Lloyds Banking Group plc (LON:LLOY) has announced its Q1 2022 Interim Management Statement.
“In the first three months of 2022, we delivered solid financial performance, with strong income growth and capital build. These results demonstrate the consistent strength of our business model.
In February, we announced our ambitious new strategy, aiming to transform our business, generating a stronger growth trajectory and enabling the Group to deliver higher, more sustainable returns and capital generation. In March we announced a new business structure, aligned to the new strategy and have started work on the strategic initiatives which will drive revenue growth and diversification, strengthen our cost and capital efficiency, as well as maximise the potential of our people, technology and data.
Whilst we are seeing continued recovery from the coronavirus pandemic, the outlook for the UK economy remains uncertain, particularly with regards to the persistency and impact of higher inflation. We are proactively contacting customers where we feel they may need assistance and will continue to help with financial health checks and other means of support. We encourage customers, where affected, to get advice early and talk to us.”
Charlie Nunn
Group Chief Executive
Solid financial performance
• Statutory profit after tax of £1.2 billion (first quarter of 2021: £1.4 billion), reflecting higher net income and a limited underlying impairment charge versus a net credit in the prior year. Tangible net assets per share of 56.5 pence
• Strong revenue growth supported by continued recovery in customer activity and interest rate changes. Net income of £4.1 billion, up 12 per cent, with higher net interest and other income, alongside low operating lease depreciation
• Underlying net interest income benefitted from increased average interest-earning banking assets and deposit growth in recent quarters including the first quarter of 2022 and a stronger banking net interest margin of 2.68 per cent
• Operating costs on the new reporting basis1 of £2.1 billion, up 3 per cent compared to the first quarter of 2021, reflecting stable business-as-usual costs and planned incremental strategic investment
• Underlying profit before impairment up 26 per cent to £2.0 billion in the quarter, driven by strong net income growth
• Asset quality remains strong. Underlying impairment of £0.2 billion, reflecting a low incurred charge and limited impact from revised economic outlook, including higher inflation offset by stronger house prices and unemployment
Continued franchise growth and capital strength further enhanced
• Loans and advances to customers at £451.8 billion, up £3.2 billion in the quarter, including continued growth in the open mortgage book (up £1.7 billion in the quarter to £295.0 billion)
• Customer deposits up £4.8 billion to £481.1 billion, with continued inflows to the Group’s trusted brands. Loan to deposit ratio of 94 per cent, continues to provide robust funding and liquidity
• Strong capital build2 of 50 basis points has allowed for significant accelerated pension contributions, comprising the full 2022 fixed contributions, as well as around half of the variable element. The Group’s CET1 ratio was 14.2 per cent
Outlook
Given the solid financial performance in the first quarter of 2022 and based on current business performance expectations and macroeconomic assumptions, the Group is enhancing its guidance for 2022 for banking net interest margin and return on tangible equity:
• Banking net interest margin now expected to be above 270 basis points
• Operating costs of c.£8.8 billion on the new reporting basis1
• Asset quality ratio to be c.20 basis points
• Return on tangible equity now expected to be greater than 11 per cent
• Risk-weighted assets at the end of 2022 to be c.£210 billion
1 See page 22 .
2 Excluding regulatory changes on 1 January 2022, variable pension contributions and dividend accrual.
REVIEW OF PERFORMANCE
Statutory results
The Group’s statutory profit before tax for the three months ended 31 March 2022 was £1,623 million, compared to £1,898 million for the same period in 2021, reflecting higher total income, net of insurance claims and an impairment charge for the period (compared to a net credit in the first quarter of 2021). Statutory profit after tax was £1,204 million (three months to 31 March 2021: £1,397 million) and included restructuring costs of £24 million and volatility and other items of £138 million (comprising negative insurance and banking volatility, the amortisation of purchased intangibles and fair value unwind).
The Group’s balance sheet reflects continued franchise growth. Loans and advances to customers were up £3.2 billion at £451.8 billion, compared to £448.6 billion at 31 December 2021, driven by continued growth in the open mortgage book of £1.7 billion and increases in Corporate and Institutional lending of £2.9 billion, partially offset by continued reductions in the closed mortgage book. Customer deposits have increased by £4.8 billion since the end of 2021, with continued inflows to the Group’s trusted brands.
Underlying resultsA
The Group’s underlying profit for the first three months of the year was £1,785 million, compared to £1,914 million for the same period in 2021, reflecting higher net income offset by an impairment charge for the period (compared to a net credit in the first quarter of 2021). Underlying profit before impairment for the period of £1,962 million was up 26 per cent, driven by strong net income growth, partially offset by marginally higher total costs reflecting planned incremental strategic investment. Tangible net assets per share were 56.5 pence, enhanced by profit but down from 57.5 pence at 31 December 2021 given movements in the cash flow hedge reserve reflecting changes in the UK Bank Rate.
Net income of £4,112 million was up 12 per cent on the first three months of 2021, with increased net interest income and other income as well as a reduction in the charge for operating lease depreciation. Underlying net interest income of £2,945 million was up 10 per cent driven by average interest-earning banking asset growth, increased deposits built up in recent quarters and a stronger banking net interest margin of 2.68 per cent (three months to 31 March 2021: 2.49 per cent). The net interest margin benefitted from the UK Bank Rate increases, deposit growth, structural hedge earnings from a rising rate environment and continued capital base optimisation, offsetting headwinds from mortgage book growth and pricing. Average interest-earning banking assets were up 2 per cent compared to the first three months of 2021 at £448.0 billion, driven by continued growth in the open mortgage book, but slightly lower compared to the fourth quarter of 2021, due to lower average lending within the Commercial Banking portfolio.
The Group manages the risk to its earnings and capital from movements in interest rates centrally by hedging the net liabilities which are stable or less sensitive to movements in rates. As at 31 March 2022, the Group’s structural hedge had an approved capacity of £250 billion (up £10 billion on 31 December 2021), including some of the balances from the substantial deposit growth since the start of the pandemic. The Group continues to review recent periods’ deposit growth and its eligibility for the structural hedge. The nominal balance of the structural hedge was £245 billion at 31 March 2022 (31 December 2021: £240 billion) with a weighted-average duration between three and three-and-a-half years (31 December 2021: approximately three-and-a-half years). The Group generated £0.6 billion of total gross income from structural hedge balances in the period (three months to 31 March 2021: £0.5 billion, three months to 31 December 2021: £0.6 billion).
Underlying other income of £1,261 million was 11 per cent higher compared to £1,135 million in the first three months of 2021, reflecting solid performance in Retail and Insurance new business year-on-year as well as stronger Commercial Banking markets performance versus the fourth quarter of 2021. Operating lease depreciation decreased to £94 million (three months to 31 March 2021: £148 million), reflecting strong used car prices, combined with the continued impact of a reduced, but stabilising Lex fleet size, given industry wide supply constraints in the new car market.
The Group experienced good organic growth in Insurance and Wealth assets under administration (AuA), with c.£2 billion net new money in open book AuA over the period. In total open book AuA grew by c.£33 billion with AuA from the acquisition of Embark, partially offset by the impact of negative market movements in the quarter.
As announced at the full-year, the Group has adopted a new basis for cost reporting, including all restructuring costs, with the exception of merger, acquisition and integration costs, within operating costs. Non lending-related fraud costs, previously included within underlying impairment, are also now reported as part of operating costs. Comparatives have been presented on a consistent basis.
REVIEW OF PERFORMANCE (continued)
Cost discipline remains a core focus for the Group. The Group’s cost:income ratio was 52.3 per cent compared to 57.6 per cent in the first three months of 2021. Total costs of £2,150 million were 2 per cent higher than in the first three months of 2021. Within this, increased operating costs of £2,098 million (up 3 per cent) reflected planned strategic initiative investment and new businesses. Business-as-usual costs were stable. Remediation charges of £52 million (three months to 31 March 2021: £65 million) were recognised in the quarter, principally relating to pre-existing programmes. There have been no further charges relating to HBOS Reading since the year end and the provision held continues to reflect the Group’s estimate of its full liability, albeit significant uncertainties remain.
Asset quality remains strong with new to arrears remaining very benign and below pre-pandemic levels, resulting in an asset quality ratio for the quarter of 0.16 per cent. Underlying impairment was a net charge of £177 million, compared to a net credit of £360 million in the first three months of 2021, reflecting a low incurred charge of £150 million and a £27 million charge from economic outlook revisions (first three months of 2021: a credit of £459 million). The economic outlook revision charge reflects an improvement from lower unemployment and stronger HPI, offset by additional provisions taken to capture the elevated inflation risk assumed in the updated base case and its potential impact on asset quality.
Overall the Group’s loan portfolio continues to be well-positioned, reflecting a prudent through-the-cycle approach to credit risk with high levels of security. The Group’s expected credit loss (ECL) allowance remained stable in the first three months of the year at £4.5 billion (31 December 2021: £4.5 billion). The Group continues to retain £0.8 billion of net management judgements in respect of coronavirus (31 December 2021: £0.8 billion); within this, the Group has maintained its central adjustment of £0.4 billion to recognise the downside risks outside of the base case conditioning assumptions. As noted above, additional judgements have been raised to capture the increased risk of inflation and impact on the cost of living, with a further £0.1 billion added in the quarter, largely within segments of the Retail book that are considered less resilient to disposable income shocks.
Following changes in credit risk measurement and modelling associated with CRD IV regulatory requirements during the quarter, the Group has amended its definition of Stage 3 for UK mortgages to maintain alignment between IFRS 9 and regulatory definitions of default. Default continues to be considered to have occurred when there is evidence that the customer is experiencing financial difficulty which is likely to significantly affect their ability to repay the amount due. For UK mortgages, this was previously deemed to have occurred no later than when a payment was 180 days past due; in line with CRD IV this has now been reduced to 90 days, as well as including end-of-term payments on interest-only accounts and all non-performing loans. Overall ECL is not impacted as management judgements were previously held in lieu of these known changes, however they result in £0.2 billion of ECL moving from Stage 1 and 2 to Stage 3 with £2.8 billion of additional assets in Stage 3. These changes also lead to £6.1 billion of additional assets moving to Stage 2 given the consequential change in approach to the prediction and modelling of up to date accounts and their likelihood of reaching the new broader definition of default in the future. Given these are up to date accounts with low probability of default that are moving to Stage 2, there is no material ECL impact. Absent this definitional change, the sustained low levels of new to arrears observed means that mortgage accounts that are classified as Stage 2, due to being in early arrears, have reduced slightly in the quarter.
The Group’s operations are predominantly UK-based with no direct credit exposure to Russia or Ukraine. The Group does have credit exposure to businesses that are impacted, either directly or indirectly, by higher energy costs or commodity prices, or potential disruption within their supply chains. Such activity is monitored through prudent risk management. The Group continues to monitor and analyse carefully key internal and external indicators for signs of contagion risk and any second or third order risks that may arise from the war in Ukraine above and beyond those captured in the macroeconomic outlook. Investigations so far have not revealed any significant risks, although the Group remains vigilant and proactive risk mitigation is undertaken as appropriate to ensure that it supports clients, including those in financial difficulty, whilst protecting its portfolios.
Capital
The Group’s CET1 capital ratio reduced from 16.3 per cent on a pro forma basis at 31 December 2021 to 14.2 per cent at 31 March 2022. This largely reflected the reduction of 230 basis points on 1 January 2022 for regulatory changes which, as previously reported, included an increase in risk-weighted assets and other related modelled impacts, in addition to the reinstatement of the full deduction treatment for intangible software assets and phased reductions in IFRS 9 transitional relief.
REVIEW OF PERFORMANCE (continued)
Strong capital build of 50 basis points during the first three months of the year (excluding the impact of the 1 January 2022 regulatory changes) largely reflected banking profitability (pre-underlying impairment charge) of 61 basis points, with a limited net impairment offset of 7 basis points. The capital build further benefitted from a reduction in risk-weighted assets, post 1 January 2022 regulatory changes, equivalent to 14 basis points and other movements of 13 basis points. This was offset in part by accelerated full year fixed pension deficit contributions of 31 basis points.
In relation to capital usage, the impact of the foreseeable ordinary dividend accrual in the quarter equated to 17 basis points, based upon a pro-rated amount of the 2021 full year dividend. Variable pension contributions of 19 basis points were also made to the main defined benefit pension schemes.
| Capital movements | |
| Pro forma CET1 ratio as at 31 December 20211 | 16.3% |
| Regulatory change on 1 January 2022 (bps) | (230) |
| Pro forma CET1 ratio as at 1 January 2022 | 14.0% |
| Banking build (pre-underlying impairment charge) (bps) | 61 |
| Impairment charge net of regulatory expected losses (bps) | (7) |
| Risk-weighted assets (bps) | 14 |
| Fixed pension deficit contributions (bps) | (31) |
| Other movements (bps) | 13 |
| Capital build (bps) | 50 |
| Ordinary dividend accrual (bps) | (17) |
| Variable pension contributions (bps) | (19) |
| Net movement in CET1 ratio excluding regulatory change (bps) | 14 |
| CET1 ratio as at 31 March 2022 | 14.2% |
1 31 December 2021 ratio reflects the dividend received from Insurance in February 2022 and the full impact of the share buyback.
Given the strong capital build in the quarter, the Group decided to accelerate pension deficit contributions. A total of £1.3 billion in deficit contributions (both fixed and variable) has been paid during the first three months of the year into the Group’s three main defined benefit pension schemes, compared to £0.4 billion in the equivalent period of the prior year. The fixed contributions for the year of £0.8 billion (equivalent to 31 basis points) have been paid in full. The variable contributions of £0.5 billion (equivalent to 19 basis points) represent around half of the agreed variable pension contributions relating to 30 per cent of the 2021 final dividend and share buyback, in accordance with the current agreement with the Trustees. This is considered to be an efficient utilisation of capital build in the first quarter, whilst not altering the total contributions to be paid during the year nor the expected impact on the full year capital position following the payment of the remaining variable pension contributions.
Risk-weighted assets increased by £16 billion to £212 billion (pro forma) on 1 January 2022, before reducing by £2 billion during the quarter to £210 billion at 31 March 2022. The increase on 1 January 2022 reflected the impact of the regulatory changes, including the implementation of new CRD IV models to meet revised regulatory standards for modelled outputs and a new standardised approach for measuring counterparty credit risk (SA-CCR) following the UK implementation of the remainder of CRR 2. The Group continues to see minimal impact on risk-weighted assets from credit migrations with the subsequent reduction during the quarter largely reflecting optimisation activities within Retail and Commercial Banking, model recalibrations and lower market risk exposure, partly offset by the growth in balance sheet lending. The Group continues to expect risk-weighted assets at the end of 2022 to be around £210 billion. The new CRD IV models remain subject to finalisation and approval by the PRA and therefore uncertainty over the final impact remains.
Following the increase in risk-weighted assets, the Group’s nominal Pillar 2A CET1 capital requirement is now the equivalent of around 2.0 per cent of risk-weighted assets as at 31 March 2022, but otherwise remains unchanged. During 2022, the PRA will revert to setting a variable amount for the Group’s Pillar 2A capital requirement (being a set percentage of risk-weighted assets), with fixed add-ons for certain risk types. Lloyds Banking Group’s CET1 regulatory minimum capital requirement remains at around 11 per cent and the Board’s view of the ongoing level of CET1 capital required to grow the business, meet current and future regulatory requirements and cover uncertainties continues to be around 12.5 per cent, plus a management buffer of around 1 per cent.
