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

Good morning, everybody, and welcome to the UBS European Conference. It's my great pleasure to welcome William Chalmers, the CFO of Lloyds Banking Group, a great supporter of the conference. My name is Jason Napier. I run European financials research in the equity department here at UBS. William, thank you so much for joining us.

Pleasure. Thank you for inviting me, Jason.

So there's an awful lot going on in the world, and there's an awful lot going on in U.K. banking. Let's start with the elephant in the room, perhaps. It's been 2, 2.5 weeks since we had the court judgment in the Court of Appeals. What have we learned? How has the thinking evolved over that time?

Sure, sure. Yes. Well, thanks for the question, Jason. And again, thanks for inviting me. The -- as you say, we may as well get the big issue on the table in the first place. The Court of Appeals ruling was an unexpected change in the law at the time, as you know. It moved the debate from a question as to commission's fairness, which was the focus of the FCA inquiry into motor commissions to a debate around the disclosure of commissions and, likewise, the informed consent on commissions. So in that sense, it's moved the debate along, as I said, a somewhat surprising and unexpected turn of events in terms of the interpretation of the law. Now what is very clear right now is that there are a lot of uncertainties in this topic. So three main buckets that come to mind. One is judicial uncertainties. Will the appeal be taken? If it is taken, what is the determination? Likewise, the Court of Appeals put the remedy in the hands of the lower court, so nobody quite knows what a remedy might look like if one were to apply. Second set of uncertainties, what type of factual circumstances might this Court of Appeal ruling apply to? So questions about customer vulnerability or alternative sophistication, questions about disclosure around documentation, questions around sales processes, these types of questions, what are the factual circumstances to which that ruling applies? Third bucket of uncertainty is what will the FCA do. Will the FCA determine to make any changes to motor complaints, for example? Will it execute a stay of complaints? So you can tell from those comments, Jason, the situation right now is replete with uncertainties. I've mentioned three buckets, there are probably others. And realistically, that is going to take a while to play out. It's going to be with us for a few months yet, and we'll see how it plays out. The position of the bank, as you know, remains that these are uncertainties that we're just going to have to deal with for the time being. We are determined from a customer point of view to stick with our customers where we can. Pretty much the day after the ruling, we went out with a no commission and, therefore, compliant structure, which allowed us to stick with customers, which allowed us to continue to play our role, if you like. As we speak, we're now rolling out a compliant commission-based structure, which obviously has disclosure and obviously has informed consent alongside of it, which, again, allows us to continue to play our role in the transportation sector and participate in what we consider to be a long-term profitable and attractive business.

So we published a short note last week where we just looked at the historic sort of time lines of Supreme Court action. As you said, the Supreme Court needs to first decide if it's going to hear an appeal. But it looks like on historic averages, a decision is an early 2026 event, although there have been calls for an expedited process. Lloyds and FirstRand are sort of fairly unique in the sector in having made provisions so far for what was a narrow area of inquiry. How should we be informed by just how complex and uncertain this issue is when we think about the potential for a need to revise those sorts of provisions?

Well, you can tell from my comments, Jason, there are a lot of uncertainties out there right now. I mentioned judicial. I mentioned the fact patterns that this ruling might apply to. I mentioned the FCA terminations or intervention or otherwise. There's three right there, they're all pretty major. And within that, there's a whole spectrum of uncertainties. So I think that's going to be with us for a little while. You mentioned, Jason, that you thought a Court of Appeal ruling might come in 2026. I'm not so sure. It may come sooner than that. There is the potential at least for an appeal to be granted sometime in the not-too-distant future. If it is granted, it may come in an expedited format, which in turn will allow us to reach a decision potentially around halfway through next year. Let's see. This is speculation right now as are many things in connection with this issue. But I think we -- if we are fortunate, if you like, we might have resolution somewhat ahead of the time table that you're suggesting there. In terms of where we go with respect to any provisioning, as you know, we've got GBP 450 million provisioned right now for the FCA inquiry, which, as I said, was around the fairness of commissions. This is a new, and as I said, unexpected legal development, which is around disclosure of an informed consent to commissions, so a slightly different point. We, from our perspective, at least, remain very committed to our capital distribution commitments and objectives. We're sitting on, as you know, a very healthy capital position. It's a very capital-generative bank. We'll keep the motor situation under review, recognizing those uncertainties. And any provisioning that might be required as a result of them, Jason, is going to take a while to play out.

Very good. And certainly, I think we're on an agreement that early resolution is better than delayed, for sure. Turning to sort of issues more pertain to today's banking environment, the budget. We've had yields move up, sort of quite a lot of talk in the market around why that is and what that implies. As far as the bank itself is concerned, how do you see the consequences of the budget for the firm?

Yes, it's interesting. When we look at the budget, it was focused, as everybody knows, on education, on housing, on health. And all of that kind of makes sense, but it probably had a bit less immediate growth impetus than we might have expected. It's good to see that there weren't any targeted impact upon banks. That is to say no bank tax in there. There were some relatively minor product implications, EGM, pensions, but on the whole, not terribly meaningful. So all of that is good to see. I think when we look at the budget, it is likely, we think, to provide a near-term fiscal impetus. That is to say the increased levels of spend probably will raise growth profile a little bit above what we have previously expected. You've commented there upon the rate picture in particular, Jason. We have seen a period of volatility post budget in rates. Let's see where it settles. It was the case before the budget that actually rates were settling a little bit below our expectations. As you know, we're expecting rates to settle around 3.5% by 2026, and the market is coming in inside of that. I think then in the speculation post budget, they've kind of moved in the other direction. Right now, it's not terribly far from where we would expect rates to settle. Maybe it's a little bit above. I think as long as rates don't, if you like, quell or hinder economic activity, then overall, from our P&L perspective, that is probably a net benefit -- a modest net benefit. But nonetheless, it will come through the benefits to the refinancing of the structural hedge and, as I said, may provide a bit of a macro stimulus to the economy in the context of 2025 and beyond as the fiscal stimulus comes through. One further point, when we look at the particular measures within the budget, we've seen the NIC increase. That will impact us just as it will impact all businesses going forward. We think that's probably about a GBP 100 million full year run rate NIC impact from what we've seen.

So the reloading of the hedge at better yields is fairly easy for us to sort of think about. Does it do much to sort of impact the forward on mortgage spreads, do you think? So net-net, it's a marginal positive, as you say. Do we need lower rates in order to get the right balance between asset and liability spreads in the way that you model out the future?

Well, maybe just take a step back in terms of what we've seen. We've seen mortgage spreads actually be pretty stable over the course of this year. So we've seen about 70 basis points typically in terms of completion spreads. It was a touch above that in the course of quarter 3. I do think, as your question implies, Jason, that those mortgage spreads are somewhat couched in the overall margin environment. So as you know, we're seeing margin environment right now that is 2.95%. We're seeing it strengthen as we speak. That's an expectation for the remainder of this year. It's an expectation for '25, and it's an expectation in a ramped up way for 2026. So that margin environment is improving. Now within that, what happens to the mix between mortgage and liability spreads, I think, is in a sense of slightly lesser important. What you're measuring more is just the overall spread that the business is achieving. As I said, what we really need for mortgage spreads is a period of swap stability. When we get a period of swap stability, we'll see them settle maybe a touch above where we are right now. That's traditionally been our expectation. But on the other hand, if we're seeing an overall spread of the type that we're seeing today and certainly heading in the direction that we're seeing today, we'll be happy with that.

Certainly. We think that the U.K. domestic sector will probably produce the best NII growth in Europe over the next 2 or 3 years, the hedge being a particular driver of that. If we were to just take a step back, because I appreciate it's the day job to get the aggregate right captured on both sides, if you were looking to a generalist PM-type conversation who was convinced that mid-single-digit NII growth over the next 2 years is what the system ought to, in what environment does that not happen now given the base case we have around macro?

Well, I might just start your question at a slightly earlier point, Jason, and say what environment does it happen? So where are we right now? As I said, we've seen an improvement in the margin over the course of quarter 3 versus quarter 2, a couple of basis points, 2.93% going to 2.95%. That is also matched by an improvement in NII of around GBP 70 million, GBP 75 million or so quarter 2 into quarter 3. As I said at our Q3 results, we expect that to continue looking forward. It may be that it's slightly slower in the course of Q4, largely because of nonbanking net interest income developments, but that's just a temporary factor, and it won't be terribly significant. It does put us on a trajectory both for rising NIM and rising net interest income in '25 and then stepping up the pace further in respect of 2026. So I expect a pretty good picture for net interest income in '25 and then a better picture in respect to '26. Now what's going on behind that? And I'll come to your question in just a second, Jason. What's going on behind that is basically three main factors. So we're seeing the headwind of mortgage refinancing, if you like. Mortgages are coming off at around [ 110 ] in quarter 3. They're being refinanced back on at around 70 basis points. So you've got a 40 basis point mortgage headwind there. That continues into '25, more or less exhaust itself by the first half of '26. And then you've got deposits as a headwind. We are seeing slowing churn in deposits, that is to say slowing migration from noninterest-bearing to interest-bearing and within interest-bearing to fixed term. So that is slowing down for sure in Q3. But it is also being somewhat augmented by base rate cuts. Every time you got a base rate cut, you've got a lag in terms of repricing of deposits. We expect 3 base rate cuts in '26 -- sorry, '25, forgive me. And so that is going to be a factor. But again, it is somewhat mitigated by slowing pattern of churn consistent with the falling rates environment. Now those are the headwinds. They are offset -- more than offset by the strength of the structural hedge as it comes in refinances, which, as you know, is GBP 242 million of balances, currently earning 1.8% on a yield basis, refinancing into, let's say, 3.5% to 4%. That is a very powerful tailwind. It's certainly in place for '25. It picks up even further in '26. And we put numbers behind that before, Jason, as you know. So we said we expect that structural hedge to deliver growth in contribution of greater than GBP 700 million in '24, growth of significantly greater than that GBP 700 million again in '25 and then materially greater than that in '26. So there is a ramping up of the structural hedge contribution, which, as I said, more than outweighs those headwinds that I mentioned in the form of mortgages and deposits. Now that is augmented by average interest-earning asset growth. We do expect decent loan growth over the course of next year off the back of the macro that we talked about a second ago. So that's also building the NII picture. And overall, it leads us to feel comfortable with respectable growth next year and then growth in NII that picks up further in 2026. You asked what might kind of present the counter case, if you like, Jason, what might go wrong, I suppose. One relatively extreme point that one might make there is if we had a sudden collapse in rates. If we're back to the 0 rate type environment that we experienced before COVID, I suppose, where we see a very flat curve, that's a tougher environment for banks. No question about it, and it puts pressure on basically the system on the asset and liability side. We saw a little bit of that in the course of the 2010 to roughly 2020 period. So that's one. I think that is unlikely based upon everything that we see right now. And in any case, it's always a relative game, right? So Lloyd's as a scale player in all the major markets would expect to fare better than others, particularly with its business focus in retail and commercial. So it's not an environment that we would welcome, frankly, but we would still expect to compete very, very strongly in that type of environment. I think that's the main one, Jason. There are other scenarios, which are tougher from a bank perspective. A deteriorating macro might be a further example. That's less about spreads, clearly, but it's more about total returns that we might expect to see. In fact, in that type of environment, as you know, historically, spreads tend to go up, but it's just that you're in a slightly less welcome impairment environment. So probably those two, I would highlight.

That's helpful. We published a sector piece yesterday. We think the bank sector will do 25% in the next 12 months, and that may be the last 25%. We've had a 5-year bull run. But the base case for that is that, as you say, 12 months from now, the curve is upward sloping and the rate cuts are done says the curve. The curve changes its mind every couple of days. It feels like at that point, deposit mix will have stabilized, margins will be rising, default risks will be lower, loan growth will be coming through. It all feels like the sector that shouldn't be trading at 7x, and Lloyds is obviously at a small discount to that.

I won't obviously comment on valuation. That's really for the room to determine. But there's no question those trends that you just described, Jason, in terms of spreads, in terms of loan growth, in terms of income, it's happening as we speak, right? We saw it in Q3. We're seeing it again in Q4. We expect to see it in '25 and then growing in '26. So I don't have any question about that. We've talked a bit about the structural hedge, and maybe I'll make one more comment there. The structural hedge in many respects is a legacy of previous years, right? Let's not forget that. The structural hedge in its earning capacity of 1.8% is effectively a function of where rates were over the course of the last 3 or 4 years, not a function of where rates are today. So where rates are today is a much better reflection of the enduring earnings power of the bank.

One of the other things that Lloyds has been more vocal on and, I believe, invested more in is diversification of the business. Your other operating income line, the GBP 750 million you're looking to add this year, that's 10% of group PPP. It's a big number, and you're looking to double that over the next 2 years. It feels like as much as in February, we'll look at your 2025 guidance. Very quickly, we're going to move on to '26. The hedge is doing better. You've promised much more on OOI. In terms of building blocks for that, the past investment that you've put in, is there much that you can add to reassure investors that, that '26 number will come through, given that if it does, I think consensus is probably 10% too low for '26, and that's not far into the future anymore?

No. I think with every day that we get closer to 2026, our confidence in the '26 outcomes builds, for sure. The -- you asked about OOI generally, Jason, and you asked about strategic initiatives, revenues as part of that. Maybe to pause on the first point, OOI, as you know, it has been a good story. We're up 9% year-to-date, year-on-year. It's a pretty good performance. We expect that to continue over the course of the next couple of years. So we've seen robust OOI growth, and we, again, expect that to be a pattern going forward. Now what's behind that? I think a couple of things, really. One is a bit of a resumption of activity supported obviously by a relatively stable macro that we've seen. That's coming out of COVID. We've probably taken advantage of the catch-up period post-COVID. But again, it's supported by reasonably robust macro circumstances. And then it's obviously driven by strategic initiatives, as your question highlighted there, Jason. What are we seeing in that area? We have two main commitments out there. One is GBP 0.7 billion of incremental revenues with respect to '24. We're well on track to deliver those. We'll give you more commentary at the year-end. The second is the GBP 1.5 billion of incremental revenues in '26 as per your comments, Jason, of which we think about 50% are going to be OOI. We expect about 50% to be OOI. And again, we feel very comfortable with respect to those commitments on the basis of what we're delivering so far and what we see in the pipeline, if you like, for the year or so ahead. I think what's good about that is that it is, a, it's growth; b, it's diversified, I'll come back to that in just a second; and c, it's capital light effectively. So all three of those things feel pretty good in terms of the strategic transformation of the business. And just commenting briefly on each of them. The growth point I've just commented on, 9% year-on-year, year-to-date, we'd expect a pattern to that end in a similar spirit. On diversification, we're seeing it come through retail, for example. We're seeing it come in the context of mass affluent. We're seeing it come in the context of transportation. Commercial, C&I revenues, for example, up 30% versus half 1 '21 and a consistent pattern of, if you like, productivity out of the strategic investments that we've made. IP&I, we've seen significant growth in GI. GI Q3 year-on-year net income after claims or net of claims is up 19%. AuA in terms of workplace, up 10% in half 1. So a good diversified set of earnings streams coming through there. And then again, the capital-light point, often enough in the commercial area, for example, these are ancillary revenues that we're seeing develop in a pretty capital-light way. Likewise, insurance, as you know, is a relatively capital-efficient business for us, quite an attractive earnings streams. And so again, the development of OOI is critical to the transformation of the business. It's good for us because it's growth, it's diversified and it's capital light, and we expect to see more of it.

Just with 5 or 6 minutes left on the clock. Are there any questions from the audience? William, you mentioned the sort of expectations around average interest-earning asset growth in the next couple of years. I think investors, the margin of safety in a stock that's growing is always higher than one, which is not, why the OOI, I think, is important. But loan growth is afforded real status when you look at a bank. What are the signs you're seeing now? And what do you think the cases are for a proper acceleration in growth? Perhaps, the budget is a place to sort of think about where we might see more spend on things like infrastructure.

Sure. Yes, yes. The picture of growth, as you say, has been pretty good actually over the course of recent periods for us. So you have seen lending growth up GBP 4.6 billion in the course of Q3, which is good to see. The confidence that we have in AIAs being greater than GBP 450 billion this year is very clear, consistent with our commitments. It's off the back again of two things, really. It's a relatively solid macro and alongside of that strategic delivery, whether that's in mortgages, personal loans and so forth. So those two, I think, are giving us some benefits in terms of the growth pattern. Highlights that one might mention. Mortgages up GBP 3.2 billion over the course of Q3, 21.5% market share, not a bad outcome, particularly when it's consistent with margins, as I said earlier on. They are in excess of 70 basis points. Personal loans up GBP 0.6 billion, cards up GBP 0.1 billion. So an overall pattern within retail that feels pretty robust actually for us in terms of loan growth. Probably a slightly more nuanced Commercial Banking picture. So what have we seen there? We've seen within C&I, growth in lending basically chasing things like infrastructure for sure, but also with a kind of ancillary revenue spirit in mind. That is to say, we're not chasing lending for lending's sake in C&I. We're rather doing it because of a holistic approach to clients, which is a mantra that is held quite strongly within the bank. And then at the same time, within SME, we've seen a picture which is paying -- continued paying back of government-based lending from the COVID period with relatively muted underlying demand. So within SME, at least, we are seeing it slightly quieter from a loan perspective. Now looking forward, I think the budget may help in the sense that the uncertainties, if you like, have now been removed, and so people can figure out how they get on, how they want to invest going forward. As I said, we think the budget is probably a modest fiscal stimulus going forward, which in turn may inspire kind of capital formation and investment and the like, and we should be a big beneficiary of that. But it will be relatively modest, I think, in terms of the impetus that is given. More importantly, I think, is the way in which we hope to stand out from that by continuing with our market share gains, by continuing with the performance in terms of strategic initiatives and by continuing to promote the type of growth that you've seen in the course of Q3 over the course of 2025 and beyond.

The strategic plan calls for a cost-income ratio below 50% in 2026. I think the market is higher than that. You've just confirmed that the NI is going to cost GBP 100 sort of million. Could you talk a little bit about how you characterize the state of investment in the business and whether -- I don't think Lloyds is viewed as a company that's got fat in the OpEx. And I just wonder whether it's about strategic spend being above normal and how you think about landing that objective as you come into 2026.

Yes, yes. The -- your question, Jason, is essentially around costs and how we're managing efficiency. As you know, efficiency is a kind of closely held strategy within Lloyds. It has been for a while. It certainly has been since I got here, but it's also been for a number of years before I got here. And that commitment is unchanged, and the resolution or rather resolve to meet our commitments is very high. It's very strong, Jason. We've got a commitment for GBP 9.4 billion out there this year. That includes the Bank of England levy, and we'll meet that commitment. Likewise, we've got a commitment for GBP 1.2 billion of gross cost saves. We'll meet that commitment. So we continue to be very strong adherence to what we've said publicly, and that includes also the less than 50% cost income ratio in respect to 2026. There's a couple of factors in that cost-income ratio, Jason, as you know. One is the income side of things where you've made a few comments there on where you think the market is versus our expectations. So that's one side of the cost-income equation. And then our cost commitment to efficiency, as I said, remains resolute. What are we delivering there? And how much of that is investment driven, if you like? I think there's probably three main buckets that I would highlight. One is our kind of BAU efficiency approach, which is around things like matrix management. It's around organizational design. It's around third-party supplier management, these types of things, which are, I suppose, in some sense, at least lasting components of Antonio's strategy that continue to this day. The second is investment-driven, often technology-based commitments that we have. And that's all part of the strategic transformation that we have pursued, investing part of that GBP 3 billion over 3 years, GBP 4 billion over 5 years that we talked publicly about. Where is that headed? It's headed towards digitization, automation of back-office processing, for example, automation of customer service. It's headed towards rationalization of data centers. It's headed towards decommissioning of legacy technology. These types of things that can make a real difference to the cost base on a lasting basis going forward. So that's the second bucket. And then the third bucket, which entails both efficient management and a degree of added investment is around property optimization. So whether that is head office, whether it is branch rationalization or the like, that's a third bucket of cost savings that we expect to deliver and indeed are delivering pretty much as we speak. Now what that leads to, Jason, is a BAU cost pattern and an investment cost pattern that, I suppose, delivers on the cost base in the way that you've seen in '23 to '24, i.e., a rising cost base. But it is also a pattern that once depreciation catches up allows us to deliver a flatter cost base going into 2026 because at that point, the benefits of your investments start to come through. That includes all the three buckets that I've described. It also includes a little bit of excess severance that we're taking on board last year, this year, next year in order to deliver lasting cost efficiencies, which again then just start to deliver that flatter cost base in 2026, combined with the income, it delivers operational leverage. And as you know, it's operational leverage that gets us to a cost-income ratio below 50% together with our ROE greater than 15% and our capital delivery greater than 200 basis points. That's the story.

Thank you. And that brings us perfectly to time. So thank you, William, for joining us today.

Pleasure. Thank you, Jason. Thank you, everyone.