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

Well, good morning, everybody. My name is Jason Napier, I run financial research on the equity side at UBS. Welcome to the UBS European conference. We're thrilled to have so many people with us today. We're thrilled to be in this new venue. And we're very pleased that William Chalmers, the CFO of Lloyds is opening this particular stream for us today. William, thank you for joining us.

Thank you very much for inviting me, Jason. It's a pleasure to be here. Thank you.

So you've been CFO for 6 years now, it feels like maybe more than 6 years potentially on some days. The market is already focused on the next strategic plan, which we get next summer. I wonder whether you wouldn't mind sort of setting us off by reflecting a little bit on what it is you saw in the group at the outset of the last plan, what it is you are looking to change and how you think that process is going?

Sure. Yes, very happy to, Jason. As you say, there are definitely some days when it feels more like 6 to 10 years, let's say, and some days it feels much less. So it goes up and down. But overall, it's been a fantastic journey for the management team and for the bank, but we've got a lot more to do. Jason, in respect to your particular question, I guess, what would I say? I think the inheritance that Charlie and I had was, of course, a fantastic bank with a fantastic customer base, but also a bank that had spent essentially 10 years being optimized post the financial crisis. And so it was really incumbent, I think, upon both Charlie and I to set out a growth agenda to allow the bank to capitalize upon the opportunity in front of it and indeed to put up a much more resilient franchise for the future. I think within that, as you know, we set out a strategy that was U.K. focused that was in turn digital-led, that was in turn about an integrated financial services proposition and that allowed the bank to capitalize on opportunities with the scale that it has. That's what the strategy was focused on. Three elements to that. We described them as grow, which shows obviously about revenue growth and diversification. We described it as a focus, which is around cost and capital efficiency. We described it as change, which is around maximizing the potential of people, of data, technology. So grow, focus, change is what was behind the strategy as a whole. Where have we gotten to in respect of that? Growth, first of all, we've obviously benefited from the rate cycle, for sure. That has been supported by some pretty decent franchise growth. But at the same time, it was important for us to diversify that growth and to reduce the net interest income dependency. And you can see that coming through in terms of the other operating income, 9% year-to-date, similar pattern in 2024, supported by a broad base of businesses. When you look at change, the change agenda -- or sorry -- the focus agenda maybe is around cost efficiency. At the end of 2024, we delivered in excess of GBP 1.5 billion of cost efficiencies versus where we were in 2021. Those gross cost efficiencies are now running at in excess of GBP 1.9 billion. And we'll see more of that as we unfold the remainder of the strategy going through into 2026. Capital efficiency, we've seen RWA growth off the back of lending growth, but also off the back of regulatory calibrations. But we've also optimized against that now in excess of GBP 21 billion of RWA efficiencies since we started out in the strategic journey. Alongside of that, the growth has been focused on those areas, which are capital light, if you like, i.e., can produce efficient and indeed return generative components of the business, i.e., insurance pensions and investments in businesses like workplace for examples of that. And then finally, on the focused agenda, we have tried to remove capital blockers to distributions. The pensions deficit was the best example of that. GBP 7.3 billion when we came in, it's now 0. And so as a result, what was previously a significant capital blocker has been removed. And then finally, on the change agenda. Jason, you'll be aware and we talked a bit about this in the context of the digital seminar last week, but we've invested heavily in talent. We've invested in the Lloyds Technology Center out in India to allow us to enable an efficient change process. We've invested in removing legacy, data centers down by 40% since we started. And we are engaged in the building of product efficiently. So for example, the Lloyds Premier product was built with 60% less time resources versus similar product builds earlier on in our journey. So all of this allows us to deliver a more efficient change process, which, of course, is behind the kind of continued fulfillment of our strategic ambitions. So there's a lot to reflect on when we came in. There's a lot that's been done since then, but as said, there's a lot more to do going forward.

I mean, yes, exactly. And I guess, none of those themes are time-barred or ever done, really. And so I guess the expectation in the market would be sort of more of the same next summer, but I guess we'll have to wait and see for that. One of the issues that is unfortunately continuing front page news in the U.K. is the sort of legacy product refund issue. The banks that we track have paid GBP 69 billion in refunds so far. That's 20% of today's NAV. Just government have said they want motor to be the last one, notwithstanding the disquiet that we have with the FCA's first proposals around how to repay people around motor. What is it that from the outside we should be looking to see delivered so that we can have any confidence that this will indeed be the last one?

Yes. It's a fair question, Jason. And obviously, something that we are acutely aware of as a management team. I think the first point that I'd make is that we agree with the premise of the question. That is to say, there is no doubt that conduct risk is impacting or has impacted investability and therefore, something on which we should all be focused. The -- your question, Jason, is around what should the market be looking out for, for signs of change in this respect, i.e., for change, for signs of lasting improvement, I suppose. I guess I would make 3 or 4 points. The first off is when we look externally, we should look for signs of acknowledgment of the problem. And so what I mean by that is when you look at things like the government and regulatory statements, Mansion House is an example of that, the Leeds reforms is another example of that. There is, I think, a clear acknowledgment of the issue. That is to say the conduct agenda needs to be addressed in order to secure U.K. investability as a whole. So that acknowledgment point is the first sign. I think then you would hope to see some appetite for change. And again, you look at things like statements, the FCA statement on the motor issue being the last mass redress event has been pretty clear and unequivocal actually. So you look for appetite for change as reflected in governmental and indeed, regulatory statements. I think then third and perhaps most importantly, you look for signs of meaningful reform, not least in the conduct agenda in respect of the financial ombudsman, the so-called FOS. And we're seeing there signs of reconsideration of the read-across obligations, which FOS has previously imposed on the financial services sector. Likewise, reconsideration of the look-back period. Both of these 2 topics are really up for debate and potential reform right now, and we see very realistic chances of the situation being improved. And so meaningful reform. The third element, I think, is starting to come through. More to see for sure, but nonetheless, we think the direction of travel is good. I think then we would also look for what I'll describe as appropriate implementation of existing regulation. What do I mean by that? Most specifically, you might refer to things like the consumer duty. When we look at how the consumer duty is being implemented right now, we see it as basically being appropriate. There is no sign that the consumer duty is being used in an obstructive or difficult way from the FCA. Rather it is a constructive ingredient to producing sensible and appropriate customer outcomes. So you're looking at existing regulation being implemented in an appropriate way. And then the final point, which is really on us, is to ensure that we and all the other banks behave in the appropriate way. And so in reference to that, since 2012, we've implemented something called conduct risk appetite metrics, which in turn allow us to look carefully at things like product pricing and disclosures and make sure they are absolutely appropriate. Likewise, we have very extensive customer contact programs when we do things like change prices on products. Likewise, we trial products in the FCA sandbox, and you'll have heard a bit about that in the context of the AI seminar last week. So banks have to get it right, too as part of this. And I think there is significant progress that has been made certainly by us, and I suspect by the sector as a whole. But those 4 or 5 things or themes, if you like, Jason, I think are the types of things that you look for. And as I said, from our perspective, at least, we are seeing meaningful signs of progress here. Again, more to be done for sure, but nonetheless, the direction of travel is positive.

Interesting. So the other area of I guess some gathering interest as to whether we might see a change in capital requirements, the review that we get the results from on the 2nd of December. If you watch the U.K. banks as long as I have, one feels that RWA density is up, risk is down, data is better, conduct risk is lower. Should we have any expectation of a sort of a more competitive capital setup, do you think out of that process?

It's a good question, Jason, and obviously, one that we look at with a great deal of interest. I think it for me, it falls into the broader context of what is going on in terms of the governmental straight regulatory agenda that is conducive to or supportive of the U.K. financial services sector. I think the first point that I'd make in that context is that the government has been pretty clear about the importance of a competitive sector to drive U.K. growth. And that's a helpful backdrop to have in the context of any of these exercises, if you like. I think then you say, well, how can that be driven? And I think 3 directions of travel, I suppose. One is around the prudential agenda, one is around the conduct agenda and the other is obviously around the fiscal agenda. In respect to the conduct, we just made some comments a second ago, which hopefully are helpful. In respect to the prudential, you highlighted the FPC review there. When we look at that, there are a variety of areas that the FPC review could consider. You mentioned risk weighting there. One might also mention the calibration of buffers, which are relatively high by international standards, at least if you look at the countercyclical buffer. Sure, absolutely. There are other aspects, if you like, within that, the leverage ratio is, for example, an inclusion or exclusions from that. These are the types of areas that the FPC review could look at. It's hard to be too specific at the moment about exactly where the FPC review would go. But I think based upon the commentary that we see externally, based upon the discussions that we and others are having, it feels like it is unlikely that nothing is going to come out of it. Why is that? I think it's coming back to those points that I made earlier around the appetite for change around the constructive statements, and these types of things give you a lead into what might be arriving, if you like, in December. Allied to that, I think the secondary growth objective that the PRA has now been given alongside the FCA is constructive in that context. So we'll wait and see. I mentioned the fiscal agenda there. And I think there, it's about a stable and predictable and competitive tax regime that we'll be looking for. So I think if you add up all of these things, you have a conduct agenda, which hopefully is making progress. You see a prudential agenda where the FPC is a review, if you like, is a piece of evidence that we may see some progress. You might also add to that, things like the ring-fencing review that is going on as a further example. And let's see what happens with the fiscal agenda in the upcoming budget. But overall, I think a relatively constructive backdrop for the sector, probably better than we've seen for at least the period that I've been in charge.

So if we turn to sort of more Lloyds-specific, mercifully more Lloyds-specific factors, the U.K. domestic banks are going to produce the best revenue growth in Europe driven by the hedges. Then the market as is its habit is looking to interrogate what happens beyond that already even though that may be 3 or so years from now. If you talk about the capacity of the organization to deliver positive jaws ex-hedge for a second because it's -- I mean it's interesting, considering the tailwinds we've had around growth in rates and so on the cost-income ratio of the bank now is the same as it was before rates went up. And so if you could just talk to the capacity to keep the jaws between the 2, which are going to be like 9% next year, can you sustain that ex-hedge is the first question, I guess.

Sure. Sure. In short, Jason, the answer is we look forward into 2026 is that, yes, ex-hedge there should be positive jaws. Now a couple of points in respect of that. Why is that, first of all, people in this room will be aware of the strength in OOI growth that we've seen over recent periods. 9% year-to-date follows a similar pattern in respect to 2024. It's based off of a set of broad-based and diverse drivers across the business units. And we do expect that to continue going forward into 2026. It will also be bolstered by the acquisition or the full acquisition, I should say, Schroders Personal Wealth, now renamed Lloyds Wealth. And so that is all helpful on the income side. And that is allied with as you would expect from Lloyds rigorous cost discipline. So specifically, what do I mean by that? In '25, we'll see costs up 3%. If you exclude severance, it's up 2%. We've talked before about a flatter cost expectation for 2026, and indeed, that remains our expectation, off the back of maturing investments, achieving a full year run rate off the back of the usual BAU cost discipline that we apply kind of across the piece. But I think coming back to your question, Jason, removing the structural hedge, I think, is the wrong way to look at it. And the reason for that is because the structural hedge for us and for everybody else drives their income profile. That, in turn, drives the sector's ability to reach returns and indeed drives the sector's ability to meet targets. That means in turn that structural hedge drives pricing decisions. And if you remove the structural hedge, then those pricing decisions elsewhere in the asset and the liability profile change. The best example of that is in respect to mortgage pricing. Mortgage pricing completion margins right now are around 70 basis points. It's not far off the cost of equity, i.e., there or thereabouts. If you remove the structural hedge, that mortgage pricing changes. If you look back at the pre-COVID and indeed the COVID period, you saw mortgage completion margins double or more what they are today. And that was in a period when we had much flatter curves and therefore, much less structural hedge growth. And so there's kind of concrete empirical evidence there, if you like, is that if you remove the structural hedge as a driver, you then affect other pricing elsewhere in the balance sheet. And therefore, the removal of the structural hedge in the context of pricing decisions, Jason, should not be seen in isolation. It is rather part of a holistic picture. When we look at the structural hedge, with that in mind, with it in place, we're delivering about 2.3% yield on GBP 244 billion of deposits and equity over the course of '25. It is still below 3% by the time we go into '26, and that is below -- well below churn rates. And therefore, the structural hedge should continue as it refinances to deliver meaningful growth through the P&L. As said, I don't think removing it is the right way to look at it, but if you do remove it, you can be pretty sure that all other pricing within the business will change with it.

And of course, the further out you sort of project, the more important, the product pricing becomes in what NII actually is, which sort of brings you back to a fairly philosophical, but an important question, which is what is the clearing RoE for U.K. domestic banks? Without the hedge, we might have earned more on mortgage spreads and so on, but it does feel like we're going into a Q4 and in your case, summer '26 outcome, where it's going to be very hard not to promise a higher RoTE than in the last plan. How do we sort of think about the right return for financial services in domestic U.K.? It's a tricky question. I appreciate that.

No, I think it's a fair question. I think the -- when we look at the business and its return objectives, I mean, first of all, there's a lot of data out there in terms of the returns that us and others expect to earn in the business. This year, next year and indeed, by the course of, I guess, end of year next year and indeed into the summer, you'll see a bunch of new targets from us and other providers. But I think at a more fundamental level, Jason, the right way to look at it is to look at the industrial structure, to look at macro expectations and then to look at each individual's competitive position. And it's those 3 things that I would really look at in answering your question. And specifically, what do I think that delivers? What I think it delivers is a sustainable RoE that is at least similar to what we expect to achieve next year accompanied by an appropriate growth rate. I mean that's the bottom line that I think those 3 ingredients deliver. And maybe just take a moment on each of those. If you look at the industrial structure, first of all, it's a competitive industrial structure for sure. You see it from the incumbent, you see it from the neobanks, you see it from big tech, you see it from stablecoin providers increasingly. But it is also a relatively stable industrial structure. And why is that? I think it's because of the investments that we make. It's because of the competitive moats that we all have, it's because of the regulatory supervision of the sector, too, to be perfectly frank, and that produces a relatively stable industrial structure, albeit quite a competitive one. The second point, I think, Jason, is you have to look at the macro and the set of macro expectations. And when we look at the macro, we see pretty unspectacular, but nonetheless, a stable macro outlook. And if we look at rates in particular, going back to the earlier comments around structural hedge, we are still refinancing, as I said, GBP 244 billion of deposits and equity at rates that are meaningfully below term rates, meaning that there is quite a lot of growth still to come through structural hedge. And as long as you think that rates are going to be more or less stable in the period thereafter, i.e., a bit of variance for sure, but more or less stable, then you're seeing a relatively stable contribution from that part of the balance sheet. So I think overall, that is also long-term supportive. And then I think you have to look at the competitive position of any given bank. And speaking for ourselves, at least, we have an outstanding brand. We have the trust of around 28 million customers on a daily basis. We have around 20% plus of key asset and liability markets. This is a very strong competitive position. And as everybody in this room knows, we are investing very heavily in the business right now to make sure that we maintain that competitive position. So I think when you add those things together, you've got an industrial structure which is competitive but stable. You've got a macro outlook, which is inspiring at some level, but nonetheless stable. And you've got a competitive position of Lloyds Banking Group, which is really very strong and being continually invested in to maintain that strength. And that, in turn, leads us to a strong conviction in the sustainable RoE of the bank, as I said earlier, looking towards '26 and beyond.

Right. Now, one of the things that I'm not sure receives enough attention was one of the things you said earlier around the gross cost savings that you've delivered in the plan, massive number. But because we're guided to higher costs every year, we're not sure whether that produces a Lloyds that's much better invested. Is it a coiled spring that can be much more efficient in the future, or whether this is just the nature of modern banking, fewer branches more engineers. When you think about the right sort of cost income ratio for the bank or the right kind of cost structure for the bank, is the NVIDIA market cap an indicator of a bright future for banking efficiency? Is there a step change to come, do you think, for the way that you run?

It's a good question, Jason, and obviously pointed towards AI, in particular as a driver of the cost base. I mean, I think overall, start point for me would be cost discipline is an incredibly important ingredient of the Lloyds story. It has been since Pitman took over, it was inherited by Antonio, it was then taken on the mantle by Charlie, and it remains absolutely critical to the success of the story going forward. That, in turn, is what allows us to deliver the absolute cost target circa GBP 9.7 billion this year, plus a little bit of SPW or now Lloyds Wealth costs. But that is what gives us confidence in the Lloyds absolute cost targets. And then behind that, you've got 2 or 3 particular drivers. Strategic investments, for example, in property and technology and automation, decommissioning these types of things. Alongside of that, efficiency of the change program. I mentioned the investment in Lloyds Technology Center in India as an example of that earlier on. And then finally, the BAU savings, sourcing, matrix management, organizational design, and these types of things. These 3 strands are pieces of, if you like, solving the cost puzzle, and in turn allowing us to deliver what we would expect to see. When we then overlay the potential of AI on top of that, I mean, it comes into the first of my 3 strands, that is to say, it is a source of meaningful strategic investments for the group going forward. And when we look at that, I think there is a number of points to make. I mean, first of all, we see this as a really quite significant opportunity within the group. You heard all about it with Charlie and Ron last week in the digital and AI seminar, but 2 or 3 points to make there. A lot of work going on, around 50 major use cases, for example, greater than 35,000 co-pilot licenses within the group, for example. More than 800 machine learning and AI models within the group. All of these things are signs, if you like, of serious implementation within the business. But I think we have to do a couple of things. We have to put this in context, in the context of time to maturity and indeed allow this progress to build up from the foundations to scale as we look forward. Specifically, what do we mean by that? The opportunity is large, therefore, and it cuts across both revenue potential and indeed cost opportunity. Personalization is an obvious example in the context of revenue potential, customer interactions, AI assistance. You probably heard last week about the use of generative AI and SME, where we're effectively allowing generative AI to do much more than processing, allowing the relationship manager to free up time to deal with customers. The cost opportunity is much talked about, colleague assistance in the case of things like KYC and AML, for example, customer help likewise, engineering solutions much more effectively and efficiently sponsored with the help of AI. So a lot of stuff going on and a lot of potential in the context of revenue and cost opportunity. But as I said, put it in context in the sense that there is a need for a little bit of time to maturity. Because essentially, what we're doing right now is we've organized ourselves into 5 domains, if you like, key areas of focus for AI. They are having the foundations built this year. We will be scaling them up over the course of '26, '27 and beyond, and therefore, meaningful benefits from the revenue and from the cost side, you should expect to come through, as I say, a scale way in the course of '27 and beyond. We're getting benefits from this year. From this year onwards really '25, '26, Ron and Charlie talked a bit about that last week, but it is in the kind of GBP 50 million to GBP 100 million type zone. When we get to '27 and beyond, you should expect a meaningful scale up in that context. But Jason, coming to the bottom line of your question, what does that mean for the cost ambitions of the bank going forward? For sure, it allows us to scale more efficiently within the bank. For sure, it allows us to manage costs more efficiently. But don't forget 2 facts. One is that we will be investing heavily in the bank at the same time. And that includes, obviously, AI as part of that investment. But alongside of that, it also includes investment kind of across the piece within the bank. So you'll for sure see cost benefits and indeed effective cost management off the back of AI and related technologies, but also expect us to continue investing in the success of the franchise going forward because ultimately, that's what we'll -- that's what we'll deliver that sustainable RoTE that we talked about earlier on, which in turn will allow us to deliver an attractive capital return for shareholders.

Any questions from the audience? We've got time for maybe 1 or 2. Over here in the middle. Is there a microphone? Go for it, [ Ian ]. Yes.

Who knows what stablecoin will bring to the bank, but it's definitely on the radar, and potentially disruptive. My question is, how do you think about the role of a structural hedge in a banking world where stablecoin has meaningfully disrupted deposit franchisees? Because I worry that deposit duration or your ability to behavioralize the duration might change in a meaningful way.

Sure. Shall I answer that first, Ian, and then come to the second. It's an interesting question, particularly right now when stablecoin is changing so fast. I think when we look at stablecoin and where it is, if you like, gaining momentum versus where it is more slower, if you like, to make progress. The areas where it gains momentum is the areas where there are greatest friction costs, if you like, and greatest times to execution. And so examples of that are things like international payments, where stablecoin is really making inroads into international payments business because you can effectively transfer money instantaneously at next to 0 cost. If you look at the application of stablecoin within the U.K. domestic payment system, however, it has to come up against competition such as faster payments, where already payments are effectively instantaneous and also 0 cost. And so the competitive advantage of stablecoin in that context in the U.K. domestic scene is much less than it is in the international scene for those very reasons. And that's important because it will impact, if you like, the take up of a stablecoin. Now alongside of that, we recognize that the whole context, if you like, of digital programmable capabilities is a really interesting context. And that's why we're looking to solve this and address this through something called GBTD, Great British Tokenized Deposit. And that is a solution which is a digital programmable payment source which allows all of the advantage of, as said, programmable payments. I'll come back to use cases in just a second, but also preserves the singularity of money, and therefore, gives customers assurance that their deposits are 100% safe, meeting all of the KYC obligations that we already meet and a deposit is freely exchangeable between what's in their bank account in an analog form and what is a GBTD, a GB tokenized deposit. That, from our perspective, is a much stronger competitive proposition versus stablecoin, which is not on the bank's balance sheet, for which the customer has no protection and for which as said earlier on, doesn't offer an obvious competitive advantage versus what's already available in the U.K. domestic scene. Now as I said, we do think that there are use cases, whether it's account to account payments, so for example, payment on proof of delivery or whether it's in the context of mortgage conveyancing, greatly reducing funding and indeed settlement times, or for that matter in the wholesale area, digital gilt. We do think there are benefits from implementing digital programmable currencies in each of those 3 use cases, and that's, from our perspective, the areas in which we are developing pilot use cases. We think that more than offsets the stablecoin risk. And so in a sense, I think the premise of your question is one that we would challenge. What is it that stablecoin has to offer? And by implementation of things like GB Tokenized Deposits, we should be able to offer the customer much more value than either stablecoin can offer and indeed even to make progress upon what we already offer them in the domestic payment scene.

Do you want to ask the second one?

Last week, I heard being introduced to the debate for the first time, the thought about taking the franchise beyond the U.K. and a reflection of your confidence in the digital capabilities that you've built. Could you just contextualize that for me a little bit, please, because that is something quite new.

Yes. The start point, Ian, is simply to say that the strategy is and remains, very much a U.K.-focused strategy. We have a purpose of helping prosper, as I replied to Jason earlier on, our strategy as set out in 2022 was around U.K. focus, increasing digital interaction, taking advantage of opportunities at scale. And that has not changed, Ian. And there is no prospect, if you like, of that changing in substance on a look-forward basis. Now having said that, what we do want to make sure is really 2 things: One is that we have a fully fledged and serious franchise in pursuit of that strategic agenda. So for example, areas like corporate and institutional, for example, will demand our ability to compete in things like U.S. dollar currency, which in turn will demand a degree of U.S. presence, same thing within the euro. So in order to get an effective corporate and institutional strategy, you have to have a dose of non-U.K. presence for sure. And that indeed is what we will do and make sure that we inform the strategy with. We also have -- in a similar vein, we also have, as you know, a decent Dutch mortgage business, which at the moment is about GBP 20 billion in assets. It's a very attractive low-risk, high-returning business, which we've had for a long time actually within Lloyds Group, and it's always been an interesting option for us to develop. It is, as I said, relatively modest in the size of the overall balance sheet. It is, at the same time, low risk and high returning. So we're very happy just to kind of keep that turning over. I think then when we look forward -- and this is the second point, when we look forward, if we are able to build real capabilities that have a competitive advantage that we believe that will then benefit from further scale, then of course, there is a possibility that we see -- we will seek to plug those into other areas. But at the moment, at least, that is based upon our ability to build those capabilities in due course because we are very focused, as I said, in executing our strategy informed by the purpose of helping Britain prosper, within the perimeter, if you like, of the strategy as laid out in 2022. And going back to Jason's question about what you should expect to see thereafter, it is effectively completion of the projects that we have taken on and then gradual extension from there. It's not really about geographic transformation.

William, thank you so much for joining us today.

My pleasure. Thank you very much indeed. Thank you everybody.