyclical buffer. We are 90% ring-fenced, that is really helpful. And in terms of costs, we have a commitment to be below GBP 7.7 billion. You know our track record on costs.

Yes, very good.

Obviously, the situation requires more action, as we have already discussed in our Group Executive Committee for 3 weeks now. And we have significantly [ weigh ] in our investment program. I have always said, so apart from the fact that lower activity leads to lower ROI, that leads to lower cost as well because people are at home, they don't travel, we have less costs as well. But apart from that, I had always said I would never decrease my investment program because it was providing exactly what I wanted, building the competitive advantage, and uncertainty should not change that if I thought that the direction was the same. Now we have a huge external shock, which will provide a delay, and therefore, we will absolutely use that lever and delay our investment program accordingly. Competitively, it will not affect us because everybody will be in the same position, starting from the fact that you have to work remotely. And when you work remotely, you can assure basic functions of the bank for the benefit of customers. But you are not able to implement change programs as quickly and as effectively when you are working remotely. So we have decided that we are going to see the programs one by one, and we are doing that as we speak. And we will obviously delay our strategic investment program according to the delay of the coronavirus impact. So we have some lever there, which will be used already this year, and we will comment more about it in the next few weeks.

Perfect. Perfect. So António, thank you very much for being here with us today, and thank you very much for everyone watching. Thank you.

Thank you.