Lloyds Banking Group - Earnings Call - Q3 2025

Transcript

Operator (participant)

Thank you for standing by and welcome to the Lloyds Banking Group 2023 Q3 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 wish to ask a question, please press star one on your telephone. Please note this call is scheduled for one hour and is being recorded. I will now hand over to William Chalmers. Please go ahead.

William Chalmers (CFO)

Thank you, operator, and good morning, everyone. Thank you for joining our Q3 results call. As usual, I'll run through the group's financial performance before we then open the line for Q&A. Let me start with an overview of our key messages on slide two. We continue to make great progress on our strategy. In doing so, we are creating value for our customers and wider stakeholders through improved propositions, targeted growth, and enhanced operating leverage. In Q3, we delivered robust financial performance supported by healthy growth across the business, driving continued income momentum. We maintained our cost discipline and strong asset quality, reflecting stable credit performance in the period. Taken together, this is driving strong capital generation. As you know, in the third quarter, we've taken an GBP 800 million additional charge relating to the FCA consultation process on motor commissions.

Clearly, we are disappointed by this outcome, and I'll talk more about it later in the presentation. Accordingly, we've revised our 2025 guidance to reflect the motor provision. Excluding the charge, we are beating our prior targets. We remain highly confident in our 2026 guidance. Before turning to our financials, a brief update on two important strategic developments. Firstly, I'm delighted to say that we have completed the full acquisition of Schroders Personal Wealth to be renamed Lloyds Wealth. This is an exciting step forward for both our customers and shareholders. It will deliver full control of a market-leading wealth management business that has GBP 17 billion of assets under administration, more than 300 advisors, and 60,000 clients. Embedding Lloyds Wealth into the broader group will advance our end-to-end wealth ambitions, delivering clear benefits in proposition and journey for our customers.

Secondly, we've taken significant steps forward in our digital asset strategy. Earlier in the year, we partnered with abrdn to deliver a UK-first FX derivatives trade, collateralized with tokenized digital assets. Alongside, we're co-chairing the UK Finance project to deliver GB Tokenized Deposits. Retail and commercial pilot use cases in programmable digital money are due to deliver in H1 of next year. These developments will ultimately drive material customer opportunity and maintain our commercial leadership. We look forward to elaborating on this alongside other areas of our technology, digital, and AI strategy in an investor seminar on the 6th of November. Let me now turn to the financials on slide four. The group demonstrated robust financial performance during the first nine months of the year. Year-to-date statutory profit after tax was GBP 3.3 billion, with a return on tangible equity of 11.9%.

Excluding the motor provision, return on tangible equity was 14.6%. Looking at the full year, we now expect ROTE to be around 12% or around 14%, excluding motor. We are pleased with the group's continued income momentum. In the first nine months, net income of GBP 13.6 billion was 6% higher than the prior year. This was driven by further growth in net interest income, alongside a 9% year-on-year rise in other operating income led by customer activity and strategic investment. Within the quarter, net income was up 3% versus Q2. This was supported by a net interest margin of 3.06%, in line with our expectations for a gradual increase, again alongside ongoing OOI growth. Looking forward, we now expect net interest income for the full year to be circa GBP 13.6 billion, slightly ahead of our previous guidance. We remain committed to efficiency.

Year-to-date operating costs of GBP 7.2 billion were up 3% year-on-year, in line with our expectations for this stage. Credit performance, meanwhile, remains strong. The year-to-date impairment charge of GBP 618 million equates to an asset quality ratio of 18 basis points. Given our performance to date, we are upgrading full-year guidance on the asset quality ratio to circa 20 basis points. Meanwhile, tangible net assets per share increased to GBP 0.55, up GBP 0.026 in the year-to-date and GBP 0.005 in the quarter. Our performance delivered strong capital generation of 110 basis points year-to-date, or 141 basis points excluding motor. Our closing CET1 ratio is 13.8%. I'll now turn to slide five to look at developments in our customer franchise. We have seen good growth across both the lending and the deposit franchises so far this year.

Group lending balances of GBP 477 billion are up GBP 18 billion, or 4% year-to-date. Focusing on Q3, lending is up GBP 6 billion, or 1% versus Q2. Within this, retail lending grew GBP 5.1 billion. This was driven by an increase in the mortgage book of just over GBP 3 billion, reflecting both market growth and a completion share that remains at around 19%. So far, we are seeing no sign of a slowdown in mortgage applications ahead of the budget in November. Elsewhere in the retail business, we saw continued growth across each of our cards, loans, and motor businesses, as well as growth in European retail. Commercial lending balances, meanwhile, are up by GBP 1.3 billion in Q3. As has been the case throughout the year, we saw growth in CIB across our targeted sectors, including in institutional balances.

In BCB, balances were broadly stable, with new lending in mid-corporates offsetting the net repayments of government-backed facilities. Turning to the liability franchise, year-to-date deposits have grown GBP 14 billion, or 3%. In Q3, we also saw good performance, up GBP 2.8 billion quarter-on-quarter. Within retail, PCAs grew by GBP 1.2 billion, driven by income growth, subdued spend, and lower churn during the quarter. Alongside a reduction in savings balances of GBP 0.9 billion, which was largely due to some fixed-rate savings outflows following our post-ISA season pricing decisions. Commercial deposits are up by GBP 2.4 billion in Q3, driven by growth in targeted sectors across both CIB and BCB. Pleasingly, NIBCO balances were up in the quarter. Alongside deposit developments, we continue to see steady AUA growth in insurance, pensions, and investments, with circa GBP 3.3 billion of open book net new money year-to-date.

Let me turn to net interest income on slide six. Year-to-date and in Q3, we are seeing sustained growth in net interest income. Net interest income for the first nine months was up 6% year-on-year to GBP 10.1 billion. This included GBP 3.5 billion in Q3, up 3% quarter-on-quarter. Income growth continues to be supported by positive momentum in the net interest margin. The Q3 margin of 306 basis points was up 2 basis points on Q2, driven by a growing structural hedge tailwind. Net interest income was further supported by average interest earning assets of GBP 466 billion in Q3, up GBP 5.5 billion versus Q2. The increase was driven by sustained lending growth, particularly in the mortgage book. Looking ahead, we now expect net interest income for 2025 to be around GBP 13.6 billion.

This incorporates the healthy volume developments we have seen, alongside a slightly more supportive rate environment. We remain very confident in the trajectory for net interest income growth. Let's turn to other income on slide seven. We continue to demonstrate strong and broad-based momentum in other income. Indeed, our diversified franchise has supported consistent high single-digit growth over the last three years. Year-to-date OOI is GBP 4.5 billion, up 9% year-on-year. In the third quarter, OOI was GBP 1.6 billion, up 3% versus Q2. This was particularly driven by growth in motor and LBG investments. It also represents a good performance in protection, boosted by improving mortgage take-up rates. Other income growth continues to be supported by investment and strategic progress across the business. I spoke earlier about two specific areas of delivery.

The slide shows a number of other proof points to testify to our progress, including, for example, the launch of the Lloyds Ultra card in retail, as well as further scaling of capabilities in our commercial franchise. Looking forward, the full acquisition of Schroders Personal Wealth will further support OOI growth. We see an opportunity to meaningfully grow the business in the coming years as part of our integrated wealth proposition. Briefly turning to operating lease appreciation. The Q3 charge of GBP 365 million was up slightly, in line with growth in the fleet, driving other income. Moving to costs on slide eight. The group continues to maintain strong cost discipline. Year-to-date operating costs of GBP 7.2 billion are up 3% on the prior year, in line with our full year expectations. Excluding growth in severance, operating costs are up 2%.

Business growth and inflationary pressures continue to be mitigated by savings driven by strategic investment. Within the third quarter, costs of GBP 2.3 billion are down 1% compared to Q2. This is partly helped by investment timing. Looking forward, Q4 will see higher operating costs due to the usual seasonal factors and added costs from the full acquisition of SPW. We will meet our GBP 9.7 billion full-year guidance, excluding these additional SPW costs, or modestly above this, including them. Remediation was GBP 875 million in the quarter. This reflects low levels of non-motor-based charges, alongside the GBP 800 million incremental motor finance provision. I'll now spend a moment on that on slide nine. The additional GBP 800 million provision for the potential motor commission remediation costs takes our total provision to GBP 1.95 billion. The recent FCA proposals are subject to consultation, and so the final outcome may differ.

However, as it stands today, they represent an outcome that is at the adverse end of our previously modeled expectations. Based on the proposals, there are a high number of cases determined to be unfair. Presumptions of unfairness do not apply the legal clarity provided by the recent Supreme Court judgment. The redress calculation is less linked to harm than it should be. We will, of course, be making representations to the FCA on our points of concern, and we look forward to engaging in a constructive dialogue. Our total provision of GBP 1.95 billion, still using scenario-based methodology, includes both redress and operational costs. It represents our best estimate of the potential impact of this issue. Moving on to asset quality on slide ten. Asset quality remains strong. EU2 arrears are low and stable across our portfolios. Early warning indicators also remain benign and again very stable.

The year-to-date impairment charge is GBP 618 million, equivalent to an asset quality ratio of 18 basis points. The charge of GBP 176 million in the third quarter represents an asset quality ratio of 15 basis points. This is the result of a low underlying charge, reflecting our prime customer base, a prudent approach to risk, and stable macro conditions, as well as some one-off model benefits. It also incorporates a small MES charge of GBP 36 million in the quarter. Our stock of ECLs on the balance sheet, meanwhile, is GBP 3.5 billion, which remains around GBP 400 million above our base case expectations. Given the strong performance year-to-date, we now expect the asset quality ratio for the full year to be circa 20 basis points. Let me turn to our returns and tangible equity on slide 11.

The group delivered a return on tangible equity of 11.9% year-to-date, or 14.6% excluding the motor provision. This benefits from strong business performance, cost control, and low impairments. Below the line, volatility in other items were GBP 157 million in the nine months, or GBP 109 million in Q3. The third quarter charge was driven by negative insurance volatility, given market developments and the usual fair value unwind. Tangible net assets per share at GBP 0.55 are up GBP 0.026 since year-end. This continues to be driven by profit build and the unwind of the cash flow hedge reserve, partly offset by shareholder distributions. Looking ahead, we expect material TNAP per share growth in both the short term and in the medium term. Including the motor charge, return on tangible equity for the year is now expected at around 12%.

Excluding motor, the ROTE is expected at around 14%, an upgrade versus prior guidance. Turning now to capital generation on slide 12. Our business performance has driven strong capital generation in the year-to-date. Within this, total RWAs ended the quarter at GBP 232 billion, up GBP 7.7 billion year-to-date and GBP 0.9 billion in the third quarter. This increase reflects strength in lending, partly offset by optimization activity. Q3 also saw the full reversal of the remaining GBP 1.2 billion of temporary RWAs that we had previously highlighted. Note that while we've taken no new additions for CID4 secured risk weightings in the year so far, we do expect to do so in the fourth quarter. Year-to-date, our strong banking profitability has driven capital generation of 110 basis points in the first nine months, or 141 basis points excluding motor.

Expected full-year capital generation is now circa 145 basis points, or circa 175 excluding motor. Our closing CET1 ratio is 13.8%. This is after a 74 basis point accrual for the ordinary dividend. We still expect to pay down to around 13% by the end of 2026, with this year a staging post towards that target. I'll now wrap up on slide 13. To summarize, the group demonstrated a robust performance in the first nine months of 2025. We are building momentum in income growth whilst retaining cost discipline and strong asset quality. Together, this is delivering meaningful operating leverage. The business is performing as we expected, if not a little better in some areas. Whilst the motor provision is obviously unwelcome, the underlying business continues to drive strong, growing, and sustainable capital generation.

This financial performance results in improvements to our underlying 2025 guidance, including net interest income, asset quality, and return on tangible equity ex-motor. Alongside, we remain confident in our 2026 targets. Guidance for both years is laid out in full on the slide. Overall, the business is in good shape to deliver for all stakeholders. The third quarter represents another step in this journey. That concludes my comments for this morning. Thank you for listening. We'll now open the lines for your questions.

Operator (participant)

Thank you. If you wish to ask a question, please press star one on your telephone keypad. To withdraw your question, you may do so by pressing star two to cancel. There will now be a brief pause while questions are being registered. Thank you. Our first caller is Benjamin Toms from RBC. Your line is now unmuted. Please go ahead.

Benjamin Toms (Senior Equity Analyst)

Morning both, and thank you for taking my questions. The first is on motor finance. The provision post-top-up leaves you with a total provision just below GBP 2 billion. That's based on a weighted average scenario calculation. If the consultation paper does not get softened and the FCA is correct with their 85% claim rate, how material would the provision top-up be from here? Just some sensitivity around that would be useful. Thank you very much. Secondly, on NIM, I think you said you expected NIM to build faster in Q4 than Q3. Is that still the case? Can you give some indication about whether you'd expect NIM to continue to build through 2026? I think the hedge will continue to be additive, and mortgage margin compression deposit mix shift should fade, so it's hard to see how NIM doesn't increase materially next year.

Is there a missing moving part like asset mix shift that we need to consider? Thank you.

William Chalmers (CFO)

Thanks very much indeed, Ben. Just to take each of those in order, the start point and perhaps the end point is to say GBP 1.95 billion in respect of motor represents our best estimate of the cost of this issue. It is, as you say, a scenario-based estimate, and those scenarios or sensitivities, as you called them, represent what we think are reasonable FCA responses to the issues that we raise, and I assume the issues that others raise. Those will be principally around things like the calculation of redress, which, as said, we think is at best tenuously linked to harm, determination of fairness, which we think is too broad. These types of things will be part of our response to consultations. When we look at scenarios, that's what's figuring into those scenarios, some slight amendment around those.

To be clear, Ben, the FCA proposals, as currently proposed, represent the heaviest weighting in our overall scenario analysis, which, given that the FCA proposals currently at the, as I said in my script, at the adverse end of our expected outcomes, i.e., they are all DCAs, most of the commission that we receive gets handed back, and it is a very high response rate. That all means that with the FCA being the heaviest weighted component in our overall provisioning analysis, it suggests that even if the FCA proposals come out exactly as they are today, then our overall position is not going to move by that much. We are not far off, Ben, in short. On your second question, Ben, in respect of NIM, NIM, as said, has had a tick up in the course of Q3 by a couple of basis points. We are now at 3.06%.

It is our expectation that we see continued, if you like, growth in that net interest margin over the course of Q4. As I alluded to, I think at Q2 and possibly before that at Q1, we do expect to see a bit of a back-end loaded step up in NIM in Q4. That is predominantly because of the structural hedge contribution, which is slightly more heavily weighted in Q4. It is somewhat offset by the usual headwinds. That is to say, bank base rate and deposit effects, predominantly deposit effects, as our next bank base rate is now not expected until next year. There is also the mortgage point. The mortgage headwinds, as you know, have a little further to play out. That includes Q4 and it includes 2026. Summing all of that up, Ben, you should expect to see that interest margin expansion in the course of Q4.

There'll be a step up there, and it will be a little greater than what we have seen Q2 to Q3. In respect to 2026, Ben, your analysis is right. You know we should expect, you should expect, we do expect to see continued margin expansion during the course of 2026. It is predominantly because of the factors that you've identified. That is to say, the structural hedge makes a meaningful contribution. GBP 1.5 billion increase in structural hedge expected earnings for 2026 is what we've guided to earlier on this year, and that still remains more or less the case as we go into 2026. There is some offset from that in the context of, again, bank base rate decisions and indeed some continued level of deposit churn off the back of a slightly higher rate environment. Alongside that, the playing out of the mortgage refinancing headwind.

Those factors are still at play, but nonetheless, the net of it for 2026 is continued and reasonably meaningful margin expansion. That is our expectation. Now, Ben, maybe I'll just finish off with the point that, as you know, we have moved from kind of margin AIAA and non-bank net interest income guidance to net interest income guidance in its totality, and we've upped that guidance for the remainder of this year, i.e., circa GBP 13.6 billion. We will be guiding to what that means for 2026 in due course. It is the combination of net interest margin expansion as well as AIAA growth that we expect will deliver meaningful NII growth in 2026, and that in turn is what will help us deliver our greater than 15% ROTE.

Benjamin Toms (Senior Equity Analyst)

Thank you.

William Chalmers (CFO)

Thank you, Ben.

Operator (participant)

Thank you. Our next caller is Jason Napier from UBS. Your line is now unmuted. Please go ahead.

Jason Napier (Head of European Banks Research)

Good morning, William. Thank you for taking my questions too, please. The first, I wonder if you could just talk about how Lloyds sees wealth as a sort of a banking business in the U.K. The Schroders Personal Wealth business today, you might, as you read your slide, think about the 300 advisors and the funds that they advise and look after. The bullet point on scaling to mass affluent and workplace might suggest that this is really just an integrated mainstream client type offering. The backdrop for this, as you recognize, is that the market's quite interested in whether you might be interested in inorganic expansion in IFA-led businesses. If you could just talk about what we can learn from the buy-in of the half of the SPW business.

The second, I don't want to steal the thunder from your upcoming tech event, but the slide on tokenized assets does, I think, invite further inquiry. At a very high level, I just wondered whether you could talk about the work that you've done so far and where you think things like tokenized assets and deposits, you know what that does to banking industry revenues in total. At a high level, people are somewhat concerned that we might see compression in things like payments and remittances and a bunch of the commercial banking revenue lines that we actually can't see from the outside as the sort of technology takes root. Any early thoughts you might have on the outlook for banking more generally, I think would be valuable. Thank you.

William Chalmers (CFO)

Sure. Thank you, Jason, on both questions. First of all, in respect of the wealth question, a couple of comments there on SPW and then a couple of comments on how we see the wealth opportunity. You know, it's worth me just repeating that we are really pleased to see the conclusion of the SPW, now Lloyds Wealth, transaction. It brings us full control of what we think is a great business. You've heard the statistics, but at the risk of repeating them, GBP 17 billion assets under administration, 60,000 clients, 300 advisors, it is a really promising start, if you like, for a business that we hope to grow into, frankly, an awful lot more. There is a great business there that we think we can really grow and help prosper going forward. It is part of an integrated proposition as we see it.

That is to say, it will sit alongside our direct-to-consumer self-serve proposition. It will also sit alongside the building digital proposition that we are currently creating. It is important to have alongside those more or less self-service facilities an advisory capability. That's really what Schroders Personal Wealth, now Lloyds Wealth, will deliver for us. It is important in the sense that we can make our customer journey seamless with those other capabilities, e.g., the digital direct-to-consumer offering. Likewise, we can, if you like, bring the benefit of the group to bear here, not just in terms of group infrastructure, cost synergies, and the like, but also in terms of plugging it into our 3 million affluent customers. There is a third really important part of that integration, if you like, which is around the workplace proposition.

At the moment, at least, we have a very strong workplace proposition in the context of our insurance, our Scottish Widows business. At the same time, we really want to build the advisory component of that as people's pensions plans mature so that we can advise them properly on what to do with those proceeds, which at the moment is a source of leakage from our perspective to other third-party providers. We'd much rather keep it within group. That's what SPW, or now Lloyds Wealth, will allow us to do. There is something with the Lloyds Wealth acquisition, the Schroders Personal Wealth acquisition, which itself is in good shape as we speak today. My statistics earlier on lend testimony to that. Hopefully, you can tell from my comments that we think it can be, frankly, a lot more going forward. You asked in that context about inorganic, Jason.

I obviously shan't comment on that explicitly, save to say that we've got a lot to do with what we've just done. The acquisition of Lloyds Wealth is a tremendous step forward for us and the franchise. It enables us to develop and enhance our existing customer propositions in what we hope will be a very compelling way, which in turn, most importantly, will create customer value. In doing so, we think create quite a lot of shareholder value, including benefits to our other operating income over the course of Q4 and looking forward into 2026 and growing thereafter. I think for now, at least, we're very happy with what we've done. We're going to focus on the organic integration of it, and we're going to build our customer propositions and shareholder value as part of that. The tokenized deposits topic is a very interesting one.

It's a topic which I could probably talk forever on, but I won't. I'll try to circumscribe my remarks somewhat. In essence, there's a couple of things going on right now. First of all, as you mentioned, in respect of our strategic update, I just mentioned that we've done what was a really exciting partnership with Abrdn, where we effectively delivered an industry-first tokenized assets use case, i.e., using tokenized assets as collateral for a markets-based trade. That was industry-first. It was more or less a proof of concept, but it offers an illustration of the potential. When we look at the landscape right now as it's developing, there are a couple of things going on. One is obviously the rise of stablecoin, which is much commented on.

It seems to us that in the international sphere, it may be that by virtue of speed of payments, for example, and by virtue of low costs, it may have something to offer in respect of international transactions. Actually, if you bring that back to the U.K., much of what is offered by stablecoin is already effectively offered in the context of things like faster payments. That is to say, they're instantaneous and they're very low cost. What excites us actually in the context of tokenized assets is an opportunity that goes well beyond stablecoins, which is around programmable currency. We're currently sitting as joint chairs with UK Finance in a project which is called GB Tokenized Deposits. GBTD is the acronym. It used to be called Regulatory Liability Network.

GBTD is essentially building a programmable and exchangeable currency in the U.K. that is part and parcel of the existing commercial money framework. That is to say, it is interchangeable between digital money and, if you like, analog money. We think that has the potential to offer customers tremendous amounts of value in terms of programmable capabilities. At the moment, we're running use cases in respect of wholesale use cases, particularly digital guilds, in respect of mortgage use cases, i.e., programmability around that capability, and in exchange of effectively payment on receipt capabilities from a consumer point of view. There are three use cases that will land in the early part of next year. The reason for just briefly commenting on that detail, Jason, is because we see that as an example of tokenized deposits, digital assets, offering a tremendous customer opportunity.

If it can be brought in the sterling monetary framework, if you like, and be interchangeable with analog money in the way that we're proposing, I think there's a lot more that we can do with our customers to offer them value. Far from this being a threat, it's an opportunity.

Jason Napier (Head of European Banks Research)

That's really helpful. Thank you.

William Chalmers (CFO)

Thank you, Jason.

Operator (participant)

Thank you. Our next caller is Pearlie Mong from Bank of America. Your line is now unmuted. Please go ahead.

Pearlie Mong (UK Banks Research Analyst)

Hello. Good morning, William. Just a couple of questions. One is on distribution. It sounds like you're pretty comfortable with the motor finance charge or any top-up if necessary. You've talked about paying down to 13% next year. As you think about full-year distribution at 2025, would you think of it as there is no more uncertainty in your mind regarding motor finance? While we are on that topic, one of your peers has moved on to quarterly buybacks. You're still on the annual buyback. Is there any thinking about maybe moving to a more frequent distribution cadence? Secondly, on mortgage margins, your peer reported yesterday talked about five-year mortgages rolling off next year, and that cohort had a relatively high margin. I presume that is already in your guidance and in the way you think about 2026 mortgage margins.

As we come into this period, do you expect competition or behavior of competitors to change in any way, given this is something that is happening across the board?

William Chalmers (CFO)

Yeah. Thank you, Pearlie. There's perhaps three questions there. At least that's how I'll interpret it. You'll have to let me know whether I'm responding appropriately. First of all, in respect of motor, as said, our current provision is GBP 1.95 billion, best estimate. To the extent there's a worst case, we can't be far off simply because, as said, the FCA case is most heavily weighted in our scenario-based planning. Alongside that, the FCA case captures a pretty adverse outcome. All DCAs, for example, most of the commission will be received being handed back, a very high response rate. Those three things tell us that the FCA case, the proposals, if currently enacted, are, as I say, at the adverse end of the spectrum and most heavily weighted in our overall provisioning. Not terribly far off.

When we look at distributions for 2025, a couple of points to make there, really. One is we remain very committed to distributing excess capital. Two is, as per the comments earlier on, we are generating strong capital generation over the course of this year. We've put forward guidance now of 145 basis points, which is post-motor, to be clear. When we look at our expectations for the full year in terms of distributions, we also have the reduction in CET1 ratio that we have previously advised you of. We expected to reduce our CET1 ratio from about 13.5% end of last year to about 13.25% or thereabouts, give or take, towards the end of this year before landing at circa 13% at the end of 2026.

That is an additional 25 basis points of capital there, which if you add it to the 145 basis points that we're guiding to, is 170 basis points in total. Pearlie, you'll be able to tell from our numbers today that the dividend will be about 100 basis points of that. We've accrued 74 basis points year-to-date. Therefore, a full year is about 100 basis points of that 170 basis points that I just mentioned, which in turn leaves about 70 basis points of excess against what will probably end up being about GBP 234 billion, GBP 235 billion of risk-weighted assets, something like that. All I'm doing is simply taking Q3 outcomes in RWAs and adding on a bit for continued lending performance and indeed a CRD4 add-on in the course of quarter four.

That gives you an idea, 70 basis points against that GBP 234 billion, GBP 235 billion of RWAs gives you an idea of the excess capital that will be available and up for consideration by the board as to what it chooses to do with it towards the year end. Pearlie, you asked about buyback and whether we should move to a more frequent buyback. What I'd say to that is, first of all, capital distribution, not just the quantum, but also the form, if you like, is always going to be a matter for the board. We'll, of course, respect that. What we have done to date, of course, is once per annum. Our view is that that has allowed clarity in terms of our guidance, number one, and it has been appropriate as we reduce our capital ratio, number two.

As we look forward, there are some advantages from considering a switch. Lower CET1 over the course of the year is one of those. The timing benefits, obviously, from a shareholder point of view is another. There are also some considerations to take into account, which is to say a lower capital base implies a slightly lower level of flexibility, either for dealing with contingencies or alternatively to take advantage of opportunities. These are the types of things, Pearlie, that we'll have to consider when we look at the buyback. Every year we consider not just the quantum, but also the form in which we make distributions. This year, in that respect, will be no different. We'll have a conversation with the board at the end of the year to that effect. The third of your topics, Pearlie, around five-year mortgages. In a sense, it's welcome to the club.

We've been talking about a mortgage refinancing headwind for about two years now. Our expectation was that that would continue during the course of 2025 and that it would continue into 2026. We said that before, and that remains the case. What I am pleased to say, though, is that our guidance in that respect has not changed. When we've talked about in the past our expected increase in net interest income, including in response to Ben's question earlier on, that incorporates our expected headwind from a mortgage point of view over the course of 2026. We do expect continued growth in net interest income and indeed margin. That does incorporate the headwind that we see from the type of five-year mortgages with the spreads written at that time as they mature in 2026. Yes, it is all integrated into guidance for sure.

In terms of what effect that might have, it's obviously a little hard to say, but at the risk of speculation, maybe there is a chance that as these higher spreads roll off, people reconsider the spreads that they're currently writing business at today. Maybe therefore there is a marginal benefit to spreads being written during the course of 2026. Clearly, that is, of course, speculative. As these higher spread mortgages come off, will that cause people just to reconsider the rate at which they, or rather the spread at which they write new mortgage business and cause them to revise up what they think an appropriate spread is for mortgage business? Possibly, yes. If it does, we'll obviously welcome it.

Pearlie Mong (UK Banks Research Analyst)

Thank you. Very clear.

William Chalmers (CFO)

Thank you, Pearlie.

Operator (participant)

Thank you. Our next caller is Jonathan Pierce from Jefferies. Your line is now unmuted. Please go ahead.

Jonathan Pierce (UK Banks Analyst)

Morning, William. I've got two questions. The first is on the structural hedge. Again, sorry about that. I wondered if you could help us a little bit to scale the contribution in Q4. You talked previously about a significant increase this year. That contribution to the new movement has been as low as 4 basis points in the latest quarter and 10 basis points in the first quarter. Maybe you could put Q4 in the context of that for us. That would be helpful. Just as a supplementary on the hedge, I wondered if you could just talk a little bit again about what happens by 2026 in terms of timing because I'm still not entirely sure I understand how you're thinking about that. For me, it strikes me that the 2027 tailwind is probably more about the full-year impact than the 2026 maturities.

We get because a lot of the 2021 stuff starts to roll through. It would be helpful just to get a little bit more of a feel on that. Secondly, the strategy update. Do you have an idea of when that will be next year and how far forward you'll be looking in the sort of metrics you will be updating on? I assume the priority distribution costing and so forth. Will this be sort of 2028, 2029 look forward? Thanks very much.

William Chalmers (CFO)

Thanks, John. A couple of questions there. First on the structural hedge, second on strategy and what we'll be talking about and when next year. In respect of the structural hedge, maybe just a kind of a mark-to-market. The Q3 yield on the structural hedge is about 2.3%. As you rightly said, the contribution to the margin of the structural hedge in respect of Q3 was about 4 basis points. We've previously highlighted and maintain still today that the contribution of the structural hedge going into Q4 will be meaningfully greater. We haven't put a precise number on that, but just maybe help the discussion. The expectation for the yield as a whole during the course of 2025 will also be around 2.3%. I'll come back to 2026 in just a second.

The expectation is, as said, that the structural hedge contribution to the margin will meaningfully increase in the course of quarter three. I would expect in that context, Jonathan, again, without putting too precise a number on it, that the structural hedge contribution to the margin will more than double in quarter four versus what it was in quarter three. That all leads in combination with the deposits headwind and the mortgages headwind to an expectation that the margin in totality will step up in Q4. It will step up in a way that is more significant than what we saw Q2 to Q3. I know I'm not putting precise numbers on it, but hopefully that gives you some steer. When we look at 2026 on the structural hedge, the expectation for the yield in 2026 is consistent with our previous discussions, actually, on average about 2.9%.

You can work that out, obviously, from the circa GBP 6.9 billion guidance that we've given you for structural hedge earnings off the back of about a GBP 244 billion structural hedge. You'll get to 2.9% through that path too. That gives you a sense for the year as a whole. There is obviously a bit of a journey in respect to the structural hedge. At this point in the year, I'm not going to kind of go through it on a quarterly basis, but it isn't all delivered on quarter one, and it isn't all delivered on the course of quarter four, and it won't be perfectly linear in between. Overall, that is the contribution of the structural hedge, i.e., GBP 6.9 billion in total, incremental circa GBP 1.5 billion versus what we got over the course of 2025 as we look forward.

It is important to say in this context, actually, that the structural hedge then continues to build over the course of future years. I won't give precise numbers on it, but you should expect continued build, most notably in 2027, and then continued build in the years thereafter, 2028, 2029, and so forth, but at a slightly lower level. We'll talk more about that at the course of the year end to give you more specificity. In respect of strategy, Jonathan, you know our focus right now is very clearly on delivering 2026. We've set out some very explicit, some very clear, and I think some very important commitments in respect to what we're going to do in 2026. Cost-to-income ratio less than 50%, ROTE in excess of 15%, and capital generation in excess of 200 basis points. We are going to deliver on those 2026 commitments.

That is very much our focus. It's a very fair question for you to ask, having said that, about where do we go from there? Our expectation is that we will, of course, update in the course of next year as to 2027 and beyond. It'll probably be around the middle of next year when we come to market with that update. That gives you a sense of timing. In terms of the look forward period, you know that's something which we should probably discuss, actually, over the course of next year. These things often end in round numbers, and maybe I'll leave it there.

Jonathan Pierce (UK Banks Analyst)

Okay, great. Thank you.

William Chalmers (CFO)

Thanks, John.

Operator (participant)

Thank you. Our next caller is Aman Rakkar from Barclays. Your line is now unmuted. Please go ahead.

Aman Rakkar (Senior Equity Analyst)

Good morning, William. Thanks very much for the presentation and questions. I actually had two, please. I wanted to query on non-banking funding costs. I think that's actually probably trending a touch lower than your commentary previously around up GBP 100 million year-on-year. I was wondering if you can give us an update for that. I don't know if that's contributed in any way to the slightly firmer outcome for this year, but if you could just kind of update us on that particular line item within NII, that'd be great. Just another one on other operating income, actually. Obviously, the headline rate is good again. It's quite divergent trends within the division. I think it looks like retail's kind of reaccelerated again in Q3. The insurance business looks like it's actually tapering off if I look at the year-on-year trends through the course of this year.

Commercial continues to be quite soft. Could you give us a bit of a kind of steer on how to think about these divisional trends going forward? I'm just trying to work out how we arrive at a similar kind of run rate next year. If there's anything kind of episodic or lumpy that we should think about or, you know, one-off elements that might kind of unwind into next year, that'd be really helpful. Thank you very much.

William Chalmers (CFO)

Yeah. Thank you, Aman, both of those questions. Taking them in turn, in terms of NB, NII, non-banking net interest income, at Q3, as we disclosed today, GBP 136 million. That is running at about 10% ahead of where it was last year. year-to-date, I think it's about GBP 372 million, thereabouts. That's about 10% up versus where it was. What's going on there, as you know, it is very much about the funding of the other operating income streams insofar as they're not related to banking. LDC is an example of that. Lloyds Living is an example of that. Of course, motor is an example of that, but so is the insurance, pensions and investments division, and so is commercial banking activity. It is probably running a little bit more slowly, i.e., slightly slower growth rates versus what we previously thought.

That is, if anything, partly attributable to commercial banking activity, which has been a little bit less in that space, at least, than we previously expected. I'll come back to that in a second. Overall, what's going on within the non-banking net interest income that is most important is that we're seeing the takeover of volumes rather than rate rises driving it. If you look at the trend last year in non-banking net interest income, it was probably about half and half to do with volumes, number one, but also increased rates in refinancing, number two. If you look at it this year, it's more like 15% or thereabouts in terms of rates and 85% in terms of volumes. Volumes is really making the running in terms of the increases in non-banking net interest income that we see over the course of this year.

Of course, looking forward, what that means, Aman, is that if you believe in other operating income growth, which we do, and I'll come back to in just a second, you should expect that non-banking net interest income to continue to grow over the course of 2026, but continue to grow from very much a volume-driven perspective as opposed to a rates perspective. Rates won't be zero because there is some term financing going on, in particular in relation to motor, which has got about a three-and-a-half-year average life. It won't be zero, but it will be predominantly a volume-led story within non-banking net interest income. Before moving on, it's worth just wrapping that up in the context of the net interest income guidance that we have given you and will give you for 2026 and beyond. That is including, obviously, non-banking net interest income in all of that.

That is wrapped up in the guidance that we give you for net interest income for 2025 this year, circa GBP 13.6 billion now, and indeed for the guidance that we'll give you next year for 2026. In respect of other operating income, maybe just to start off with the core point that, as you know, when Charlie Nunn and I launched the strategy in February of 2022, it was very much focused upon trying to ensure that we diversified the business from an undue dependency on rates, looking to avoid being, if you like, pressured by a downward trend in rates during the next cycle, and also achieve the benefits of what is a strong and very highly present franchise right the way across the U.K., across the retail, the commercial sector, and indeed within insurance, pensions, and investments.

The other operating income strategy was a strategic diversification, which was intended to benefit from the strength of the Lloyds Banking Group franchise. It's that combination that led us to deploy significant strategic investments in this area. We've seen the benefits of customer activity, if you like, picking up on those strategic investments and helping us drive other operating income now for about three years of high single-digit growth. That's, again, what we've seen during the course of quarter three, whether you look at it year-to-date or whether you look at year-on-year. Sorry for that introduction, Aman, but before getting into your question, I thought it was important to kind of highlight those points. The individual business components within other operating income, as said, up 9% in total. What are we seeing year-to-date? We're seeing strength within retail.

I've talked about transportation there, but it is also about PCA offering. It is also about protection offering, increasingly to mortgage customers. It is also about cards year-to-date. A retail offer that is growing significantly is transportation, but it's also those other factors. Within commercial, commercial has been a slightly slower pattern over the course of the year-to-date performance. That is partly because loan markets performance has been probably slower than we would have perhaps expected, but it has been somewhat offset by things like cash management and payments, number one. It has been also the case that the comparative period in 2024 benefited from valuation adjustments on a year-to-date basis, which, of course, inherently don't repeat during the course of 2025. There's a slight comparative issue there, which has meant that commercial has been slower year-to-date versus where you would normally expect it to be.

Indeed, our expectation looking forward is that that is going to change as those comparatives come out of the analysis. I'll come back to that in just a second. Insurance, pensions, and investments are up about 5% year-to-date. That is off the back of longstanding strength. It is also off the back of general insurance strength and things like share dealing. To be clear, if you look at it on a quarterly comparison basis, weather in respect of subsidence off the back of dry weather hit us a little bit in the course of Q3. Insurance is still growing for sure. The reason why you're seeing it at 5%, in part at least, is because of that weather during the course of quarter three, which, of course, we wouldn't expect to be repeated on a business-as-usual basis. Finally, Aman, the strength in investments is clear to see.

That is to say Lloyds Living, LDC, has been a significant contributor to the business on a year-to-date basis and again on a look-forward basis. When we put that together, Aman, first of all, we would expect those growth streams to continue to build over the course of the remainder of this year and certainly into next. That is a combination of strategic investments landing, if you like, and increased customer take-up. Allied to that, we now are adding in Lloyds Wealth, previously SPW. That is going to contribute in Q4, and it's going to contribute during the course of 2026 more meaningfully.

We haven't given precise numbers around that, but our expectation is that that is going to boost other operating income for the course of 2026, at least, by around GBP 175 million or so beyond what you would have previously seen in the other operating income line. Of course, our ambitions in respect of Lloyds Wealth go meaningfully beyond that. We would expect it to build in the years thereafter. That gives you a sense as to what we might expect it to contribute in 2026, which, of course, will be added to the contributions from the other income streams that I've just been highlighting. Hopefully, that's useful, Aman.

Aman Rakkar (Senior Equity Analyst)

Amazing. Thank you so much.

Operator (participant)

Thank you. Our next caller will be Sheel Shah from JPMorgan. Your line is now unmuted. Please go ahead.

Sheel Shah (Research Analyst)

Great, thank you. The CIB business has been particularly strong this year. One of the standout performers, I think, at least when I look at your balance sheet momentum. Could you talk a little bit about this business? What's actually happening? How much of this is market-driven? How much of this is an active strategy to maybe target share gains? What are the margins looking like in this business? Secondly, to come back to your less than 50% cost-to-income ratio for 2026, just looking at consensus, it sits at 51% at the moment. You've just mentioned GBP 175 million coming from the Lloyds Wealth business into OOI. What do you think the market is missing, either on the revenue line or the cost line, to get to this cost-to-income ratio target? Thank you.

William Chalmers (CFO)

Thanks, Sheel. Two questions there. One in relation to commercial banking, CIB in particular, and one in relation to costs. Just before getting into CIB, just a step back. As you know, our commercial banking business consists of both business and commercial banking, PCB, and the CIB business. We are engaged in quite a bit of transformation in respect of each of those two. When I look at the PCB business, as I mentioned in my comments earlier on, we've seen some really constructive signs in terms of BAU lending growth, which is great to see. When you look at it externally, that is offset by the government repayments that have been going on in respect of bounce-back loans. The net, if you like, is affected by that. We are encouraged by some decent and positive signs, if you like, of ongoing BAU growth.

That is alongside creating a much broader digitalized proposition to our customers, which in turn is going to help us drive other operating income growth going forward. When we look at CIB, again, that is going through a significant period of transformation, but it is about product broadening and product deepening. There have been some areas that have probably been slower than we might like to have been, for example, the loan markets area. There have been some areas that have been successful, particularly successful over the course of this year. I mentioned cash management and payments, for example. Capital markets have shown some sign of strength alongside working capital. The indicators that we've got on an early Q4 basis have been really promising in respect of CIB.

Now, CIB comparatives, as I mentioned a second ago, have been a little bit weighed down by strong valuation adjustments in the course of 2024. Please bear that in mind. The underlying momentum in CIB, we're really encouraged by. We think it's really positive, and it's a big part of our transformation story going forward. In respect of your second question, Sheel, on costs, the cost shape for 2026, as said, remains very much a commitment to sub 50% cost-to-income ratio. Within the cost-to-income ratio, it is clearly composed of two elements. One is to say income strength. We've talked a bit about that during the course of this call. I shan't repeat those points. Your specific question is around the cost part of that equation. How do we see that developing? I guess a couple of points, really.

One is we've spent quite a lot of money on various strategic initiatives, which in their orientation are cost-focused. As we go into 2026, we see the full-year run rate benefit of those investments take place. Whether those are around the business units or alternatively around the functions, including things like our systems and, of course, our various other risk finance and other support functions, those strategic investments engineer, or rather help us engineer, a lower cost base going forward in 2026 represents a full-year run rate for a number of those. At the same time, our cost growth in respect of OpEx is slowing somewhat. That in part is because of some of the investments in things like the FTE reductions that we have made over the course of this year.

You'll remember earlier on this year, we talked about our severance budget being higher for 2025 than it had been previously. That has been the case. In turn, that helps us address OpEx growth over the course of 2026. The result of that is that we expect 2026 costs to be flatter than you have seen recently. I won't commit to absolute zero, but nonetheless, you should expect to see them be flatter than they have been previously. That in turn, or rather in conjunction with the income developments that we talked about, is what helps us deliver a cost-to-income ratio of sub 50%. Now, to be clear, Sheel, it is not going to be sub 50% by much. We've said that before, and it's worth repeating. Nonetheless, it will be delivered, and it will be sub 50%.

Operator (participant)

Thank you. Our next caller is Chris Cant from Autonomous. Your line is now unmuted. Please go ahead.

Chris Cant (Head of Banks Strategy)

Good morning. Thanks both for taking the questions. I had one on stablecoin and tokenized deposits and one on motor, please. On the former topic, obviously, lots going on, and you're involved in this UK Finance initiative in terms of tokenized deposits. In terms of timescales and relative regulatory burdens, I guess the question is, can the industry move fast enough to deliver tokenized deposits ahead of stablecoin providers potentially trying to get a foothold? What sort of timelines do you think we're talking about to move beyond the use cases? I know there's a few things that are moving outside the sandbox in terms of remortgage, for instance. What sort of timelines are we talking about to move beyond the use cases currently envisaged by the UK Finance initiative? On programmable money, could you give us an idea of the use cases that you see?

I guess it's corporate clients that are more interested in these options. Could you give us some examples of use cases that corporate clients are looking for? That would be interesting. On motor, the FCA consultation, obviously, you're going to feed into. One of the points from the FCA's perspective, I suppose, is that if we don't capture the majority of cases through a redress program and it goes through the courts, then administrative costs would be potentially materially higher. Is that something that you agree with? I.e., you would be pushing for a narrower scheme potentially or for less redress and taking then some risk that the administrative burden of more cases remaining in the court system would push costs in that area. Thank you.

William Chalmers (CFO)

Yeah, thanks. Thanks for those questions, Chris. First of all, on stablecoin and tokenized deposits, a couple of points to make there. One is about the path forward on that. The second is around use cases. As I said earlier on, the rise of stablecoin has obviously been notable in recent periods. It's been particularly notable in the context of international payments where, as I said, there may be some advantages in terms of speed and cost. What we think in the U.K. is that the GB Tokenized Deposits, GBTD, that we are constructing together with the industry is effectively commercial bank money in its current form, which allows interchangeability between a digital coin, if you like, and an analog coin, i.e., the current coin that is there in the market. That has tremendous advantages.

It has tremendous advantages from a customer point of view because it is basically one and the same. They should be able to move freely between digital money and, if you like, analog money. That makes it a much more kind of customer-friendly approach. It also means that we as banks can offer that to customers as our money, effectively, together with all of the security and indeed insurance benefits that are currently in place. Of course, from a regulatory point of view, together with all of the KYC and so forth that we currently have in place. It goes hand in hand with today's money in a way that is, as I say, very user-friendly from a customer point of view. In that sense, it has material benefits over what stablecoin has to offer, which is clearly not interchangeable with commercial bank money.

It is not one and the same thing. In terms of timetable, Chris, I think your point is good. Your question, rather, is a good one. We need to move quickly on this. Indeed, use cases, as I said, landing in the first half of next year, we would expect off the back of that to be able to get something out in a workable customer proposition format, I hope by the first half of 2027, if not before. What we really need to fall into place in order to secure that progress, if you like, is a regulatory framework that is consistent with the ambitions of the industry and indeed is consistent with how the Bank of England would like to see this play out.

As a form of digital money in the U.K., it is important that that regulatory framework, that regulatory backdrop is in place in a supportive manner. That's really what we need. If that is in place, then the speed of this is very much within the sector's hands. We would expect to play a leadership role in securing that, making progress, and indeed getting to the customer benefits that we think are promising as a result of this. In terms of use cases, you mentioned wholesale, and for sure there are wholesale use cases here, Chris, but I don't think it's just that. That is to say digital money offers use cases both in the wholesale and in the retail space. Wholesale, we've just done an example with abrdn using basically tokenized assets as collateral.

That offers meaningful efficiencies in the context of collateral management and indeed speed and pace, and indeed cost of collateral alongside transactions. Likewise, the digital guild is an innovation that is being sponsored in terms of one of our use cases and again offers meaningful speed, cost, and efficiency benefits from a customer point of view. Of course, transacting with each other, that is to say if corporate is going to transact with each other in digital asset format, again, that is going to offer speed and transaction cost benefits. As I said, these are also retail benefits. Two out of three of our use cases are in the retail space, one being effectively cash on delivery to meaningfully cut fraud in the retail space, and the other being effectively re-engineering the home buying journey off the back of programmable money for just that journey.

I think there are meaningful retail benefits there too, Chris. We've got a lot to do in this area of digital assets, but as I said, if we get it right, there's an awful lot of customer value to be created. On the second topic, Chris, on motor finance remediation. It is our view, as I mentioned earlier on, that the motor finance remediation proposals as put forward by the FCA are currently disproportionate. They're disproportionate, as I said, for three main reasons. One is because we believe the determination of unfairness is too broad. Two is because we believe the judgments that are inherent in the proposals do not align to the Supreme Court clarity that was provided earlier on this year. Three is because we think the redress calculation, as I said, is at best tenuously linked to harm.

What that all means, Chris, is that indeed, if the proposals remain as broad as they are, in many respects at least, we would expect to see better outcomes in the context of litigation because presumably the courts will take into account the Supreme Court rulings in the way in which they were made, and presumably the courts will take into account the linkage between redress and harm. In that sense at least, I would expect litigation outcomes to be better than much of what is in the FCA proposals right now. Having said all of that, Chris, we clearly want to move on from this. We clearly want the business to move on and to focus on customer value-creating propositions just as we have been today and just as we expect to be in the future.

As a result, that is why we've taken a GBP 1.95 billion best estimate for the provision, which in turn is not far away from what it would be if the FCA were to enact their proposals in full. It's very much in the spirit of saying, "OK, look, we don't agree with them. We're going to do what we can to change them and get them into a better place. We are provisioning on the basis that a large part of them is going to stay in place, and we want to move on." That's what this provision is designed to do.

Chris Cant (Head of Banks Strategy)

Thank you.

William Chalmers (CFO)

Thanks, Chris.

Thank you. Our next caller is Guy Stebbings from BNP Paribas. Your line is now unmuted. Please go ahead.

Guy Stebbings (Executive Director of Banks Equity Research)

Hi, morning, William. I had a couple of questions back on NIM and that interest income. The first one was around volumes. The interest on the asset growth was quite strong in the quarter, a couple billion ahead of consensus on average in owning assets, and the end-of-period position at GBP 469 billion into Q4 in a good place. If you could talk about sort of broad expectations for the outlook from here. I note your constructive comments on mortgage volumes following, arguably, a better than expected performance in Q3. It sounds like we're talking to a positive trajectory, which, given your Q4 NIM commentary, paints quite a promising picture. Related to this on mortgage spreads, interested in your comments in response to Pearlie's questions and perhaps the market reacts to the headwind from mortgage spread churn on upcoming maturing cohorts by lifting new spreads.

I wonder if within that your comments signal that maybe current spreads have drifted a little bit lower in recent months on new lending and perhaps you're getting to levels you're a little bit less comfortable with, or am I just reading too much into the remarks there? I guess I'm really trying to work out on the upside versus downside on your initial expectations. You've had the visibility clearly on the maturing yields for quite a while, but whether new lending spreads are coming in better or worse than what you'd initially envisaged. Thanks.

William Chalmers (CFO)

Yeah. Thanks, Guy. In respect of AIAAs, first of all, the Q3 performance, as you note, saw a meaningful jump in terms of AIAAs off the back of what has been increased lending over the course of the year as a whole and continued into the third quarter. Maybe taking a step back before getting to AIAAs, as you know, we've had GBP 18 billion growth within the lending book year-on-year, which, of course, contributes to meaningful AIAA growth on a kind of annualized basis, if you like. Within that, we've had cards year-to-date up 7%. We've had personal loans up 13%. We've had motor up 5% over the course of the year. We've had mortgages up GBP 8.7 billion or 3%. It's a really decent loan performance for the business. In total, GBP 18 billion up, 4% up on assets for the year.

As you say, that is now translating into AIAA growth, GBP 465.5 million in the course of quarter three. We're seeing continued growth in the course of quarter four across the assets. Of course, it is a slightly shorter period because of seasonal factors. Nonetheless, you should expect to see growth within assets within quarter four that will be perfectly respectable and off the back of that deliver continued strength in AIAAs for the remainder of this quarter and looking into 2026. It'll be that combination, i.e., AIAA growth together with the step up in the margin that I mentioned a second ago, which in turn sets the stage for 2026 and gives us a lot of confidence in our 2026 guidance. That's the picture on AIAAs, Guy, which I hope is helpful. On mortgage spreads, you know it's interesting. We've seen now 70 basis points Q1, Q2, Q3.

It is fair to say that we've seen perhaps 1 basis point or 2 basis points of erosion within that over the course of these successive quarters. We are still rounding to circa 70 basis points in the course of quarter three, and you know comfortably rounding to circa 70 basis points in the course in quarter three, to be clear. A couple of points to make within that. One is when we look forward, my comments earlier on about whether there will be a bit of repricing off the back of five-year maturities and therefore people feeling a bit more pressure in their mortgage books, we're not banking on that, to be clear, Guy.

When we put forward our guidance for in excess of 15% ROTE and the guidance that we'll be giving you next year for the component of net interest income that will make up or contribute to that outcome, we have never been and are not banking on any uptick, if you like, in mortgage spreads that is driven by that five-year maturity pattern that we talked about earlier on. We're not banking on it. If it comes, so much the better, and you'll see that in the context of our net interest income at the time. The second point that I wanted to make is the business, or rather the spreads at which we are writing business right now, contribute to ROTE attractive mortgages for us. That's certainly true on a marginal basis. It is also true, albeit at a lower level, on a fully loaded basis.

You're seeing very attractive marginal returns, even at the current spreads. You are seeing, if you like, fully loaded returns that are still above the cost of equity. We're happy to write them. We're particularly happy to write them, bearing in mind a couple of other factors. One is that we are increasingly able to contribute protection alongside the mortgage product, as our insurance and our retail businesses work increasingly closely alongside of each other. We're now up to about 20% protection penetration for mortgage products. This is a strengthening relationship that we're seeing, not just a one-off mortgage relationship. The second is that we see an increasing share of our mortgages coming through the direct channel. That is a more profitable product for us to write. It is also one that more closely aligns us to the customers, to be clear.

At the moment, at least, we're seeing about 24% of our mortgages coming through the direct channel. That is, frankly, more than we've had for a long time, and it is a result of a very deliberate strategy that we're embarking on. In that context as well, Guy, we're able to write mortgages which are attractive to us on a standalone basis, but off the back of the, if you like, relationship that we're developing and the channels through which we're distributing, is a more attractive proposition.

Guy Stebbings (Executive Director of Banks Equity Research)

Very helpful. Thank you.

William Chalmers (CFO)

Thank you, Guy.

Operator (participant)

Thank you. Our next caller is Ed Firth from KBW. Your line is now unmuted. Please go ahead.

Ed Firth (Managing Director and Senior Equity Research Analyst)

Morning, William. Thanks for taking my question. I had two questions, actually. The first one was just the sort of, I guess I don't know what the right word is, cadence, I guess, if you like, or the growth rate of NII. I mean, if I look at your, you're talking about around GBP 13.6 billion for the year, and year-to-date is 10.1%, which would suggest somewhere around 3.5% in Q4, even my analysis, I can see that, which suggests actually a slightly slower growth rate than you saw in Q3, rather than a higher growth rate. I'm just trying to think, is there something I'm missing there? Is it something about non-banking income, or is the GBP 13.6 billion really a number that we should take as a sort of very safe base that actually, all other things being equal, we could see something better than that?

I guess that's my first question. The second one was, I think you were saying that we should put another 175% in for next year for the buyout in revenue, other income for the buyout of the SPW joint venture. Is there a cost offset on that, or is that just like straight through to the bottom line? Obviously, you talk about modestly higher for the little bit for this year. I'm just wondering what sort of cost numbers might equate to that 175%, or is that just a straight number we should just put in straight to consensus? Thanks very much.

William Chalmers (CFO)

Yeah, yeah. Thanks, Ed. In respect to net interest income growth, first of all, the easiest way to explain it is, I think, the following. As you know, we've upgraded to circa GBP 13.6 billion from circa GBP 13.5 billion. That is intended to be, and I hope very clearly is, a sign of confidence in terms of our net interest income trajectory. It is, as you pointed out, hopefully as is evident from the guidance, the circa word, the C, is very deliberate. That is to say, GBP 13.6 billion is not intended to be a cap. It is saying circa GBP 13.6 billion. I'll kind of leave you to move around from that. It is circa GBP 13 billion. That in turn, how things develop will be around GBP 13.6 billion, including numbers that go above GBP 13.6 billion, provided that they are within the circa range.

Stepping back, net interest income in quarter three was, what, GBP 3.45 billion. It's up about GBP 90 million growth versus Q2, which, as you know, is about 3%. Some of that Q2 growth that we saw in Q3 is day count increase, and a slightly lower amount of that is underlying increase. If you look forward into Q4, we expect to show continued progress in NII with, to be clear, probably a similar absolute income growth in Q4 as we saw in Q3, a similar absolute income growth in Q4 as we saw in Q3. To be clear, none of that will be day count benefit, Ed. That is to say, the day count in Q4.

Ed Firth (Managing Director and Senior Equity Research Analyst)

That makes sense.

William Chalmers (CFO)

Same as the day count in Q3, which, if you translate that, means that growth is actually strengthening, not weakening. Growth is strengthening in Q4 rather than weakening. That is off the back of the factors that we've discussed before, which is the step up in the margin, which is, as I said, more pronounced in Q4, and then the AIAA progress that I was discussing with Guy just a second ago. That's coming off the back of the fundamentals. All of that, Ed, hopefully helps kind of illustrate the point. In turn, we have a lot of confidence in that number.

Ed Firth (Managing Director and Senior Equity Research Analyst)

Perfect.

William Chalmers (CFO)

Ed, hopefully that's helpful. On the SPW point, unfortunately, all good things come at a price, I guess. When we look at the $175 million incremental, that in turn comes with costs, which are probably going to be about $120 million in excess of what you saw previously there. You didn't actually see them previously because they were all consolidated in the OOI line. It's probably about $120 million added costs to procure that circa $200 million OOI, which in turn, that OOI is about $175 million ahead of what we'd previously seen. I hope that's clear. There are a couple of other points that maybe I should make in the context of the SPW transaction, now Lloyds Wealth transaction, which are important to us. One is we did it at zero capital cost.

As you know, we had to give up our 20% share in Cazenove in order to get that. The benefit that we were getting from that Cazenove share was a modest annual dividend that you saw in Q4. Frankly, this feels to us like, from our perspective at least, a really positive trade. It was done at zero capital cost. The second point is we'll have to work at it to make sure that it comes within our cost-to-income ratio. As I said, that's consistent with our sub-50% cost-to-income ratio guidance. At the same time, you can probably imagine, as with many of these wealth businesses, this is a materially ROTE positive transaction. We'll deliver a ROTE that is well above, not just our cost of capital, but probably well above the types of ROTEs that we'll be delivering on a kind of group aggregated basis.

This is a net positive contributor to the ROTE of the business. Most importantly, Ed, it's a very important strategic development and indeed a very important part of our customer proposition.

Ed Firth (Managing Director and Senior Equity Research Analyst)

Perfect.

William Chalmers (CFO)

Thanks, Ed.

Ed Firth (Managing Director and Senior Equity Research Analyst)

Thank you.

Operator (participant)

Thank you. As you know, this call is scheduled for one hour, and we have now exceeded 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. With that, our final caller is Amit Goel from Mediabanca. Please go ahead.

Amit Goel (Managing Director and Senior Analyst)

Hi, thank you. Two relatively quick questions from me. One, just on the deposits, the retail deposits, some positive trends there on the back of the pricing decisions. Just curious whether that's largely done now or whether we could continue to see a little bit of that shift and whether or not that can benefit the hedge capacity. The second question, just curious how engagement with the government is going ahead of the budget and also whether or not they kind of recognize the motor costs when also thinking about banking sector taxation. Thank you.

William Chalmers (CFO)

Yeah, thanks, Amit. In respect of each of those, as you say, deposit performance has been pretty good over the course of this year. GBP 14 billion up in total, 3% year-to-date increase. A good performance in deposits. Within that, retail is up GBP 4 billion year-to-date. What we saw within retail in the third quarter was a little bit of outflow within the U.K. retail savings area. That was very much within the fixed term product off the back of effectively pricing decisions that we had taken, given the fact that we had performed so strongly in Q2, in particular in the ISA season, which we highlighted at the time. This was, I suppose, an inevitable reaction to very deliberate pricing decisions that we had taken in the course of quarter three.

It was good to see that it was offset by PCA performance in the course of quarter three, which were up GBP 1.2 billion, which is a good performance. As you know, leads us to a year-to-date performance within PCA is up around GBP 500,000,000 or so. I think a couple of things are happening there, Amit, which are pretty constructive on the whole. We're seeing continued wage inflation with respect to our customers. Importantly, we're also seeing reduced levels of churn out of the PCA product into savings products and into fixed term in particular. That falling churn, it's down about 33%, i.e., down about a third in Q3 versus Q2. That's a material reduction in churn. We expect to see that pattern more or less continue going forward. It's good to see. As I said, PCA is an incredibly important customer product from our point of view.

It's an incredibly important product from a structural hedge point of view. The solidity of the PCA performance has been good to see. As we look forward, I think we do expect churn to continue to add. Q3 was particularly marked, but nonetheless, we continue to see, we continue to expect it to add going forward. PCAs, we are seeing other trends, slowing government payments, for example, probably over time slowing wage growth as well. PCA performance, I don't think we expect to see it be particularly exciting. Maybe more or less static might be a reasonable way of looking at it. We'll see how it goes. Going into next year, I think that starts to change as things pick up perhaps a little bit more.

Our expectation for the structural hedge, to be clear, Amit, insofar as it relates to this issue, is we're not banking on significant increases in structural hedge balances. All of our forecasts for you, the GBP 1.5 billion growth in structural hedge income, for example, going into next year, GBP 6.9 billion revenue in total from the structural hedge, that is built on a steady hedge. If we see performance within PCAs, instant access, and other hedge eligible deposits, including NIPCA within BCB, which has shown an uptick actually in Q3, if that performs more positively than we expect, that would represent structural hedge upside and opportunity. At the moment, we're expecting flat structural hedge performance. On your second question, Amit, in respect of budget, a couple of points to make, really. One is the business has been really only very modestly affected, if at all, by budget concerns.

I mentioned earlier on that we've seen mortgage performance be very strong. As you know, GBP 8.7 billion year-to-date, GBP 3.1 billion of that in the third quarter. We've seen applications up 19% over the course of the third quarter. We've seen completions up 23% over the course of the third quarter. No meaningful sign, if you like, of hesitation because of budget in the third quarter mortgage performance. Within the pensions business, another area that conceivably might be affected, we've seen a little bit of an increase in individual pension encashments, but no material change, to be clear, within the workplace. In any case, any change in volumes that we have seen in the pensions area have been well below what we saw last year.

Really nothing to report effectively in terms of the, I suppose, hesitation that might be induced by the budget overhang in respect to the business as usual. In respect to tax, Amit, I think those are really decisions for the government, obviously, and we'll leave them to make those decisions as and when they see fit. From our perspective, at least, the most critical thing is that we have a stable and a predictable tax regime and one that is competitive. That is to say, at the moment, we're a material taxpayer, as you know, GBP 1.5 billion of corporate tax, all in, including things like NII and VAT and so forth, about GBP 2.5 billion of total tax paid. We see ourselves as a meaningful tax contributor.

We see a stable and competitive tax regime, and indeed a predictable tax regime, as essential, frankly, to the continued prosperity of the financial services sector and by extension, all of the things that we can do for the U.K. economy as a whole. I think that's really all we'd say on the tax front, Amit, which I hope is useful.

Amit Goel (Managing Director and Senior Analyst)

Thank you.

William Chalmers (CFO)

I think, operator, we're going to call it a day for now on the questions. I just want to say thank you to everybody for joining the call today, and your interest in the stock and the company is, as always, greatly appreciated. Thanks very much indeed.

Operator (participant)

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