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

Thank you, everybody, coming to this session with CEO of Lloyds, Charlie Nunn. As usual, we're going to open with a polling question. We'll put it on the screen. Question is Lloyd's has updated its RoTE targets at 13% in '23, '24 and over 15% by 2026. What do you think stands out most about the business plan? Number one, the structural hedge and balance sheet structure delivered in a resilient NIM medium term; two, strategic initiatives, delivering additional revenue growth; three, cost discipline despite the inflationary environment; number four, resilience in asset quality share across portfolios; and number five, 175 to over 200 basis points capital generation guidance. Well, it looks like the resilient NIM, but there's also a few other replies which I'm sure we will speak to. With that, what we're going to do -- Charlie is going to make some opening remarks. I have a few questions for him, and then we'll open up to general Q&A. Charlie, do you want to go ahead?

Thanks, Alvaro. And what a great question, by the way, because obviously, the answer is all of the above. But we'll get to that as we go through this in a minute. It's great to be with you today. It's great to be with you in a time of solidity and no uncertainty around us. Start of the year has been fun. I'm sure we're going to have some questions around that. And I also understand Credit Suisse is talking in the room next door. So you're showing your colors if you're here versus there. But thanks for joining this morning. I'll just give a few opening messages, and I'll just talk about the key messages from our financial results, end of year results that we did 2 or 3 weeks ago just to set some context. And it's just these 5 points, which actually you really just teed up nicely for us, that's worth talking about. As you know, I joined 18, 19 months ago now, and last year-end results in 2021, we announced a new strategy for Lloyds Banking Group, grounding in our purpose of helping Britain prosper. And the first point is actually just to say that purpose, the focus on our customers and then the broader impact we have serving businesses, individual families, which I think is always really important for a systemically important bank to have a really clear narrative and a proven points of impact has proven very, very important in the last year. The way cost of living has impacted the U.K, the focus on supporting businesses around investment in growth, the support for our colleagues and our communities has really played out, and I won't give you the stats, but there's a set of really important ways that Lloyds Banking Group in 2022, supported customers in context of the cost of living, built financial resilience and enabled businesses to continue to invest looking forward in what is a very uncertain environment, as you know. Second core point is around our financial performance. My guess is you've got a chance to see that. I have a CFO who comes up with a different set of adverbs for every result session. This time, it's robust. But I hope what you did see was a robust set of financial performance. If you look underneath the performance and actually the performance overall, our return on tangible equity was 13.5%. We had very strong capital generation last year, 245 basis points. The business was growing and taking advantage of the interest rate cycle, which was important. We continue to show very strong BAU cost discipline whilst we ramped up the investments. And the net of that was we increased our dividend 20% and we announced a GBP 2 billion share buyback. And what I've taken away from this is now 18 months in, we do have very resilient customer base. We have very strong underlying financials, and we are in a position where we can both continue to invest for the future. We can support customers in what we are predicting to be a mild recession over the next 24 months. And we are demonstrating we can -- we want to return through our Board's material capital distribution to our shareholders. And hopefully, 2022 reaffirmed that for all of you, and I'm sure we'll get into the detail of what that looks like. We also reaffirmed our strategy, and we announced Lloyds Banking Group strategy on the day that Russia invaded Ukraine, so we've had -- you were just saying this conference always is around big events. I was very nervous that there was going to be some big geopolitical event in my second big results strategy. What's been really interesting from my perspective is I've obviously gone with the team and looked back at the strategy we announced last year. And our belief is that the initiatives we committed to, which is getting -- committing to really doubling down on the strength of our core franchises today in our client group businesses, driving growth and diversification, and we'll come back to that later, I'm sure, which we committed to GBP 1.5 billion of additional revenue, of which 50% would be other operating income. So we diversify into new sectors and segments in the U.K. and then investing in more medium-term efficiency initiatives. That strategy is even more important when I look at what we're facing today than it was on the 24th of February 2021. And it's been an interesting year for me. When you manage a GBP 900 billion asset bank, you have to manage the bank, with 26 million customers, for through-cycle returns. And very simply, the dialogue last year, which was all about when is peak NIM coming and how are you leveraged on the way up. I said, "Look, we're well positioned for that, but you need to be asking me the questions about what happens when the economy softens and when rates start to come down." And what our strategy now gives us is just a very, very strong medium-term perspective, which says, as rates start to come down, we're going to see real momentum coming out of our stable retail funding base and our structural hedge, which really builds strongly. We've got the best and most leveraged asset base in our markets with a good mix of assets between commercial, retail and secured and unsecured, which is the only way you manage through cycle returns on both sides of the balance sheet. And we are a year into growing our revenues by GBP 1.5 billion. Those 3 things together really give us confidence about the next 3 to 5 years. And hopefully, that comes through in what you've seen. We're only a year into a 5-year strategy. I would characterize that the first year is a good start. We can see the early signs, green shoots of growth, but a lot of what we've done is pretty foundational. And I've totally restructured the bank. We've brought in a set of new talent, the ways of working are starting to feel different with inside the organization, which gives me confidence that we can operate with a different level of pace and intensity and focus around our customers. And we've kicked off about GBP 900 million of additional investment last year, which is peaking this year. So a good start to new strategy. My commitment to all of you is really clear, which is I've always said, you're not going to believe us as a management team until we start delivering quarter-on-quarter, and that's what we're planning on doing. So we'll continue to update on it. And the result of all that is we upgraded our financial outlook and guidance for Lloyds Banking Group. And I suppose the key measures, which were summarized in the questions just now is we increased our return on tangible equity targets for '24 and '26 by 300 basis points, so circa 13 basis points for '24, greater than 15% -- sorry, 13% in '24 greater than 15% in 2026 forward -- looking forward. And then our capital guidance, we've said about 175 basis points for the next 2 years, but greater than 200 basis points from 2026 forward. And that's founded in the momentum that you can hear I'm talking about building through the balance sheet. I won't talk about this now, but we'll get back to it, but just for those who aren't close to Lloyds Banking Group, we have a really clear set of areas where we are differentiating and growing, and that's what we're investing in. And that's what I'll continue to talk to you about. But I think given everything that's going on Alvaro, I might stop and go to Q&A, and I'm going to shamelessly if I can go back. You can put me back to the first slide. I'll leave up our lovely branding for you to look at whilst we're talking.

Very nice.

For those who like horses, which I love.

I do as well.

Maybe we can start off with one of the last points you made, you reminded everyone that you've increased the RoTE targets by 300 basis points to 13% and above 15% RoTE in '26. That's obviously very healthy profitability. But for me, one of the things that stands out is the growing profitability despite lower rate assumptions. Maybe you can speak to that resilience in profitability. And in light of the events of the weekend, any update on the state of play, how you see the world? Is this going to be that significant? We're going to touch on competition for funding and deposits later on, but maybe some opening remarks to contextualize [ the environment ].

Great. Let me try and keep it simple. And I'm sure there'll be more Q&A around this later. The strengthening confidence we have around our profitability in the medium term is really linked to the what I just said with an additional build and the question teed it up nicely. The first is -- when we look at the strength of our customer base, we see real resilience still. I'm sure we'll talk about our provisioning for the economic cycle we're going into. And we are seeing the very, very early stages of some of that. But overall, the customer base is very, very resilient. And the fact that we have a very high percentage of retail deposits as Lloyds Banking Group, and we're the leader in every retail product that has any meaningful scale and relevance to profitability means that we have a very different dynamic than some other institutions actually in the U.K. and certainly Silicon Valley Bank. Yes, we have more than 65% of our deposit base is retail as opposed to I think it was 7% for SVB. And what that means is we can use that deposit base to invest in a structural hedge. The structural hedge we exited 2022 was returning about 1.13%. Well, in fact, it was returning 1.13%. So you'll have seen in our baseline economics, we're below the yield curve or at least we were below the yield curve until last night. I think we still are. Where we were peaking that base rates in the U.K., will peak at about 4% this year and then settle at about 3% and then be relatively stubborn at 3% because we had a view over the last 3 or 4 months that inflation will be a bit more stubborn than the market was predicting. So the first big thing is if we can invest as the hedge rolls off at anywhere above 2%, there's really meaningful uplift from a revenue perspective. So that's the first thing that gives you confidence. The second is what I said, which is we all know, right, we've -- I've been leading banks in inflationary environments for my whole working career in the last 10 years with my previous colleague [ 8 in all ], and when rates go up, liability margins widen and asset margins tend to shrink and when rates go down, the opposite happens. And what you need to manage a good customer outcome. And financially, your revenue line is good leverage. So your loans-to-deposit ratio being healthy. But more importantly, that you've got a strong client base that's well diversified across the different types of lending, so you can respond to competitive dynamics. And as you know, Lloyds Banking Group has a fantastically diversified lending portfolio. And as I've come in, I've realized the way that that's been managed over the last decade is with very good and strong origination standards. And then the third thing is you want to see that there's some additional growth, and that's where we need to continue to prove to you that we are delivering on the additional revenue growth, but we announced these revenues -- these strategic commitments around GBP 700 million of additional revenue in 2024, GBP 1.5 billion in 2026. And I love the percentage weightings because you can do the math and realize the structural hedge will be a bigger benefit than the strategic initiatives. But at some stage, the tide will go out on banking. We've lived that for the last decade of rates. And that incremental customer-driven growth with a more diversified set of fee and non-fee-based income is going to be really important. So those are the first 3 dynamics on the revenue line. You need to have strong cost discipline, and you'll have seen we have committed again to an absolute cost target in 2024. We're not immune to inflation. I'm sure we'll talk about it later, but you need to have strong cost discipline, and that's been one of the joys around inheriting Lloyds Banking Group. It's a team that understands how to manage costs, and we're now able to invest for some medium-term efficiencies, and that's what we've built within the plan. And then obviously, capital efficiency and recycling of capital out of lower returning assets and businesses or segments into higher returning businesses and then some of our strategic initiatives we announced to increase the velocity of our balance sheet last year is really important. So you can get the revenue leverage without the capital drag. And it's the combination of those things that give us confidence to upgrade our capital distribution targets or at least our capital generation targets for 2024 and 2026. Now there's a lot to play out over that period of time. But that's been founded on a set of baseline economic assumptions that I think are appropriately prudent or conservative. And I said to you last year, I'm a CEO and our management team is a team that wants to not just make our numbers look good by taking good, easy external assumptions and then focus on the controllables. So I'm not going to give you very, very easy base rate assumptions that make our numbers look better. We've given what I think is appropriately prudent and conservative baseline assumptions. And then we'll try and focus on what we can control is, which is how do we grow the business and manage the costs and build the capital efficiency going forward. In terms of what's happened in the last week and the weekend was very busy, but you've just spoken to now. So you'll know that. It's obviously very, very interesting. What's happened with SVB, I think, is relatively idiosyncratic relative to the U.K. You'll be having your own discussions around other medium-sized banks in the U.S. But certainly, it's completely different from us, obviously, relative to the way our balance sheet is formed, the nature of our customer franchises and then our own strategy around managing the liquid asset portfolio to underpin our liabilities. And if you want to go there, we can. The change shift we've started to see the flight to quality shift in the U.S. We haven't started seeing that starting here, but I'm not surprised because I think for most of the retail and business community outside of life sciences and tech, the whole SVB thing and SVB U.K., it's not really a main event. But I think it's going to be very interesting to see how that dynamic plays out in our customer base over the next 3, 6 months. I don't know how that's going to play out. I have a clear view based on having managed bank through rate cycles around what was going to happen independently of this event. But given Lloyd's Banking Group and our customer base, I'm not concerned it's going to be a negative on us, if anything, I think that would be a positive. And then in terms of the impact on the rates and bonds markets, again, there's many people in this room who are going to be better at forecasting this than me. It does feel like it's a slight overreaction at the moment in some of the adjustments, but I'm never one to discount the information that comes through the market. I think that we all need to see what's coming next. I think in the U.S., it's more complex because the actions the Fed has taken are quite structural on how banking works. Obviously, the fact that HSBC made it easier in the U.K. means I don't think we have those issues. And I think the important thing is when I look at the shift in the yield curve, which underpins some of Lloyds Banking Group's economics, the market hasn't yet come down to our baseline. So nothing that's happened yet compromises the foundations of what I've just told you as to why our customer base, which is resilient with the growth initiatives I just talked about for our structural hedge through taking advantage of the assets out of the balance sheet as rates start to decline. And then our growth initiatives, nothing is compromised by what I've seen yet. So we'll have to see, right, how the MPC responds based on whatever data we see in the next few weeks and then over the next few months. And when then the peak of base rates is going to be, we still don't know.

Maybe we'll touch on what I think pre-SVB captured the market's attention in the U.K., which is all the banks pretty much guiding to peak NIMs. There's a liability and a [ massive ] component to that guidance. Maybe we can start on the deposit side. At the full year, in the call, I think you mentioned that you had taken pricing action. And with that pricing action deposits, you expect them to be stable or even grow during this year. Maybe we can discuss what the deposit dynamics -- were deposits going to other institutions? What's triggered your actions, your pricing actions and how do you see these evolve?

Okay. Let me start that just on overall NIM and I will then focus on deposits. The simplest version of the story for us is there are 2 headwinds this year and 1 tailwind. The 2 headwinds are competition around deposits and then are starting to pass on more of the base rate increases, which we'll come to in a second. If that's all right, I will talk about it in more detail. The second is the mortgage margins repricing in the U.K. market, particularly, there was a set of business written in 2021 during the middle of COVID at about 180 basis points. And you'll have seen the completion margins we're all talking about at the moment, Q4 and then Q1. I'm sure we'll come back to that, a significantly lower margin. So there's the headwind of that margin repricing on the mortgage book as a real glass half full view of that because I think we'll be through the mortgage repricing in the next couple of years, and then Lloyds competes with a completely clear mortgage book -- clean mortgage book which is a real strength for the banking group. And then the real tailwind is the structural hedge but our structural hedge is very back-end loaded this year in Q3 and Q4. So when we gave the guidance of greater than 305 basis points of NIM for this year, we then had to do some explaining, say, how does it come off a high after Q1 then drops down because of the 2 front-loaded headwinds I just discussed, and then it stays relatively flat in terms of how we're thinking about it for the year. And based on our numbers so far, it never goes below the 300 basis points. So that's the dynamics. On deposits, look, so far, deposits have played out pretty much as we thought they would and we guided last year to, and I'll give the view around that in a second. The one caveat around all of this is no one has a crystal ball, and this market hasn't been through a rate cycle for 15 years, so no one knows what the elasticity curves are for different segments of the customer base in the U.K. bluntly. So we're all going to have to kind of work through this together. But what we said last year was for small business and retail deposits, which are obviously the really core part of how we generate value for you, the shareholders through the structural hedge -- the structural hedge-eligible deposit base, they typically aren't that dynamic until you hit a base rate of about 3%. That's true in every market I've operated in the world. And then depending on where the base rate goes to, and we gave guidance of about a 50% pass-through, what you'll see is across the different types of deposits and savings products, you'll end up with 150 to 200 basis points spread between the pass-through and the base rate. So in Mexico, when I was managing HSBC in Mexico, it was 7% rate and we had a base rate -- we had a pass-through of about 5%. We always said the base rates would end up at about 3% in 2024. But if it's 3% or 4%, we'd expect 50% pass-through. And typically, it takes a couple of years for balances to reposition to enable that. And so part of that is financial institutions like us offering higher rates on time deposits and instant access savings accounts. And part of it is our consumers and businesses moving money from 0 interest current accounts into instant access savings or into time deposits if they have the money and the liquidity to do that. And the same on the businesses in commercial side. So what happened was actually almost exactly as we thought would happen, which is when base rates got above 3% in Q4 last year or just at the end of Q3, we started to see more dynamism, more activity of consumers looking for a return and moving money both within our bank between our different accounts and then competition to move money to other players. And that's pretty much what we've seen for the last 2 quarters on the retail and small business side. And obviously, as we saw that happening, and then we got 2 base rates landing in November and December in quite quick succession. We took a bit of time to think about how we would compete on the products, and we've launched some new products and some new pricing at the start of February. So there was a gapping benefit, if you like, that we didn't pass through, but we wanted to be able to compete in a way that we thought was best for our customers and then would enable us to compete the deposits going forward. The commercial and SME business is really different. And you saw in Q4, we had GBP 9 billion of outflows. The majority was on the commercial side. And that's a much, much cleaner -- there's 2 or 3 dynamics. That's a much cleaner NPV decision. So there is a whole bunch of institutional deposits, we don't -- either don't want to we're holding for broader relationship value, and we have a very transparent discussion. There was that GBP 4.5 billion that we told you in Q3 last year was on our balance sheet we didn't really want. I don't mean that as a negative, but it didn't create an NPV, and we expect it to reverse out which it did. And then there's competition around corporates that have money to put into term deposits moving between -- more actively out of site deposits into term. And then there is a small set of corporates whose burn down is happening, whose payments have gone up to deal with inflation and supply chain costs and employee payrolls, and that's above their revenue or price pass on. So we can see some segments actually burning down their cash. But both on the retail side and the commercial side, overall cash deposits are above where they were pre-COVID. But it's the really stressed segments that we focus on in that context. Now what's happened in the last week, not much yet. So we haven't seen what we've seen in the U.S., which is the flight to quality. But let's see how that plays out, and we'll see how people feel over the next period of time. And January and February was a continuation of what I said, which is competition for customers that have money and are looking for return and us starting to compete with a broader range of savings products. And I think that's to the point in the cycle we're at. As I said, what we'd expect is this will shift and that's what's in our assumptions around our NIM, this will shift over the next 18 months. You will have all looked back at the U.K. even in 2014, the U.K. had a very, very different mix of retail and SME deposits between what was held in site deposits versus instant access savings versus term deposits. So it's a very, very different mix just 10 years ago, and I would expect to continue to see that shift over the next few years, and that's what we've got in our numbers.

And I think to -- I think you called out in the full year results that 50% beta in the interest rate sensors of deposits. In light -- maybe help us think through -- reassure us around the assumptions, maybe how you come up with that number? And in light of the events, do you think that deposit beta could go up, could differentiate between players? Maybe if there's a long lasting effect of what's happened over the weekend, maybe help us think about that.

Yes. I'll help you think about it. It's difficult to predict, right? So -- and in fact, I know some CFOs and CEOs refuse to predict NIM, as you know. I think the first issue, which is differentiated between the banks is how much of the deposit base is retail versus commercial? Because the active management of commercial deposits is obviously typically higher than retail. And the sensitivity to the kind of shifts we've seen is higher, and that makes a difference. And then it's really the retail deposit base that gives you the confidence around your structural hedge. So the structural hedge-eligible deposits. So that's the first thing that's important to look at and that we look at closely. Even within retail deposits, and you know my history, different institutions have a different mix between wealthier clients with big balances that account for a majority of the deposits versus a more distributed mass market bank, which is what Lloyds Banking Group has, where you have lots of people with less deposits. And although this is by customer, not by value, and I know you all want to talk about value. 80% of Lloyds Banking Group customers have less than GBP 5,000 in either their current accounts or their savings accounts and 5% on GBP 1,000 is GBP 50 a year. It's irrelevant in the context of the current cost of living challenges, which is why you see less activity, less movement in those kinds of customers with those kinds of balances. So that's the first thing to look at. And you can imagine, we play to our strength in that. The second thing is, obviously, the distinction between current account deposits versus broader deposits. We disclosed that for Lloyds Banking Group. We obviously have a very, very material amounts of current account deposits. And typically, there is obviously a segment of larger balances within that. Typically, customers are looking there for a great transactional account service with a great digital experience with the ability to move money in and out in whatever way they want to. And it's a free banking service, right? So they are -- the value exchange there isn't really interest rates. It's actually something completely different. And then when you get into instant access or instant access savings accounts. The real question then is, do people need that money for their own liquidity and even some quite large balances when we talk to customers, they believe they needed the liquidity if they're wealthy or do they have the ability to lock it up for 2 years, 3 years and put it into a time deposit? Interestingly, the dynamic we're just seeing that doesn't -- I don't think it changes the whole current account dynamic. At the moment, if you believe the kind of yield curve is coming down out 2 to 5 years, we'll reduce the time deposit rates that are available in the market, as it feeds through, if they stay down. So there may be less of an incentive to move money that way. And the real question for me is how much churn is there from current accounts to instant access savings and how much the banks need to pay to keep money in instant access savings? And that's where, obviously, again, the broader relationship and the value of your relationship makes a real difference. Savings is a very competitive market. So pre the rate rises even, we saw 5% to 7% of savings coming in and out. And it was a 2-way flow per month, per month. It's been that dynamic for the last decade. It has been that dynamic, most of the way through my banking 30 years in the U.K., certainly since the U.K. became a digital market. So this is what we do, day in and day out, trade against other institutions for those deposits. And as you know, even in a 0 base rate environment, we had a tack of banks and fintechs and kind of small building societies offering 2% or 3% instant access returns. So this has been the dynamic of the market all the way through the last few years.

Maybe let's touch on the other big focus. I think it was the mortgage margins. Obviously, there's a sharp slowdown in the market last year post minibudget. The completion margins were also impacted there, but maybe you can touch on that and more importantly, going forward, how do you see margins evolve? Obviously, we're going to have the COVID -- very profitable mortgages from COVID rolling over. Maybe you can give us some confidence and what do you think is a sustainable spread there given the ring-fencing liquidity trap and the usual sort of debate around that? What gives you confidence throughout the plan?

Great. Let me say that again, everything comes with a caveat that, as you just pointed out, there were some changes in the structural dynamic in the U.K. financial services that we don't fully know, right? How that's going to play through a cycle. But let me tell you what's happened and how we are envisaging it. And you'll recall that February last year, we in our strategy said we thought over the next -- through the cycle, mortgage, margins would fall to about 75 to 100 basis points. And that was the basis in last year for our forecast. As you'll recall, we were the only bank that came out with that view and a number of you challenged us on that. But we had a really clear view from the very start that when rates go up, asset margins always decline and then the structural changes in terms of ring-fencing was going to mean more competition for assets because they need leverage on their balance sheet, the other players in the U.K. market. So again, as I'd say, we started with that. What we saw through last year was actually a slightly more challenging outcome and Q4 was a good example for 2 reasons. One was every time we saw a base rate increase and the swap curve jumped up, which were obviously pricing the mortgages. And what we disclose as our completion margins is relative to a competitive 2- and 5-year swap curve, recognizing that most mortgages are fixed price and the split between 2 and 5 years has changed a bit, but it's kind of 50-50. It was more 2-year recently, and it was more 5-year at the start of last year, but broadly 50-50. So what we saw last year all the way through last year was completion margins were squeezing as competitors were taking a few weeks to adjust their pricing, but then they were coming back to somewhere between 70 and 80 basis points on new business. And apart from the minibudget, which I'll talk about in a second, actually, we have seen that continue into Q1. So new business margins have continued after an adjustment in base rates competitively to get back to that kind of range, which is good. It shows that there's sensible pricing happening in the market. It's materially lower than the COVID loans, as we just discussed. But as you know, the net impact on my NIM is very positive. And that's what happens always in rate cycles, you get a lower margin on assets as rates rise, and you're going to get more on your liabilities. So the trade for you as shareholders is still very positive at this stage. And that's a healthy margin with respect to individual mortgages and our ability to originate them. Now 2 things that happened on top of that. In October last year when the minibudget -- September, October, when the minibudget happened, if we call it that, because of who we are, we wanted to stay in the market and we -- although we pulled some of our products, we wrote a lot of business around the period that the minibudget happened. That ended up being lower margin -- significantly lower margin than that. And it's where most of the volume in Q4 happened. So even though margins recovered pretty strongly in November and December, there wasn't enough volume to offset the margin dilution of that period in October. On a gross interest base -- basis, those mortgages are very attractive, but obviously, relative to the hedging that we communicate the completion margin by they look like low-margin business. That's the first dynamic. And then the second one, which is -- we're just William and I, the CFO are just thinking about how do we help you with the disclosure going forward is we have a product transfer business, which is around existing mortgage customers offering them a better rate to remortgage with us. We call it PT here, the Americans call it refi business normally. And that's a business that we are happy to do at a lower margin. Because we know the risk is lower because we know the customer, we typically have additional cross-sell follow-ons. So we actually get a longer duration relationship, which provide us better returns and not included in what I'm about to say we have a lot of relationship value around other products if they keep their mortgage with us. So that product transfer business is at a lower margin. And that's been a very significant part of the market as customers have been looking to deal with higher rates. And when I -- if you use a 50% -- when front book is at 80%, you could say product transfer is around 50% -- 50 basis points, sorry, margin, that's diluting the total completion margins. So one of the things William and I think about is do we try and make that split out for you going forward or do we just stay focused on the new business margins? But that's what's happening in the mortgage market. Our view is that this year, the combination of those things will be below the 75 to 100 basis point margin that we communicated in February last year, but that's built within our NIM guidance of greater than 305 basis points. We'll have to see how this plays out because obviously, as you all know, and you'll hear from my competitor bank CEOs, you have to look at this across the whole balance sheet through cycle. And actually, the progression overall is very positive as we've talked about the whole way through this discussion. And that gives us real opportunities to build the client franchise and the balance sheet for through cycle returns. And so there's going to be some interesting competitive actions through this period, but I'm pretty comfortable with that being the guidance still, and it certainly what gives us confidence around how we're playing. One final thing. There were -- when I came in there were a lot of things I could -- you asked me and I could say about Lloyds Banking Group, but there were 2 really, really obvious issues that I wanted to fix early. One was I had a much bigger legacy back book of mortgages at higher margins that I think many of you certainly eye, in my own spreadsheets, discounted the value of for all the reasons that we talked about. And the second thing was I had a pension deficit of GBP 7 billion in 2019 that bluntly was stealing my ability to distribute capital to you as shareholders. The plan we've laid out, means that most of the mortgage repricing will have cleared through the system by the end of '24. So I'm distributing more capital with -- I'm probably the only bank above my cost of capital in the U.K. has strong returns with a better trajectory for the future whilst investing for strategic growth. And I'm clearing out the mortgage drag headwind, and that will position me really nicely from '25 onwards to compete with a clean back book, if I can put it that way. And the second thing is, although we're going through the triennial discussion with our pension trustees, the pension deficit we expect to be less than GBP 2 billion by the end of last year. And that means we can -- we're going to position to say there'll be no additional variable contributions, which was what takes capital away from the discussion with the Board around what we can distribute to shareholders. So those 2 big issues that probably you've been discounting Lloyds Banking Group's capital returns for a while. With everything going on, we'll have got through in the first couple of years of my tenure, which is part of the proposition we just need to make sure everyone understands.

That tees me up to a very quick final question because I want to leave time for audience to ask on the capital generation that you've alluded to 175 basis points this year and next increasing to over 200 basis points. That's over 10% free cash flow yield effectively. Should investors expect all of this to be distributed? As you look to invest in the business, what kind of acquisitions, if any, would you consider as a possible use of that capital? What are your priorities?

So capital distributions are a decision for the Board. But obviously, we, as a management team, take a recommendation. And we've always said we think this phase of the strategy is largely an organic plan with infill acquisitions where we can accelerate building capability and buying capability, which is interesting in the context of last weekend. We've done 2 acquisitions. One was just completed, as I was coming in, but obviously involved. One was Embark, which was a wealth digital platform player and an IFA platform, and we announced Tusker, which is a digital SME EV vehicle car leasing platform. And one was GBP 500 million, one was GBP 300 million acquisitions. GBP 500 million was Embark. Both meet those criteria. But we have said, our strategy is largely organic. And I do -- I will continue to look at infill capability-based acquisitions. But I'm not looking at in this strategic cycle unless something materially changes, anything other than that. So I think that's the first important point on kind of the uses of capital that could be significant. The second thing around distributions, I hope -- I've only done this 2 years for you, but I hope you're starting to build confidence. I'm committed to capital distributions through what we did in 2021 and what we're now doing -- we've announced in 2022. You need to build confidence that the Board, the new Board under Robin and me have that commitment. But all I can say is look at what we're doing. And hopefully, you'll feel the commitment is one around capital distributions if that's what's right for the group at that stage and there isn't a better use of the money. So we're certainly doing that. The final part of this is we committed to getting down to our CET1 target by the end of 2024 of 13.5%. We exited last year at 14.1%. We reconfirmed that commitment. A big part of that, as you'll know, is how do you maintain the confidence in your regulators and the government about how you're managing capital. And I think what you've seen -- you've hopefully seen with us is the provisioning we took in Q3 last year, the overall management around our risk, the positioning of the group with respect to supporting customers and businesses in this cost of living crisis all gives us confidence and the capital plan that we just made was obviously signed off by the PRA. So I'm very proactively, as the CEO managing, how do I maintain confidence in my government and my regulators in our capital plan and our medium-term capital planning so that we can continue to pay down that 13.5%, and that's clearly what we recommitted to. There was a transaction that you may not have seen that was -- we did a GBP 2.5 billion legacy portfolio, mortgage portfolio sale in quite an innovative structure. And that was because it was NPV positive for us, for you and from a shareholder perspective. But it also got rid of a meaningful amount of stressed assets under stress. And again, that's about medium-term capital planning, giving our regulator confidence that we know what we're doing, giving you confidence that we're managing this very, very proactively. So we're confident in the plan we've laid out. What I hope is you're going to have your increased confidence around us as a management team and as a Board as to our commitments around us.

We should open it up for questions. Who wants to ask the first question? There's one in the middle there.

I just had a question on what you think the likely treasurer or savior of these high balance sheets from here. We saw the response from the earlier survey that a lot of investors here expect the response to last week's event to be increased deposit betas or more competition. Equally somebody could say that this week treasurer or savior is going to be [ chastened ] and maybe less likely to change rate or term out. What's your view as a bank executive?

So I think it's too early to say what last week means. Well I'll just go back to what I said earlier, which is, at this stage, we've not seen a huge response. I mean the businesses, individuals, families across our 26 million customers. Our experience in the past, as we all know, is if uncertainty is significant, there is a meaningful flight to quality in the U.K. and we will be one of the trusted brands and the biggest by far, obviously, given the mix and scale of our business for that flight to quality. So we haven't seen that yet. If that were to happen, that means, as you've pointed out, the pressure on having to pay to retain deposits will be less, but I'm not going to predict that at this stage because I'm not sure SVB is so idiosyncratic, and it's so not in the mind of U.K. retailers and businesses more broadly outside of the fintech and tech sector. I'm not sure that by itself will be enough. There will have to be a broader kind of narrative emerging for that to be the case, to be honest, I think. And then the question comes, if that doesn't then drive a flight to quality, which makes it easier? We're back within the dynamic I just talked about, which is yes, there's been a slower growth of the big banks' deposit bases over the last year as people who are looking for return were putting money in smaller institutions. And the big banks' balance sheets have started to offer a better return in the last 3 months, and we're back into that competitive dynamic. And it's all about the quality of your customer base, the value you provide to them more broadly, your ability to differentiate pricing and launch products that meet customer needs to retain deposits and then how you win on the money that is flowing between institutions. And we're the best digital bank with the best customer base with the best data. So I feel well placed for that competition. The one thing I've said repeatedly and I'll continue to say is nobody has a crystal ball in an economy, which hasn't had a rate cycle for 15 years. I've managed businesses in every inflationary -- meaningful inflationary market in the last decade, and I can tell you exactly what happens in each of those. I have no data to say what this customer -- what the U.K. customers will do in a higher rate environment because what happened for you for credit crisis, it was very, very different. So we kind of don't know. My commitment to you is we've laid out very clearly our view on NIM, I've given you a view that we think we can broadly manage the balance to stable, to potentially up. If that changes, we'll just tell you quarter-on-quarter. And we'll make sure it will highlight what that means for Lloyds Banking Group. I'm not worried about our underlying dynamics. We have a GBP 25 billion buffer on top of our structural hedge as we exited 2022. So -- and I've got GBP 35 billion worth of the structural hedge rolling off this year, even before I think of other actions. So I've got lots of flexibility to manage this and whether or not we've said that we think we can keep the structural hedge at GBP 255 billion because we want that medium-term engine of growth for all of us to build that medium-term capital, but whether that's GBP 250 billion or GBP 260 billion is irrelevant to the value story or whatever number you pick. So we're pretty confident today. I'm not going to sit here and tell you I can predict the future. If anything changes, we'll let you know. But it's not going to change the value story unless there's a very, very significant difference or shift in what's happening.

Next question. We'll squeeze one more in. [ Vicki ], do you want to...

Yes. In the beginning of the discussion, you mentioned that you're seeing early, early signs of the asset quality issues from the softness of economy, can you....

Yes. I find that [indiscernible] behind, I'll try to relatively quickly. So the overall message is, the customer is, and I say this, surprisingly resilient. I think when you look at the data and we look at what's happening, overall, the resilience is very strong, and there's not a single part of our business, which isn't still better than it was pre-COVID, which is the starting point. And I think that's important. We have a lot of ways we can look at this. We have a very sophisticated set of early warning indicators for every subsegment, and I pull out the bottom 1% of the U.K. population by income and wealth and I look at them alone and -- so I have a whole set of data. And broadly, the early warning indicators are very stable still at this stage. As you know, from a provisioning and a management perspective, we have provisioned against an economic scenario, which is a mild recession, 1% down on GDP. You can go through the numbers. And we put GBP 800 billion worth of economic scenario. ECLs on the balance sheet in Q3 last year and added another GBP 80 million. So I'm very comfortable with the provisioning. And at this stage, we're not fulfilling that provisioning, if that makes sense. So -- but we're very, very early stages in the year. So what I was alluding to is, if I then with my team, say, let's go and look at the lowest income customers who have a high LTV mortgage from 2006 to 2008, the legacy book. And where are they in arrears? Or -- actually our unsecured book is completely stable. The other area is we know transport, agriculture and hospitality are the most stressed sectors in the U.K. at the moment. So go and look at the SMEs in that sector, which don't have cash flows that cover more than 1 month and see what stress you're seeing. And when I go and look at those customers, I can see there's early signs that they're moving into arrears at a higher rate than they were through last period of time. But the overall level is still materially below COVID, we're materially below what I provisioned for. The overall health of the customer base is very, very resilient. If I sat here and told you something else and anyone that does, they're not looking closely enough at their data, number one; number two, I would be worried, given my forecast for the economy, which is we've got a baseline set at the end of last year, which is 1% down on GDP with strong unemployment, whether it ends up at 0% or 1%. This isn't a very healthy environment. And there is significant inflation going through our balance sheet. So if I weren't seeing those -- that point of stress, I'd be telling my team to go and recut the data because I need to go and support those customers. But I'm not worried about it from a financial perspective at this stage. If it changes, I'll let you know.

I'm afraid we've got to leave it here. But thank you very much, Charlie.

Thanks for having me [ in Q&A ].

Thank you.