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

So obviously, this is hugely exciting for us. We think this is one of the key points of differentiation for Lloyds Banking Group. And obviously, the context is the U.K. has relatively low other operating income as a percentage of total income. And that's a consequence of the financial crisis and regulation, if you think about it. And the backdrop for our commitment around this was we knew regulators, and the U.K. economy had realized that customer outcomes on the back of punitive sales practices, punitive approaches to fees and growing those other businesses and then capital regimes who encouraged the banks to sell all of these businesses has resulted in a bad place for money. Now in the last cycle, as you say, we grew these businesses at 8% CAGR. This year, we're already 11% up year-on-year, partly because of the acquisition of the Schroders Personal Wealth and the build-out of our Wealth business. By the way, that acquisition cost our shareholders nothing. We were really pleased with that deal and gave us the capability. So we're seeing good momentum in those businesses. And as you say, we think we can continue to grow them at that kind of high single-digit rate. We've gone from about 30% share of our income that was other operating income to about 34%, 35%. We were going to guide towards a number, but I think it's a hard one to guide towards because it depends on the other side of the revenue stream, i.e., NII. But we're heading towards 40% through this strategic plan, whether we get there or not or whether we get past it will depend on a whole bunch of things we don't control. And I think that's a much healthier place for an organization to be because through cycle returns and then the profitability of these businesses is really important to be able to give that consistency of returns and capital generation. So how are we doing it? We're doing it through 2 things I think are important. The first is a very diversified set of businesses. So from transport finance through payments businesses, through workplace pensions and life protection through our rates and FX and corporate institutional businesses, working capital, all the way through to Lloyds Development Capital, which is an equity investment business and our professional management rental property portfolio that we've grown from 0 to 10,000 homes, it's a very diversified set of businesses, and that's important for the obvious point, but we have lived this in the last 5 years. In any one quarter, one of those businesses will underperform or outperform. On average, you can start to deliver that kind of sustainable growth level. And even though we are a U.K.-centered organization, we have by far the broadest range of products, the most diversified set of products. And so that's the first thing. And of course, all of the businesses we have connect or join up across the bank. So we sell our transport finance business to our retail customers, and our SMEs and corporate institutional customers, our workplace pension customers are sold both ways into our corporate franchise, and then, we can target the underlying employees with other propositions and services from our retail bank. I won't go through every example, but every single one of these businesses benefit from the scale of the franchise. And going forward, the scale and value of data and technology and AI. The second way of thinking about it is there's kind of 3 quite different types of businesses in there. There are businesses, which are a bit more like banking-based businesses, which are more predictable. So transport finance is basically like a lending business with a 3.5- to 4-year duration asset. And the workplace pensions business, we actually book a lot of the value upfront as a liability on the balance sheet for CSM, and then, it predictably rolls off. So the nice thing about those businesses is they're much more predictable, much more stable. We then have a set of businesses, which are more transactional, but we are focused on growing market share, and we've done that successfully, whether that's home insurance, life protection, parts of the transport based business, which aren't financing businesses, or in fact, our rates and FX and DCM businesses underpinning our corporate and institutional businesses. We're showing we can get market share gains and grow those businesses. And they are, therefore, really about showing differentiation and growth, which will enable us to grow faster than our market and faster than the economy. And then the final thing is innovation. And we've got some really exciting things, especially in the connected commerce, digital assets, wallet space, which no one else is going to be doing and which we think could give upside. And the range we gave for our 2030 targets was kind of upper single-digit growth or high single-digit growth. If we deliver the innovation, and it adds value, we'll be at the top end of that range. If we don't, we'll be more in the middle of that range. But that's where we're seeing the growth and the portfolio of businesses. And at the heart of it, if you haven't got scale, you don't have the data and the digital assets we have and you can't join up enough from a cultural and a technology perspective with the breadth of products, you won't be able to compete with us.

That's great. I'm glad you mentioned innovation because clearly, the success in here partly reflects the investment decisions you've made in the last few years, right? And you've said in the previous strategy cycle that you have invested GBP 4 billion above your normal run rate. What were those investments in? And how do they support the current cycle? And looking forward, how are you assessing investment opportunities from here, especially in relation to AI?

Yes. I'll try and answer the question and then probably keep you honest because it's a hard question to answer in terms of detail. But broadly, the investments we've made historically and in the future have been in kind of 3 buckets, things which really are around differentiating and driving growth. And I know that's a simple statement to make, but when you're winning market share and you're driving increasingly connected and digitally led services, there's investments in those digital services, the data, the frontline colleagues and RMs to drive that growth. So that's one area. The second is around operating efficiency and risk management and capability to be kind of, what I call, a better, faster, cheaper organization. And as you know, we delivered over GBP 2 billion worth of gross cost savings in the last phase. We've committed to another GBP 2 billion worth of gross cost saves. And so there's a whole series of investments in that space. And then there is finally a set of stuff more around dealing with our legacy and ensuring we remain a resilient, well-regulated business. And it's harder to put those investments into hard dollars or hard sterling, sorry, still very U.S. centered. But they're really important, both for ensuring the resilience and trust in the organization today, but building and future-proofing some of the capabilities for tomorrow. So some of the big investments we did around our data environments, for example, to modernize and port the data into really reusable environments even before we knew of AI or generative AI, they have been foundational for our ability to then innovate and drive pace on what we're doing going forward. So that's the kind of framework. We run a very disciplined process, as you'd expect, around both ROI and then tracking benefits and returns, and you should expect that from us going forward. And we've kind of given you a broader number this time, which is we're spending about GBP 3 billion, GBP 13 billion over the next 4 years, per year in that investment portfolio. When we look forward, the mix is similar. We're still driving operating efficiencies, improvements in capabilities and then driving this significant revenue growth that we talked about. And as I say, in some cases, it will be frontline colleagues and capability to drive the extra activity at the front line. Sometimes it will be around new digital services and acquisition strategies to drive the revenue growth. And sometimes it's much more traditional costs. So we still have opportunities to drive customers to support themselves through digital engagement rather than through our colleagues to optimize our real estate and portfolio to optimize legacy technologies and applications. And those investments are important for the future as well.

Well, I mean, I know AI is something that you're very excited about, so I'm not going to miss an opportunity to ask you more about it. You've previously said that from your experience, technology tends to reduce margins in banks, but allow you to scale to the extent that, that increase in volumes more than offset the forward margins. So where do you think we are in that cycle? And are there products or areas that you are actively building scale to prepare for that eventuality?

Yes, it's such an important question. I don't know if everyone -- we've all been looking at the financial services market for a long time. Look, I started by electronifying trading floors in the early '90s. And if for those that went through that, many of us would have gone through that, you saw a massive reduction in costs, massive improvements in efficiency, phenomenal volume growth. We ended up deploying low latency trading by the end of the '90s and massive reductions in costs for both institutional and retail investors. My favorite one is the start of the '90s, it would cost about GBP 200 to call a stock broker to buy an equity. And by the end of the '90s, Ameritrade launched their first $5 trade, right? And I was on the West Coast building that with Ameritrade. So that's our history. That's what financial services does. At the same time, if you create differentiation and growth, that's sustainable. So when you just take out costs, typically, you should expect over a period of time, the efficiency will be competed away, but the differentiation in growth and scaling you can get can be sustainable. That's been my experience, whether it's in retail, corporate, SME or institutional activity. And so when we look at the AI opportunity in front of us, we have kind of got a mixed portfolio, and I'll be simplistic, between kind of efficiency, better, faster, cheaper stuff, which is going to be a hygiene factor and important, and we are right at the front end of that in this market, but also differentiating for customers and trying to drive growth. And we think you need a portfolio of both things if you're going to really be positioned for the future. And what's so exciting about Agentic AI more than just generative AI is it's a technology that's going to enable us to do things we've wanted to do for 30 years, and -- but you can really make it happen in a controlled way, if you do it in a controlled way in this next period of time. Let me give you some examples. Look, just on -- I'll talk about 2, just to be quick on one -- both sides. We've launched something called an Invest AI agent, which is allowing our customers to have a conversation with an agent about what is risk, what is compounding, how should I think about my risk appetite, what are investment options, what would a financial plan look like for me today, later in my life, how do I think about goals. The stuff that we all in this room understand, but the vast majority of retail customers and even SMEs in the U.K. don't have an intuitive understanding of. And under the new regulatory regime in the U.K., we're in a sandbox working with the regulator. In the next month or so, we're moving that to what they call targeted support that can get them through to an understanding of what they might want to do. And then by next April, if we can get the regulator comfortable with the outcomes, we'll move into actual product recommendations. That will be the first time the U.K. has ever had mass market intelligence around investments available to retail customers. So really differentiating, really exciting if you've got the kind of franchise we have got with 28 million people, 22 million of which are logging on 7 billion times a year with a pensions platform, a self-directed platform and great simple investment products. And we still have people they can talk to if they get nervous, right, which you need to have that combination of things. So that's one example. You can multiply that by a big factor across all of our businesses and across the different activity we're doing. But we've come up with this phrase for our vision for customers' experience, whether they're a sophisticated corporate or individual, which is to be simpler, smarter, more connected. And if you use those words and you use them and look at way financial services delivers today, we're nowhere near being actually simple, smart, you can say for intelligence AI and then connected is properly connected across products, services today, tomorrow, the breadth of products that we have across financial services. So that's an example on the kind of differentiation side. I could wax lyrical on this for the next 2 hours. On the efficiency side, look, it's what everyone looks at. What I think is really important on the efficiency side and what we've already learned in the first 2, 3 years of this is the vast majority of use cases aren't that complex. They do require a use of generative AI. They typically don't require frontier models. And if you build to use frontier models, the economics won't work. But I'll give you an example. We have 2,000 people helping customers who have a declined fraud card, a debit card or in a fraud activity on the telephones. That's a kind of 12-step process. Very quickly, we identified 50% of the time was taken up by 4 steps, and we could build an agent that was better at predicting what the customer's issue was and whether or not it was a fraud, and they could do it in less than a few seconds as opposed to 5 minutes. So the customer got the resolution quicker. There was a significant efficiency opportunity and the risk management is better. And we built that, deployed it, created iterated learning. And we know we can get. If the regulator gets comfortable with it -- with those outcomes and we can prove it, we could do all 12 steps. But we have hundreds of journeys across the bank, which are going to create that kind of better for customer experience, more efficiency for the bank and actually better risk management. And you need to deploy that with highly qualified engineers, great product managers and a culture that empowers that level of change. And that's what we're doing. So I'm really excited about the next 5 years.

I think we're all as excited as you are. I'll take the opportunity to open the floor up for questions. Please raise your hand if you have any questions for Charlie. Not immediately, so I'll take the opportunity to ask you more. So I think William said last week that any discussion on U.K. macro and taxes, et cetera, should be taken together with what's happening on the regulatory side of things. So -- I mean, the treasury has proposed reforms ring-fencing to create a more agile and proportionate regime and the new growth allowance could enable banks to provide up to GBP 80 billion of additional lending. I know this is something that Lloyds Banking Group has been supportive of. So how do you expect that to -- the benefits of those proposals to come through?

Yes. Look, it's a really good question. I think it's -- if I take a step back, it's a kind of obviously complex moment because we have a new administration for this government. And I've obviously had a chance to meet the Chancellor a few times in the last few weeks. But we actually don't know what choices they're going to make on a whole series of areas, including on ring-fencing. What he has said, both privately and publicly, is they recognize that growth is the most important thing to get going in this economy, which is important. They recognize that businesses, including financial services, will be the core to enabling that growth, and that for businesses to drive growth, they need to be more profitable. That's quotes from our chancellor and the treasury in that context. And he said, on top of that, he's going to keep the existing regulatory reform process that's currently going through Parliament called the Financial Services and Markets Bill, and critically, some of the FOS reforms, which historically have been the most difficult political reforms to push through around consumer duty. He's going to keep those going forward at pace. And certainly, that's what we've seen. So a really interesting set of positions, very consistent with the last administration. And for that matter, as I've got the history, the last government as well, whether they were Conservative or Labour, because at the heart of it that conundrum around to really build a more equitable and successful U.K. society we need growth, and the government doesn't have the finances; however, it organizes its fiscal policy to drive that growth without the private sector. And there's a good recognition now that financial services is at the heart of all of those choices. So I think that's a very positive backdrop for us. Let's see what specific choices come in the next few weeks. On ring-fencing reform, which was your specific question, yes, they have created this proposal to allow 10% of the assets within the ring-fenced to be able to enable new growth. That would be important for us, and so we are very supportive of it. There are some other operating changes within ring-fencing that we think would make sense as well. We have the FPC review of capital going on at the moment, which is independent of both the Treasury and the Bank of England, but it does have representatives of both on the FPC. And so far, their proposals haven't reduced the level of capital to support real economic growth, but there are some proposals on the table for that. And so we'll need to see how that comes out. For example, for those that do want to go into the details of our capital stack, the domestic O-SII buffer, which we think materially overlaps with other buffers, if that were offset or reduced, it would make it lower cost of equity, and therefore, more available funding to the real economy in the U.K. And obviously, we -- that's our job. We support real customers, whether they're corporates, institutions, SMEs or individuals to borrow and to invest in the economy. So that's still to go out in front of us. And I probably, because you're going to go there is, have I had any discussion around bank taxes or reserve remuneration. Look, the answer is at this stage, no proactive outreach. They -- as I said, I've been with the chancellor 3 times in the last few weeks, he hasn't raised it. That doesn't mean they're not going to consider it because it's always on the list. As you know, just tactically, about 3 weeks before the budget is when they finalize what they're going to do. But I think importantly for us, I know William shared this, for every 1% increase in the bank surcharge, if that were to happen, and I don't think it's guaranteed. Let's be clear, I don't think it's clear that that's the path they're going to go down given everything I just said. But for every 1%, it would be about GBP 75 million of profit. If that were a 2% to 3% increase, GBP 150 million to GBP 200 million, 50 basis points on our RoTE, none of that would change my guidance. And I don't think it would change the investments and the strategy we've got in place. And if they did a reserve remuneration change that looked a bit like the Swiss model, it would be a similar impact. So these things, they'll be driven by the politics. We are very clear that we don't think that would be the best thing for supporting the real economy. But look, our focus is on delivering our strategy, our shareholder proposition through cycle and building a stronger, more sustainable bank.

That's great. I will just check for last-minute questions. I think there was some over -- towards the back.

Maybe just to round out on the macro. We've had a significant move up in the rate environment. How is that filtering through the customer base? Are you seeing any sort of attenuation of CapEx, because I think you almost pointed to a bit earlier, and then, on the mortgage side?

Yes. So thanks for that. Look, at this stage, we're still guiding from our expectations is that rates will be stable through this year, and the terminal rate will be 3.5%. Obviously, the market has been in a very different place all year. We're having a discussion at the moment as to whether that is our forecast when we get to Q3. But I still think that's not a bad starting point for now. As you say, specifically on mortgage customers and those looking at 5-year mortgages, they've seen an increase in the cost of their mortgages. They were trading at -- sorry, they were being priced at around 4.5%, 4.75% at the end of last year. They're now up about 5.5%, some are going up to 5.9%. We're seeing no deterioration in any of our portfolios. As you know, all of the mortgage customers have been stress-tested to 7% to 9%, depending on which cohort they were over the last few years. So we're not seeing any change in behavior. And yes, of course, I think the latest data I saw is depending on if it's 2-year, 5-year, interestingly. Some of the 2 years, they are not getting an increase. But for those people stepping up, I think on average, it's about a GBP 200 a month increase, which is material. We're seeing for those customers, they have the capacity to do that. And it's not materially changing their spending capacity either. So it's obviously a very important change for those customers, but it's not driving any concerns that we have at this stage around risk on the portfolio. And we're seeing exactly the same on our cards, loans and SME portfolios, which look both based on the current backward-looking data and our forward-looking early indicators, incredibly resilient and strong relative to history. If the follow-up around that is when do we get nervous? I suppose we got that question in 2022-'23 when we got up to 5.25%. Even then, we were stress testing. Broadly, my view is you'll have to get towards 7% to 8% interest rates to see a material impact on customers struggling to make ends meet, partly because they've been originated now for 12, 15 years with that as their stress test case. And of course, the big driver in the U.K. of a more level playing field around challenges on the portfolio will be unemployment, which is still really quite resilient.

That's great. We're almost out of time now. So I'll draw the session to a close. Thank you very much, Charlie, for joining us today.

Thank you.