Lloyds Banking Group - Q1 2023

Transcript

Operator (participant)

Thank you for standing by, welcome to the Lloyds Banking Group 2023 Q1 Interim Management Statement call. At this time, all participants are in a listen-only mode. There will be a presentation from William Chalmers, followed by a question-and-answer session. If you are joining by phone and wish to ask a question, please press star one one. This call is scheduled for an hour and is being recorded. I will now hand over to William Chalmers. Please go ahead.

William Chalmers (CFO and Executive Director)

Thank you, operator. Good morning, everybody, and thank you for joining our Q1 results call. Let me start with an overview of our key messages on slide two. The group has continued to deliver in Q1. As ever, and particularly in the current environment, our purpose of helping Britain prosper is central to how we operate. Our purpose from business model enables the group to offer significant support to customers and colleagues as they navigate the increased cost of living.

We've also continued to deliver against our strategic ambitions for the group. You'll hear more about this at the half year and in our deep dive sessions in H2. Underpinning this, we delivered a solid financial performance in Q1, including strong income growth and capital generation. Our confidence in the group's business model, strategy, and continued financial performance are reflected in our maintained guidance for 2023.

In an environment of change, our commitments have remained constant. Let's turn to the financials on slide three. Lloyds Banking Group delivered a solid financial performance in the first quarter of the year. Net income of GBP 4.7 billion is up 15% on the prior year, supported by a net interest margin of 322 basis points, growth in other income, and a continued low operating lease appreciation charge. Operating costs of GBP 2.2 billion are up 5% on the first quarter of 2022. This reflects our continued strategic investment alongside inflationary effects on the cost base. We remain committed to maintaining our market-leading efficiency position and are on target to achieve our guidance of circa GBP 9.1 billion for 2023. Asset quality is resilient.

The impairment charge of GBP 243 million is equivalent to an asset quality ratio of 22 basis points, supported by a small release relating to the improved macroeconomic outlook versus Q4. Consistent with recent periods, given the reporting changes we implemented a year ago, underlying and statutory profit before tax are now largely aligned. Statutory profit after tax for Q1 was GBP 1.6 billion, and the return on tangible equity was 19.1%. This drove strong capital generation of 52 basis points, even after taking the full GBP 800 million fixed pension contribution. Alongside, TNAV is up 3.1 pence per share after the IFRS 17 restatement. I'll now turn to slide four to look at our resilient customer franchise. Mortgage balances stand at GBP 307.5 billion.

This is down GBP 3.7 billion in the quarter, largely driven by the GBP 2.5 billion legacy portfolio exit that we mentioned at the full year. Excluding this, the open mortgage book was down GBP 0.6 billion in the quarter, reflecting lower activity levels across the market. Alongside, we continue to see modest growth in our other retail businesses, with credit cards, loans, and motor finance all showing progress. Likewise, we continue to take advantage of strategic growth opportunities within the corporate institutional business, delivering growth of GBP 0.7 billion in balances in Q1. As in previous quarters, this is offset by repayments of government support scheme loans within SME and some lower underlying balances. Turning to the deposit side of the balance sheet. Total deposits are down GBP 2.2 billion in the first quarter, or roughly 0.5%.

This includes a reduction of GBP 4.3 billion in retail and growth of GBP 2.7 billion in commercial banking. The retail balance development includes an outflow of GBP 3.5 billion in current accounts. This reflects unusually high seasonal outflows, mainly tax payments, higher spend given inflation and rates, and a more competitive market, including government NS&I offers and our own savings rates. Looking forward, it is likely that the higher customer spend levels, internal churn, and market competition continue, but we do not expect to see the circa GBP 2 billion of tax payments repeating this year. Savings balances in Q1 were essentially flat, albeit with some expected movement from variable to fixed rate. In commercial banking, we saw modest SMB outflows due to spend increasing and corporate institutional inflows. Some of these inflows were strategic, some likely short term quarter imbalances.

Across deposits as a whole, acknowledging uncertainties, we expect balances in 2023 to be broadly flat on 2022. Alongside, we've continued to see good organic growth in insurance with circa GBP 2 billion of net new money in the quarter. Moving on to slide 5 on the group's strong income performance. Net income of GBP 4.7 billion is up 15% year-on-year, with higher NII and other income. Net interest income of GBP 3.5 billion is 20% higher than the prior year, benefiting from a stronger net interest margin and higher average interest-earning assets. The Q1 margin of 322 basis points is up 54 basis points year-on-year, but stable on Q4, as we had expected.

As set out at the full year, we've seen continued pressure on asset margins broadly offset by tailwinds from base rates and benefits from the reinvestment of structural hedge. Mortgage completion margins were around 50 basis points in the quarter. This average included slightly higher new business margins and slightly lower product transfer margins.

As you can see, the nominal balance of the structural hedge remains at GBP 255 billion. The weighted average life also remains around 3.5 years. Given an average yield of around 1.2% and currently prevailing swap rates, reinvestment of hedge maturities is expected to continue providing a healthy tailwind in the coming quarters. As outlined in February, we continue to expect the net interest margin to reduce in Q2 before stabilizing in the second half of the year.

Overall, a base rate rise beyond our initial expectations has been offset by tighter product margins. We, therefore, continue to expect a full-year margin in excess of 305 basis points. Alongside, we continue to expect broadly stable AIEAs in 2023. Turning briefly to other income. OOI of GBP 1.3 billion in the quarter is up 6% year-on-year and up 11% on Q4. We've continued to see activity build and benefits from investment, providing underlying growth.

Q1 also benefited from benign weather and insurance compared to Q4, and a profit on sale of the legacy mortgage book. We continue to expect other income to build gradually, supported by customer activity, our ongoing strategic investments, and releasing the store of insurance earnings within our CSM liability. A brief word on operating lease depreciation.

The charge of GBP 140 million in the quarter is higher than previous periods. The leased car fleet grew, and we recognized lower gains on sales in Q1 as new vehicle supply constraints eased. Augmented by Tusker, we expect this trend to continue through 2023 and therefore to see the operating lease depreciation charge grow through the year. Looking at costs on slide 6. Operating costs of GBP 2.2 billion are up 5% year-on-year. As you know, the increase is driven by our planned strategic investments, the costs associated with our new businesses, and inflationary effects on the cost base. The cost income ratio of 47.1% or 46.6%, excluding remediation, continues to be competitive.

Looking forward, we will maintain our rigorous cost discipline and remain on track to deliver operating costs of circa GBP 9.1 billion in 2023. Remediation was very low in Q1, at GBP 19 million. There is no charge in respect of HBOS Reading, although as ever, uncertainties on this remain. We continue to have a base case remediation charges of around GBP 200 million-GBP 300 million per year. Let me now move on to asset quality on slide seven. Asset quality continues to show resilience across the group. Our retail businesses are performing well with arrears at or below pre-pandemic levels. Meanwhile, commercial performance is strong, with the Q1 charges largely relating to cases that were already in Stage 3. The net impairment charge for Q1 was GBP 243 million, equivalent to an asset quality ratio of 22 basis points.

This includes a GBP 322 million charge before the updated economic scenarios, roughly consistent with Q4 and equivalent to an AQR of 28 basis points. As you can see, there's a small release in respect of the updated macroeconomic scenarios. Stemming from reduced energy prices and a looser fiscal constraint, the base case represents a modestly improved outlook. As usual, the detail of our scenarios is in the appendix. The stock of ECL on the balance sheet is marginally lower in the quarter of GBP 5.2 billion, with coverage levels remaining very strong. Given everything we can see, we continue to expect the net asset quality ratio to be around 30 basis points for 2023. Turning to slide 8 and looking across our portfolios. Retail performance is resilient.

We're seeing a modest increase in new to arrears in some portfolios, but from a very low base. Movements are within or in some cases better than our expectations. Mortgage book is very high quality. The average loans value is 42% and 93% of the book is below 80%. We have seen a small uptick in arrears in the variable rate legacy books from 2006 to 2008, but the rest of the portfolio shows no noticeable movement. The unsecured book, meanwhile, is performing better than we had expected. In the commercial business, we continue to see stable SME overdraft and RCF utilization trends. Watchlist and business support unit levels are stable to modestly down on year-end.

Our commercial portfolio is very high quality. Around 90% of SME lending is secured, whilst more than 75% of commercial exposure is to investment grade clients. Within the commercial business, our net real estate exposure after significant risk transfers is GBP 11 billion and has been significantly de-risked in recent years. Lending is focused on cash flows, with 84% having interest cover of 2x or more. The average LTV of the portfolio is 44%, while 95% have an LTV below 70. The portfolio is also well diversified and subject to sector caps and limits. Our exposure to offices is around 14% of the portfolio, 10% to retail, and 11% to industrial assets. Across our businesses, we feel very comfortable on asset quality. Let me now move on to slide 9 on the group's liquidity position.

Given recent events, it would be remiss not to spend a moment on deposits and liquidity. The group continues to have a very well-diversified deposit base and a very strong liquidity position. The net stable funding ratio at 129% and loans to deposit ratio at 96% demonstrate the strength of the group's funding. We benefit from a predominantly retail focused deposit base, with around three-quarters of deposits coming from retail and a well-diversified portfolio of SMEs. Over 90% of the deposit increase of circa GBP 60 billion since the end of 2019 has been in the retail franchise. A very significant proportion of our customer deposits are insured, with over 80% of retail customer balances and 57% of total deposits protected by insurance schemes such as the FSCS.

The liquidity coverage ratio of 143% is stable and is well above both regulatory requirements and our internal risk appetite. Group liquidity remained robust throughout the recent volatility, with all liquidity measures well above internal thresholds at all times. Our liquidity pool of around GBP 140 billion is held in high quality liquid assets, with the majority held in cash and government bonds. The entire portfolio is hedged for interest rate risk, with only credit risk driving limited movements in fair value through other comprehensive income. This was negligible both in 2022 and in Q1. Together with central bank facilities, this provides over GBP 210 billion of available liquidity. A very strong position. Moving on, let's look at TNAV and capital on slide 10.

Tangible net assets per share are GBP 0.496, up GBP 0.031 in the quarter after the IFRS 17 restatement. This is largely driven by attributable profit, also benefits from the cash flow hedge reserve movement and pension surplus bill. Risk-weighted assets of GBP 211 billion are flat in Q1 as we continue to benefit from portfolio optimization. We saw no impact from credit migration. We expect to receive an update on CRD IV models later this year, for this to result in an increase in risk-weighted assets. Having said that, this will still be consistent with our 2024 RWA guidance of GBP 220 billion-GBP 225 billion. Capital build remains strong at 52 basis points. Within this, we've now taken the full GBP 800 million fixed pension contribution for the year.

The CET1 capital ratio is stable in the quarter at 14.1%. This is after the impact of regulatory change, the acquisition of Tusker, and accruing for the dividend. We remain comfortably ahead of the board's ongoing target of circa 12.5%, plus a management buffer of circa 1%. Looking forward, and including the strong performance in Q1, we continue to expect 2023 capital generation to be circa 175 basis points.

Turning to slide 11 to wrap up. In sum, the group has delivered a solid financial performance in the first quarter, supporting strong income growth and capital generation. We are committed to supporting our customers. Our franchise and portfolios are demonstrating resilience. Looking forward, we're maintaining our guidance for 2023. We continue to expect net interest margin for 2023 to be greater than 305 basis points.

Operating costs to be circa GBP 9.1 billion. The asset quality ratio to be about 30 basis points. Return on tangible equity to be circa 13%, and capital generation to be about 175 basis points. You can see that in an environment of change, the group's commitments have remained constant. We remain well positioned for the future. That concludes my remarks for this morning. Thank you very much for listening. I'll now hand back to the operator for Q&A.

Operator (participant)

Thank you. If you wish to ask a question, please press star one one on your telephone keypad. To withdraw your question, you may do so by pressing star one one to cancel. There will be a brief pause while questions are being registered. The first question comes from the line of Raul Sinha from JP Morgan. Please go ahead.

Raul Sinha (Equity Research Analyst)

Thanks very much. Good morning, William. Maybe two questions from my side to start with. Given the margin seems to be behaving exactly as you predicted, last quarter, I was wondering if I could ask you about the extent of the margin decline in the second quarter. In particular, I guess if we were to assume a base rate hike for the May MPC, should we still expect it to be down, or would you then expect it to be flattish? My second question is around the other income line, which obviously was a very good outcome this quarter. I'm just trying to get a sense of the new underlying run rate, if there is one. I mean, how big were the mortgage loan book sale gains?

It looks to me like the annualized run rate might be closer to GBP 4.95 billion almost. Would you agree with that? Thanks so much.

William Chalmers (CFO and Executive Director)

Thanks, Raul, for those questions. First of all, in terms of the margin developments in Q2, you saw in Q1 that our margin was 3.22%, which as you say, was pretty much as we had expected when we gave our full year results announcement. There were a combination of factors at play there, including the benefit of base rate changes, somewhat offset by the mortgage headwind. Those are the two main factors, together with some run through of the hedge maturities in Q4. When we look forward into Q2, we do continue to expect a step down in the margin, just as we highlighted at the full year results.

That is gonna be driven by a variety of factors, but the principal factor in terms of the headwinds into the margin in Q2 are around the bank base rate changes combined with the churn and pricing impact on the deposit side. It's really around the evolution of the deposit base and the pass-through of some of the pricing changes that we've seen into the deposits into Q2.

That has a preponderant effect in terms of the evolution of the margin going into the quarter. We do not have any structural hedge maturities into Q2, so that's an absence, if you like, of a tailwind that we'll expect to see playing through later on in the year. Further as we go into the year, the mortgage headwind starts to evolve.

In Q3, Q4, you see more or less the offsetting impact of the structural hedge maturities on the one hand against a kind of maturation, if you like, of the mortgage refinancing headwind on the other. For Q2, it's largely around that churn and deposit pricing impact. You asked about the effect of the bank base rate on that in Q2, and if we do see rather a further bank base rate change, what effect might that have? It is, as you know, normally the case that bank base rate changes will help our margin. That is off the back of leads and lags and to an extent, any liability widening that you might see.

You know, having said that, we are seeing a competitive deposit market. The question will be in Q2, Raul, if we do see a bank base rate change, how much of that feeds through into deposit pricing in the market as a whole? How much do we see it as appropriate to ensure that our deposit base is as resilient and robust and competitive as we've seen it in Q1? Those are the dynamics. I think overall, even if we do see a base rate change, and even if that does benefit the margin slightly in Q2, I would still expect to see a step down in the Q2 margin. That is not gonna change. Your second question, Raul, on OI. OI, as you say, was a pleasing performance in Q1, GBP 1.257 billion.

That was up, as I said, 11% or about GBP 130 million off the back of Q4, 1.128 or thereabout. What's going on there? There's a couple of different factors going on. In each of our business areas, we've seen some positive developments. In retail, for example, we've seen some positive underlying developments in Lex business growing, likewise in terms of cards related activity. Within commercial, we've had a strong first quarter as we normally do, but it's been particularly marked this quarter, which is good to see. Then in insurance, pensions and investments, we've seen two benefits really. One is the absence of weather that we saw in Q4, so the absence of a negative there.

More importantly, we've also seen the roll-up in the contractual service margin off the back of the IFRS 17 changes in 2022 start to then roll out off the liability into Q1 of this year. When we look forward, there are, as you say, a couple of one-off benefits. We talked about the legacy mortgage book. I've just talked about weather or the absence of weather, let's say, in insurance. Those two will clearly ebb away, but their place will start to be taken by kind of activity-led growth by some of our strategic investments, both organic and inorganic, and they will play into the OI looking forward.

I think off the back of this kind of 1.25 number that we produced at Q1, you should expect to see that consolidate over the course of the remainder of this year. As you know, we don't predict the OI, so I won't go into that precisely now, but I think that 1.25 number is likely to be a kinda roughly consistent type of run rate that we'd expect to see for the remainder of the year.

Raul Sinha (Equity Research Analyst)

That's very helpful, William. Thank you.

William Chalmers (CFO and Executive Director)

Thanks, Raul.

Operator (participant)

One moment, please, for the next question. The next question comes from the line of Benjamin Toms from RBC. Please go ahead.

Benjamin Toms (Senior Equity Analyst)

Morning, William. Thank you for taking my questions. The first one's on costs. If I take the Q1 and multiply by four and then add in something like GBP 150 million for the bank levy, I think I'm a bit below, your guidance for the full year. Is it fair to say that costs will step up slightly in the coming quarters? Secondly, a question just in response to news flow around pre-funding a deposit guarantee scheme in the UK. Have you had any discussions with the regulator in respect of this? Do you have any thoughts you can share with us on it? Thank you.

William Chalmers (CFO and Executive Director)

Yeah. Thanks, Ben. In relation to costs, I think the most important point in costs is that we're sticking with our guidance of GBP 9.1 billion for the full year. That is going to be the bottom line for the full year. We will deliver on that guidance just as we always do. In effect to Q1, as you say, we got GBP 2.17 for operating costs in Q1. There are some factors that play themselves out in the later part of the year. Bank levy, you mentioned, there's a bit of a pattern to the overall investment spend and associated charges with that. There's a bit of a pattern to inflationary pressures over the course of the year, including things like pay settlements and so forth.

That combination then is going to produce a pattern of costs which will vary a little bit quarter by quarter. Again, I would focus on the bottom line of the GBP 9.1 guidance that we'll deliver. In terms of the protection schemes that may or may not come to pass as a result of the recent volatility we've seen in the banking sector, we have not had any discussions so far with the regulator, about what may happen there, whether that's a focus on deposit insurance, whether it's a focus on liquidity, and indeed, to the extent that it's the former, how would it be funded.

It is, in its current form at least, going to be a funding mechanism, which should have a relatively modest impact on our overall earnings going forward, simply because the way in which the funding mechanism feeds through into our P&L. You know, absent some very significant change, in the way, in the quantum of insurance or alternatively the way in which it's funded, we see this as if it does change, having a relatively modest impact on the P&L, if that gives you some indication of bottom line expectation.

Operator (participant)

One moment, please, for the next question. The next question comes from the line of Martin Leitgeb from Goldman Sachs. Please go ahead.

Martin Leitgeb (Equity Research Analyst)

Yes, good morning. Thank you for taking my question. I just have two questions, please, relating to NII and the margin outlook. The first one, I was just wondering if you could comment on the evolution of product margins. You have called out product margins earlier, obviously having an impact in Q1, completion margins up 50 basis points in mortgages.

Could you just highlight what you have seen recently and whether application margins have started to edge higher? Secondly, I was just wondering in terms of deposit composition going forward, how should we think about the shift from current accounts, particularly in retail, to other pockets of deposits going forward? There's a, I believe, a 3% decline, quarterly decline in current accounts in retail. Would you expect this space to continue, or does that really change from here? Thank you.

William Chalmers (CFO and Executive Director)

Yeah, thank you, Martin, for those questions. First question on product margins. What have we seen? As said, we've seen product margins tighten slightly over the course of the quarter. It's been relatively competitive markets, both in deposits and in mortgages. Taking each of those, there are two effects really within the deposit market. One is the pricing offers that you make to customers. Obviously, some of that attracts new money, some of that also generates internal movements.

As you have that internal movement, that increases your deposit costs by virtue of deposits moving from interest free in the context of PCAs into interest bearing in the context of, let's say, fixed term deposits, for example. Some tightening up, we have some good offers out there in the market, just as others do.

That overall is leading to deposit costs, which are increasing on a quarterly basis. Within mortgages, we highlighted a completion margin of 50 basis points. As said in my comments earlier on, that 50 basis points is composed of two elements. One is the product transfer or retention part of the market, which is actually marginally below 50 basis points.

Why are we comfortable with that? It's because we know the customer, it's because we're building the relationship, and so we see an attractive return profile for that type of mortgage, even if the headline pricing or spread is slightly lower. The other component is new business margins. New business margins are in fact higher than the 50 basis points that we give.

We haven't put a number on it, but, you know, we've seen new business margins anywhere between 60 to 80 basis points through the duration of the quarter, depending upon the particular point in time that you look at. Those are higher. The challenge is that the volumes of new business in the current market is relatively modest. That overall produces a blended margin of the 50 basis points that we've given you. That's the completion margin for Q1. As we look forward, our expectation is that the mortgage market will continue to be relatively muted, and therefore, retention will continue to be a significant component of our overall completion margin within the mortgage business.

That in turn, I don't want to be too kind of predictive at this point, but that in turn leads us to think the completion margins in Q2 will probably not be terribly different to what we've seen in Q1. We'll see how that evolves, but that's our base case right now. It's worth saying at the margin as well, sorry to give a pun. It's worth saying in other products as well, unsecured, for example, we've seen slightly higher funding costs there, while pricing has stayed more or less stable. There's a little bit of margin compression going on there. All of these developments, deposits, mortgages, unsecured, and indeed the commercial book, are all contained in our greater than 305 margin guidance.

As per the comments that I made to Raul's question earlier on, you know, if we see base rate changes, and not all those base rate changes get competed away, then indeed one might expect to see a little bit of upside in our margin develop over the course of Q2 and indeed into the remainder of this year.

I think we just have to see how that plays through. You know, again, if we do see more base rate changes, perhaps that's where it ends up, but it does depend upon how the liability markets move. In terms of movement in the overall book, we have seen some movement from PCAs into fixed rate and also a product that we call limited withdrawal, which gives customers slightly better rates in turn for sacrificing instant access on a, as the name implies, slightly more limited basis.

We've seen money flow out of PCAs, about 25% of that GBP 3.5 billion outflow of PCAs has actually been recaptured in our fixed rate and limited withdrawal products. We've also seen within the savings book a little bit of movement from variable rate into fixed rate and likewise limited withdrawal. We've also seen new money from outside of the bank come into that fixed rate and limited withdrawal product. That overall is leading to the types of changes in composition of the book. You look at it on a quarterly basis, and the overall changes are pretty modest on a quarter by quarter basis. You know, that's what we saw in Q1. I would expect a little bit more of that to continue going into Q2.

Again, that's all contained in our overall margin guidance of greater than 3.05% for the year.

Martin Leitgeb (Equity Research Analyst)

Thank you very much.

William Chalmers (CFO and Executive Director)

Thanks, Mart.

Operator (participant)

One moment, please, for the next question. The next question comes from the line of Jonathan Pierce from Numis. Please go ahead.

Jonathan Pierce (Banks Analyst)

Morning, everybody. Got a couple of questions, please. The first is on net interest income. The margin was slightly better than people thought, and the interest-earning assets, likewise. The headline NII was a touch lower. It's this non-banking interest expense that has moved up quite sharply in the quarter. I just understand what that is. Is this the equivalent to what some other banks call trading book funding costs? Is there an offset there going through non-interest income? If so, should we be looking at that sort of run rate, GBP 75 million or so a quarter now, so long as base rate stays up where we are? The second question is on the scale of the risk-weighted asset increase you might be looking at later this year on the CRD4 clarification.

Could you give us a sense as to how large that is and which particular area it's coming from? Sorry, an additional in relation to that. I think when CRD IV changes came through early last year, there was not only some increase in RWAs, but there was an increase in some capital deductions as well. Can you just tell us whether this clarification may affect both the numerator and the denominator or it's just a risk-weighted asset issue? Thanks very much.

William Chalmers (CFO and Executive Director)

Yeah, thanks. Thanks, Jonathan. First of all, on the net interest income and impact on net interest margin of non-banking interest income. When you look at the progression of net interest income quarter four into quarter one, and as you point out, Jonathan, you look at the margin, it's basically the same. You look at the AIEA, and it's basically the same. To your point, what's going on there? Two things. One is there is a day count issue. There are fewer days in quarter one than there are in quarter four. That's about half of the impact. The second one, as you point out, is the non-banking interest income, for want of a better word, which actually, if you look at our disclosures at the back of the interim statement, is an expense, and it's an expense of about GBP 76 million in quarter one.

That is up a little from quarter four, on a year-on-year basis, it's up about GBP 55 million or thereabout. GBP 56 million, I think, to be precise. As you look forward, that is a run rate number. The reason to explain kind of what's behind it is that it is basically funding the non-banking businesses, the non-interest income driven businesses, for want of a better word. You described it as kind of trading expense, in other institutions. There's a bit of that with us for sure. There's also things like LEX, for example. These are businesses which are not driven by virtue of interest bearing balances, and that in turn drives the non-banking interest income expense, which is essentially a funding expense for those businesses.

To a degree, as those businesses grow, you would expect to see some benefit from that coming through other operating income. A Lex business increasing in size, for example, benefits other operating income. Likewise, some of the trading activities. Actually the main factor driving it alongside of that, let's say, is the increased funding cost, the increased interest rate environment that we're in. That's what you see playing through into Q1. As said, you should expect a run rate not dissimilar really to what you saw in Q1 for the remainder of this year. When we calculate our interest margin of 3.22%, we exclude that component. That's how you can reconcile that plus the new base point to the run rate net interest income from Q4 going into Q1. You asked about CRD4, Jonathan.

CRD4, as said in my script, we do expect to receive further news on from the PRA over the course of this year, and it is likely, we think, that that will lead to a modest increase in RWAs. Just to track back and give some history on that, when we set out our CRD4 expectations on January 1, 2022, which you referred to in your question, we saw at that point about GBP 16 billion increase in RWAs. GBP 14.5 billion of that was in relation to mortgages. We said at the time the CRD4 component for mortgages was a best estimate, if you like. It was a place marker based upon the fact that the discussions of the PRA and the models were not totally finished business.

As we've rolled forward since that time, we've learned more on the PRA technical requirements in this area. We've learned more about their approach to historical data and to a degree, their approach to cyclical sensitivity. Off the back of that, we expect a modest increase in RWAs to be informed to us, if you like, by the PRA later on in the year. I think the most important point there, Jonathan, is that that increase, I won't put a number on it precisely, but that increase is within our circa 175 basis points capital guidance and also within our 2024 RWA guidance of 220-225, which tracking back at the year end, I said it was, you know, broadly speaking, a kind of linear trajectory, 2023 going through into 2024.

That's how that CRD4 expectation from the PRA is factored into our numbers, if you like. Specifically on your point about is this a numerator and a denominator issue, no is the answer. This is likely just to be RWAs, which in turn is a denominator issue for purposes of our capital calculations.

Jonathan Pierce (Banks Analyst)

Okay, brilliant. Thanks a lot for that.

William Chalmers (CFO and Executive Director)

Thanks, Jonathan.

Operator (participant)

One moment, please, for the next question. The next question comes from the line of Chris Cant from Autonomous. Please go ahead.

Christopher Cant (Head of Banks Strategy)

Good morning. Thanks for taking my questions. I think we've covered quite a lot of ground already, just a couple of follow-ups around NII and your thinking there going forward. In terms of the mortgage piece, could you give us an update on where the back book mortgage spreads are on the non-SVR component of the book, just so we can understand the sort of degree of headwind that kind of 50 bits level are likely to present?

Then thinking about structural hedge, obviously you've seen some current account outflows. You expect the deposit market competition to expect in some of those trends outside of the tax impacts to persist. How are you thinking now about your structural hedge size prospectively? You previously said you were very, very comfortable maintaining it, given buffers, et cetera.

If you're now expecting to see, some persistent current account outflows, even if they're relatively modest, how does that then feed into your thinking on the sizing of that going forwards? Thank you.

William Chalmers (CFO and Executive Director)

Yeah. Thank you, Chris. Just taking each of those. On the mortgage book, first of all, I won't give you quite the split that you want, but I'll give you a few numbers that I hope will help you reconcile some analysis. When we look at mortgages in terms of the yield this year, the yield on the mortgage book this year, we expect to be about 1.35%. To give you some idea as to the effect of refinancing this year, we've probably got about GBP 65 billion-GBP 66 billion rolling off from the fixed rate book during the course of this year. That stock of refinancing fixed rate mortgages is at around 1.8%.

As you know from the, our comments around completions, that is rolling back on, or at least that part of which we retained is rolling back on an average completion margin of around 50 basis points. Quite a significant headwind this year. I know it's not the split FTR versus fixed that you're asking for, but it hopefully gives you some idea that will allow you to get to that answer. Having said that, the headwind from that refinancing next year starts to dampen down because the maturities or the price of the maturities at which they are rolling off, it starts to get significantly less. It's well below the 180 that we're gonna see this year.

I won't put a number on it, but it's well below the 180, and therefore is much less of a squeeze in terms of the headwind that it causes. That means in turn, as we said before, that the bulk of the mortgage headwind is addressed and dealt with by the time we get to the back end of 2024. You asked about structural hedge size. The structural hedge size is currently GBP 255 billion.

That's a size that we feel very comfortable with today. We have a buffer which is about GBP 19 billion. In the past, we've always operated with a buffer which is around 5% of the structural hedge. GBP 19 billion is more like around 7.5% of the 255 that we've got in the structural hedge today.

The buffer of GBP 19 billion is probably in excess of the types of levels that we would seek to carry going forward. Having said that, as you say, deposit churn we believe will continue. We think that we will continue to see a little bit of outflows within the PCA. Why is that? It's because spend is clearly greater in an inflationary environment than it was before.

People are paying higher interest bills for various financing and other products than they did before. We will not clearly see a repeat of the tax issue within January that we and other banks saw, having said all of that, but that means, you know, we may see a little bit more PCA flow. Likewise, PCAs will also be attracted into the savings book, including, as I mentioned earlier on, our own.

Within the savings book, we would expect to see a little bit more out of variable rate and into fixed term deposits and limited withdrawal. As said, people are prepared to give up access for a bit more income in a higher rate environment. I think we'll You know, we expect to see that continue to a degree going into Q2.

That clearly has a, an impact on the structural hedge in terms of the balances that are available to be put within there, at the same time, we have two or three tools to manage that. We have the size of the buffer, as said, GBP 19 billion, probably in excess of what we'd choose to run with. We also have upcoming maturities. Can you play, if you like, a slightly lower buffer off the back of a significant volume of upcoming maturities? Yes.

They're tools that interact with each other. Thirdly, you have the weighted average life. Can you slightly shorten elements of a structural hedge, bring the weighted average life in, again, as a further tool to manage. Finally, we have very conservative pass on assumptions within the structural hedge. You know, those in turn give us a further degree of security, if you like, as we look at the overall structural hedge. I think in sum, Chris, where we are with that is the size is currently GBP 255. We feel comfortable with where it is today. We are also conscious of the fact or aware of the fact that we're in a evolving environment.

We have not been in a rate cycle for, let's say, 15 years. It's not entirely clear how that plays out and the pace at which it plays out. We are where we are today. We feel comfortable with it, but we monitor the position, and we'll keep an eye on it going forward.

Christopher Cant (Head of Banks Strategy)

Thank you.

William Chalmers (CFO and Executive Director)

Thanks, Chris.

Operator (participant)

One moment, please, for the next question. The next question comes from the line of Aman Rakkar from Barclays. Please go ahead.

Aman Rakkar (Director, Banks Equity Research)

Morning, William. I just wanted to touch upon deposits again, if I could. I'm sure we can kind of piece it together, the various disclosure that you do give us. Could you just confirm what proportion of your deposit base is a non-interest-bearing current account currently? Also what proportion of your deposit base is term deposit as things stand? Secondly, could you maybe just give us some indication of what deposit mix you've assumed in your, in your NIM guide?

Alternatively, could you help us kind of understand some kind of sensitivity that might pose a risk to your outlook for NIM or NII? If, you know, there's actually more migration of current accounts to term deposits, kind of what's that threshold in your mind where we should kind of be thinking about? Thank you very much.

William Chalmers (CFO and Executive Director)

Yeah, thanks. Thanks for that, Aman. Couple of questions there. One is the split between interest-bearing and non-interest-bearing within the deposit book. The second around sensitivity to the margin from deposit movements. We do not formally disclose the split between interest-bearing and non-interest-bearing within the deposit book, I'm gonna give you a couple of numbers that will enable you to, you know, make some assumptions and get there.

First of all, you can see the PCA volume in our retail book. That's disclosed on our balance sheet every IMS. I'll leave you to look at that. Second of all, the commercial book is roughly speaking, 28% or thereabout, non-interest-bearing. That's giving you a very precise number, 25%-30%, it'll go up and down quarter by quarter basis.

If you combine that together with the PCAs, you've got a pretty good idea, I think, as to the non-interest-bearing component of our overall deposit book. The second question is around how do we see the flows within our deposit book and to what extent might those cause sensitivity to the interest margin.

In short, in Q1, we saw within our deposit book overall combination of variable rate to fixed rate, PCA into fixed rate term and limited withdrawal, and indeed our wealth deposits into limited withdrawal and fixed rate. That number in total was about GBP 8 billion-9 billion, thereabout. That type of movement is probably not totally unrealistic to project forward into Q2.

As we see bank base rates start to steady off, i.e., fewer bank base rates thereafter, we think you're gonna see less movement thereafter because there's less reason to move, if you like. You've got less change in rates. You'll still see some playing out of a higher interest rate picture, to be clear, but less movement. Those are the types of flows that we've seen in Q1. Those are the types of flows that we might expect to see in Q2. As you can imagine, we've built a degree of cushion, if you like, within our overall interest rate expectations to ensure that we're able to give you guidance that we can achieve and beat.

I would add to that, if we see the bank base rate environment play out in the way that was being discussed earlier on in the call, to the extent that is not fully passed on or competed away in the deposit market, that probably just causes a degree of upside to our overall margin expectations. Again, still expect that step down into Q2 and leveling off in the remainder of the year, but at all points greater than 300 basis points. Again, there may be that benefit. Depends on how the bank base rate and deposit margins play out.

Aman Rakkar (Director, Banks Equity Research)

Thanks very much, William. That's really helpful. Can I just clarify the amount of term deposits that you have as part of your overall mix? I think you refer to it in some places in the disclosure, but I'm never quite sure if you're exactly referring to fixed rate term deposits. Could you confirm that number for us, please?

William Chalmers (CFO and Executive Director)

I don't think we do disclose that, Aman. I mean, you can see on our, on our slides, page nine I think it is, the retail savings and wealth components. You can see in our, in my comments earlier on, the amount of flows that we saw in the context of Q1. The splits that we've given on the balance sheet analysis in the IMS is probably about as far as we go, I think, in terms of disclosures. Sorry, we're not gonna get back to you precisely on that.

Aman Rakkar (Director, Banks Equity Research)

Okay. Thank you very much. Really appreciate it.

William Chalmers (CFO and Executive Director)

Thanks. Thanks, Aman.

Operator (participant)

One moment, please, for the next question. The next question comes from the line of Andrew Coombs at Citi. Please go ahead.

Andrew Coombs (Director, Equity Research)

Morning. One numbers question and one more big question, I guess. Numbers question just on the AT1. You did a large issuance in March. I think you said you're gonna call another at the end of June. Just any thoughts on the AT1 balance and hold and the coupon cost over the remaining quarters of the year? Then on the strategic question, wealth, obviously an area you've focused on, an area you've talked about growing as part of your non-NII growth initiatives. I was just interested, in wealth you've seen a 10% decline in deposits

The year end, that would partly due to the tax, issue that you mentioned, but also it's a 15% year on year decline. What's causing the decline in wealth deposits at a time when you're trying to grow that business?

William Chalmers (CFO and Executive Director)

Yeah. Thanks, Andrew. Thanks for that. We did do an AT1 issue earlier on in the year. As you say, that was deliberately done in order to take advantage of market opportunities in the context of the year. To a degree, at least pre-fund any upcoming activity that we might have in AT1. As you'll be aware, we've got a call out there for a small AT1 instrument right now. We are currently operating in excess of our regular AT1 guidelines, if you like. We've got more AT1 than we would necessarily have on a run rate basis on the balance sheet. That's fine. We feel comfortable with that position. We have AT1 developments over the course of actually next year.

It's worth mentioning actually, that we got our issuance away before the disturbance within Switzerland, in turn, that allowed us to deal with any AT1 requirements that we might have for the remainder of this year. We're done effectively for AT1. There is an AT1 instrument up for call next year.

We'll obviously have a look at economic circumstances and other factors as we approach that, but we're done for this year. You asked about wealth and what's going on within the deposit base there. In short, very similar thing to what's going on elsewhere in the deposit base. If I look at that, what's been factoring into the deposit base over the course of this year so far, as said, we've seen spend trends off the back of an inflationary environment.

We've seen higher tax outtakes, if you like, in January. We've seen some migration within instant access into savings books across the book, including wealth. In particular, if you look at that wealth number, a fair bit of that wealth output, if you like, outflow, was actually captured in our savings products. I mentioned earlier on, the overall GBP 9 billion that we'd seen move around the deposit book.

At least GBP 1 billion of that, perhaps a touch more, was coming out of wealth and into those savings products. We would see that as significantly a kind of build on that wealth relationship. You know, you are offering a wealth customer who has an instant access, transaction based account, additional products, to, if you like, benefit and tailored to their needs.

As we look forward in 2023, that mass affluent, that wealth offering is going to build on asset products and liability products and indeed on the interaction with investment products. The ambitions there, Andrew, are, you know, very much in the process of being achieved. There's nothing that we're stepping away from. It's very much business as usual.

Andrew Coombs (Director, Equity Research)

Thank you. On the aggregate coupon cost on the AT ones?

William Chalmers (CFO and Executive Director)

I don't think we've disclosed the aggregate coupon costs. I mean, in short, Andrew, we were pleased with the aggregate coupon costs relative to either our historical issuance or alternatively market benchmarks. I think we felt like we got a good issue away.

Andrew Coombs (Director, Equity Research)

Okay. Thank you.

Operator (participant)

One moment please for the next question. The next question comes from the line of Guy Stebbings at Exane BNP Paribas. Please go ahead.

Guy Stebbings (Executive Director, Banks Equity Research)

Hi. Morning, William. Thanks for taking the question. I had one on interest on the assets and one on capital buyback. On interest on the assets, GBP 454 billion in the quarter and ended the quarter, I think at GBP 455 billion. Appreciate you have flat year-over-year guidance. Just thinking about that sort of exit rate and should we therefore be assuming some small reduction to get to the guidance? If so, is that just the sort of closed mortgage book and slightly softer volume trends more broadly? Am I reading sort of being too specific thinking about the guidance and really it's just a flattish outlook from here.

On, on capital, I mean, historically you've talked excess capital decision being a decision for the full year, but you're sat at 14.1%. You sound as confident as ever on delivery of the capital generation targets, even with the CRD IV changes to RWAs. Some of the concerns around asset quality have maybe receded. I recognize you're still progressing a large buyback, but you are in a good position. Might a further buyback be announced before full year results and also with the Bank of England stress test results in hand, which aren't too far away now? Should we just expect to wait until later in the year? Thanks.

William Chalmers (CFO and Executive Director)

Yeah. Thanks, Guy. On AIAs, the simple answer is just a flat outlook for the year as a whole. That's a simple answer. I mean, within that, there's two or three dynamics that are going on. One is, as you'll have seen from the Q1 results, the continued runoff of a closed mortgage book. We expect that to continue a little bit, although, you know, I suspect what will happen is it will flatten off as the year goes on, just because you'll get to a stub of customers who are happy with what they've got. Number one. Number two, government lending. We've indicated Bounce Back Loans getting repaid over the course of Q1. I think that will continue over the course of Q2 and beyond.

Three, as you'll be aware, we've had a sale of legacy mortgage book, which in turn is actually in AIEA, but not in lending. You've got a slight discrepancy going on there. Those are the factors that play into AIEA. Alongside of that, clearly there's the regular asset growth patterns. Now, you know, what we've seen so far this year is relatively muted asset growth in many of our major markets. Broadly speaking, we've seen a little bit of outflow, for want of a better word, in the open mortgage book. If you exclude the legacy sale, that's about negative GBP 0.6 billion. It's kind of negligible, but it's modest in terms of the outlook for that business, i.e.

We'd expect it to grow a little, but not very much. We've actually seen some growth in our unsecured books and motor within the retail business still, which is pleasing to see. I think that'll flatten off during the remainder of this year. Maybe CNI continues to grow a little bit and SME impacted by the points that I just made.

Overall, I think a flat AIA picture over the year with those component parts moving in the way that I've just described them. On capital, your second question is said we had a very strong performance on capital in Q1, 52 basis points. We stand, as you pointed out, in a 14.1% CET1 level, which feels pretty robust, particularly in the context of us having front-loaded the pension payments of GBP 800 million.

There are one or two factors at play for the remainder of the year. We talked a little bit about the CRD4 increase, if you like, from mortgages expected later on in this year. That asset growth that I indicated, it'll be modest, but on the other hand, it'll grow RWAs a little bit with it. Overall, the capital growth for the remainder of this year, it's probably not gonna be as strong as 52 basis points. I'll just point you to the 175 annual guidance or circle 175 annual guidance for capital growth for the year as a whole. Coming to your question, Guy, what does that mean in terms of our statements around buybacks, capital distribution for the remainder of this year?

As you know, we've put in place a progressive and sustainable dividend off the back of 2022 that hopefully will get confirmed by the AGM and therefore allow us to pay that out. I'm sure that we'll look at the interim dividend at the half year and recommit, if you like, to our progressive and sustainable dividend in that context.

Our buyback is underway right now. The number that we've produced at Q1 has been supplemented by ongoing progress in the buyback, I think it's publicly available. We've probably bought back about GBP 750 million worth of stock right now, which will help us in terms of building TNAV per share and indeed EPS per share looking forward.

There's a lot of capital activity and distribution going on right now, dividends and buyback included. I don't think, Guy, that with all of that going on, we're going to move from our standard practice of looking at capital in the form of buyback and finally our dividend at the year-end. My guidance to you would be to say that'll be a year-end board decision this year, just as it always has been.

Guy Stebbings (Executive Director, Banks Equity Research)

Okay. Thank you.

William Chalmers (CFO and Executive Director)

Thanks, Guy.

Operator (participant)

One moment, please, for the next question. The next question comes from the line of Rohith Chandrarajan from Bank of America. Please go ahead.

Rohith Chandrarajan (Equity Research Analyst)

Hi. Good morning, William. Thank you. I've got a couple please, also on margin. Apologies, you probably thought you were done with that, but hopefully they're relatively quick. The first one is on the mortgage completion spread, the 50 basis points in Q1. It sounds from your earlier comments like you thought that was probably around the number that we'll see in Q2 as well. firstly I wanted to check that, and then I guess as we progress through the year in terms of looking at where spreads are in, you know, new offers in the market today that would probably not complete till Q3, they're starting to look a little bit better.

I was wondering if those in terms of either, you know, pricing or mix, how you think that would progress particularly through the second half of the year in terms of the new mortgage spreads? The second one, just on deposits, you talked a lot about mix, which is helpful. Thank you. What... Can I ask what the pass-through is on the latest rate hike that will impact the NII in Q2, please? Sort of the most recent 25 basis point hike. Thank you.

William Chalmers (CFO and Executive Director)

Yeah. Yeah. Thanks, Rohith. In terms of mortgages overall, as said, we saw 50 basis points completion in Q1. It's a little early to comment on Q2, but our expectation is that it will not be significantly different, let's say, in the context of Q2. As we saw in Q1, I would expect that to be composed of two inputs.

That is to say product transfer below 50, new business above 50. We have seen new business, you know, materially above 50 at times during the course of quarter one, Rohith. Your point around new business margins I think is a fair one. A couple of points to add to that. One is that we've also seen quite significant swap volatility, and that hasn't really gone away.

At any moment in time, our new business margins are impacted by where swaps stand, and with them going up and down so much on a kind of daily, weekly basis, that is driving quite a lot of volatility and new business spreads with it. It's not clear to me whether that will go away or not, but I think you'll only really get a sense as to equilibrium new business spreads in an environment where you have more swap stability than we've seen for the last quarter. I would be hopeful that over time, that equilibrium new business pricing steers itself back towards the kind of traditional 75 basis points-100 basis points guidance that we've given you before.

I think as a composite based upon retention plus new business, even if it does, I would expect our completion margins to be south of that 75 basis points-100 basis points for the remainder of this year. Indeed, that is what is in our planning assumptions. That is what is in our greater than three or five net interest margin guidance, i.e. the number being less on a composite basis than the 75 corridor-100 corridor. In terms of your second question, Rohit, on mix and pass-through, the pass-through that we saw off the back of the February and March interest rate rises was around the 40% mark. That gives you some idea. What you're seeing there is effectively the pass-through moving up over time. You know, we're not done yet.

I think as we go through the remainder of this year and into next, we'll see that pass-through continue to gravitate towards slightly higher levels. 40% is the most recent experience off the back of the combined February and March rate rises. You also see, to be clear, some further effective pass-through, although it's not often described as such, because of the overall churn within the book.

That is to say every time a deposit migrates from PCA into fixed term deposit, that in a sense is another form of pass-through whereby the customer gets the benefit of the rate increase. 40% is your headline number for the February and the March interest rate rises. I would expect our pass-through, or at least our interest rates for depositors, to continue to mature second half of 2023 and into 2024.

All of that is contained within the interest rate guidance or sorry, margin guidance that we've given you.

Rohith Chandrarajan (Equity Research Analyst)

Thank you. Could I just come back very quickly on the mortgage spread? Are you seeing any initial signs of change in mix between internal transfers and new to bank as there seems to be some green shoots, at least in terms of the mortgage and housing market?

William Chalmers (CFO and Executive Director)

Yeah. I mean, there are some green shoots. It's looking a little bit stronger than we had previously thought. I think as a general comment actually, Rohith, and this applies not just to mortgages but more broadly across the business, the economics are looking a little bit more favorable than we described them at the end of Q1. You know, there's all the factors that you're aware of going into that. That's leading perhaps to a slightly more robust activity picture than we had previously thought. That in turn may play through over the course of the year. We have to see. It's too early to call that. You know, that's the direction of things, I suppose, since we struck numbers.

In terms of competition with the mortgage market, a little bit, slightly better picture, perhaps fed by some of the points that I've just made. Again, Rohit, I would be a bit cautious about overinterpreting at this stage. You know, we have to see how the coming weeks fare before really making a call on it.

Rohith Chandrarajan (Equity Research Analyst)

Okay. Thank you.

William Chalmers (CFO and Executive Director)

Thanks, Rohit.

Operator (participant)

As you know, the call is scheduled for 1 hour. We have now reached the end of the allotted time. This is the last question we have time for this morning. If you have any further questions, please contact the Lloyds Investor Relations team. One moment, please, for the last question. Last question comes from the line of Joseph Dickerson from Jefferies. Please go ahead.

Joseph Dickerson (Equity Research Analyst)

Hi. Good morning, gentlemen. Can you just clarify, I think this needs to be clarified, your comment on your non-banking NII of annualizing this GBP 76 million headwind. Does this reflect the other side, as we've seen at pretty much every other bank, higher non-interest income? Is this a more of a broadly neutral matter, if you will, for total income? If you could just address that, if this is like the kind of trading book funding cost and so forth, where there's a corresponding benefit to the non-interest income line. Thanks.

William Chalmers (CFO and Executive Director)

Yeah. Thanks, Joe. Let me take another stab at that. The non-banking net interest income is really driven by two things. One is interest rate rises because it is effectively a funding cost for non-banking activities. I mentioned Lex earlier on, but you also mentioned trading activities there. Same sort of thing. You, you're funding those activities as interest rates go up, so the cost of funding those activities go up, and that is a factor in non-banking net interest income or non-banking net interest expense as it is at the moment.

The second thing that's going on is that as the size and scale of those activities increase, whether it's in commercial banking, consistent with some of our objectives within corporate institutional, for example, or whether it's in Lex, e.g., we've now got the Lex car fleet size growing once again, that will also increase non-banking net interest expense.

Again, that's simply because the volume of what you're funding is going up. The twin effects of rate increase is number one, Joe, and activity increase is number two or scale of activity increase is number two, is what is driving that non-banking net interest expense. I think if you're annualizing what we saw in Q1, you're not gonna be far off for the year, and it's a reflection of those two underlying activities.

Finally, Joe, to the point you were making, therefore, a component part of that non-banking interest expense is playing itself through in terms of the benefits that you see in other operating income. Commercial, Lex being good examples. You do see a part of that playing through and benefiting other operating income. Part of that was at play in our 1.257, however it will continue to be play in that line through the year.

Joseph Dickerson (Equity Research Analyst)

There the short answer is there is, because of increased activity, there is some corresponding benefit to other income.

William Chalmers (CFO and Executive Director)

That's right, Joe. Yeah. That's the short answer.

Joseph Dickerson (Equity Research Analyst)

Okay. 'Cause you know what the market's gonna do. I mean, you've already been asked if you just take your costs and annualize them, and add the bank levy. You know, I think what the concern of investors is are you annualizing the GBP 76 million and taking it off of your revenue estimate? It sounds like that would be the wrong conclusion to draw here.

William Chalmers (CFO and Executive Director)

I think on a total basis that's right. There's a netting off in terms of ROI that you expect to see.

Joseph Dickerson (Equity Research Analyst)

Yeah.

William Chalmers (CFO and Executive Director)

I'll just refer you back to the ROI comments that I gave earlier on on the question there. That gives you a good sense as to where we expect ROI to be.

Joseph Dickerson (Equity Research Analyst)

Fantastic. Thank you.

William Chalmers (CFO and Executive Director)

Thanks, Joe. I think we are concluding on the call for today. I just want to say thank you very much indeed to everybody for taking the time, for your interest in the story, and we look forward to a continued dialogue. Thanks very much indeed.

Operator (participant)

This concludes today's call. There will be a replay of the call and webcast available on the Lloyds Banking Group website. Thank you for participating. You may now disconnect your line.