Lloyds Banking Group plc (LON:LLOY) has announced its Q3 2023 Interim Management Statement.
“Guided by our purpose, we remain focused on supporting our customers and helping them navigate the uncertain economic environment.
The Group continues to perform well. Robust financial performance and strong capital generation in the first nine months of the year was driven by net income growth, cost discipline and resilient asset quality. This performance allows us to reaffirm our 2023 guidance.
As we set out in the first of our four strategic seminars1 earlier this month, we are successfully executing against our strategic priorities. This supports progress towards our ambition to enable higher, more sustainable returns. Together, it will better position us to deliver for all of our stakeholders as we continue to help Britain prosper.”
Charlie Nunn,
Group Chief Executive
Continued robust financial performance and consistent delivery
• Statutory profit after tax of £4.3 billion (£1.4 billion in the third quarter) with net income of £13.7 billion up 7 per cent. Strong return on tangible equity of 16.6 per cent, 16.9 per cent in the third quarter
• Underlying net interest income of £10.4 billion up 10 per cent with a net interest margin of 3.15 per cent. Net interest margin of 3.08 per cent in the third quarter, down 6 basis points in the quarter given the expected mortgage and deposit pricing headwinds. Average interest-earning assets of £453.5 billion, stable versus the fourth quarter of 2022
• Underlying other income of £3.8 billion, 8 per cent higher, reflecting continued recovery of customer activity and ongoing investment in the business as we progress against our strategic initiatives
• Operating lease depreciation of £585 million, up on the previous year given depreciation of higher value vehicles, growth partly from the Tusker acquisition, lower gains on disposal and recent declines in used electric car prices
• Operating costs of £6.7 billion, up 5 per cent and in line with expectations. The Group maintains cost discipline in the context of higher planned strategic investment, new business costs and continued inflationary pressures
• Impairment charge of £0.8 billion and asset quality ratio of 25 basis points, reflecting broadly stable credit trends and resilient asset quality. The portfolio remains well-positioned in the context of the economic environment
• Loans and advances to customers reduced £2.8 billion to £452.1 billion, including a £2.5 billion legacy portfolio exit in the first quarter. Balances increased by £1.4 billion in the third quarter with growth across a number of businesses, including in the open mortgage book (£0.4 billion) and the unsecured and Corporate and Institutional Banking portfolios
• Customer deposits of £470.3 billion down £5.0 billion (1.0 per cent), including a £9.4 billion reduction in Retail current accounts, partly offset by a combined £5.2 billion increase in Retail savings and Wealth balances. Deposits increased by £0.5 billion during the third quarter, given growth in Retail savings
• Strong capital generation of 165 basis points; 129 basis points after CRD IV model changes and phased unwind of IFRS 9 relief
• Pensions triennial review substantially agreed with an additional contribution of £250 million to be paid by the end of March 2024, and no further contributions in this triennial period
• Risk-weighted assets of £217.7 billion increased by £6.8 billion, reflecting part of the anticipated impact of CRD IV model updates along with lending and other increases, net of optimisation activity
• Tangible net assets per share of 47.2 pence, slightly up on the end of 2022; up 1.5 pence in the third quarter, given higher profits, the reduction in share count (c.7 per cent year to date following the completion of the £2 billion share buyback) and movements in the cash flow hedge reserve, partly offset by pensions surplus changes and distributions
• CET1 ratio of 14.6 per cent remains ahead of ongoing c.12.5 per cent target, plus management buffer of c.1 per cent
2023 guidance reaffirmed, with slightly improved asset quality;
• Banking net interest margin of greater than 310 basis points
• Operating costs of c.£9.1 billion
• Asset quality ratio now expected to be less than 30 basis points
• Return on tangible equity of greater than 14 per cent
• Capital generation of c.175 basis points2
1 Event materials available at: https://www.lloydsbankinggroup.com/investors/financial-downloads/event-presentations-webcasts.html.
2 Excluding capital distributions and the impact of the Tusker acquisition. Inclusive of ordinary dividends received from the Insurance business.
REVIEW OF PERFORMANCEA
Continued robust financial performance and consistent delivery
The Group’s statutory profit after tax for the first nine months of 2023 was £4,284 million, higher than the prior year which was impacted by IFRS 17 accounting changes. The Group’s underlying profit for the first nine months of 2023 was £6,063 million, an increase of 14 per cent compared to £5,322 million in the prior year. Growth in net income and a lower impairment charge was partly offset by higher operating costs. Underlying profit in the third quarter was up 11 per cent compared to the second quarter, resulting from a lower underlying impairment charge, largely due to an improved macroeconomic outlook.
Net income of £13,700 million was up 7 per cent on the prior year, with higher net interest income and other income, partially offset by an increased charge for operating lease depreciation. Net interest income in the first nine months of £10,448 million was up 10 per cent, driven by a stronger banking net interest margin of 3.15 per cent (nine months to 30 September 2022: 2.84 per cent) and higher average interest-earning banking assets. The net interest margin benefitted from UK Bank Rate increases and higher structural hedge earnings from the rising rate environment, partly offset by deposit mix effects and asset margin compression, particularly in the mortgage book. Average interest-earning banking assets at £453.5 billion have modestly increased compared to the first nine months of 2022, with growth in the open mortgage book, Retail unsecured and the European retail business, largely offset by closed mortgage book run-off and continued repayments of government-backed lending. Net interest income in the first nine months of 2023 included non-banking interest expense of £231 million (nine months to 30 September 2022: £69 million), which continues to increase on the prior year as a result of higher funding costs and growth in the Group’s non-banking businesses.
Net interest income in the third quarter of £3,444 million was stable versus the second quarter, with a lower net interest margin of 3.08 per cent (three months to 30 June 2023: 3.14 per cent) as expected and stable average interest earning assets. As previously guided, the Group expects the banking net interest margin for 2023 to be greater than 310 basis points. Average interest-earning assets over 2023 are still expected to be down slightly compared to the fourth quarter of 2022.
The Group manages the risk to earnings and capital from movements in interest rates by hedging the net liabilities which are stable or less sensitive to movements in rates. The nominal balance of the structural hedge was £251 billion (31 December 2022: £255 billion) with a weighted-average duration of approximately three-and-a-half years (31 December 2022: approximately three-and-a-half years). The Group continues to review the stability and mix of underlying deposits and their eligibility for the structural hedge and, including the movement in the third quarter, expects a modest nominal balance reduction by the end of 2023, consistent with guidance at the half-year. The Group generated £2.5 billion of total income from structural hedge balances in the first nine months of 2023, representing material growth over the prior year (nine months to 30 September 2022: £1.9 billion). The Group continues to expect hedge earnings in 2023 to be c.£0.8 billion higher than in 2022.
Underlying other income in the first nine months of 2023 of £3,837 million was 8 per cent higher compared to £3,538 million in the prior year. This was driven by growth across Retail, Commercial Banking and Insurance, Pensions and Investments. Underlying other income was 1 per cent higher in the third quarter versus the second.
Retail other income for the first nine months increased due to higher current account and credit card activity, improved Lex performance and growth from the acquisition of Tusker. Growth within Commercial Banking reflected improved performance in trading and capital markets financing. Insurance, Pensions and Investments other income increased due to balance sheet growth from both new business and the accounting unwind benefit of adding a drawdown feature in 2022 to existing long-standing and workplace pension business. In Equity Investments and Central Items other income reflected a modest reduction in the Group’s equity investments businesses from more subdued market conditions.
The Group delivered good organic growth in Insurance, Pensions and Investments and Wealth (reported within Retail) assets under administration (AuA), with combined £5.6 billion net new money in open book AuA over the period. In total, open book AuA now stand at c.£166 billion.
Operating lease depreciation of £585 million increased compared to the prior year (nine months to 30 September 2022: £295 million). This reflects the depreciation cost of higher value vehicles, the Tusker acquisition in the first quarter and subsequent growth, lower gains on disposal and recent declines in battery electric used car prices. These trends continued in the third quarter resulting in 6 per cent higher operating lease depreciation versus the second quarter. Operating lease depreciation continues to increase towards more normalised levels, as expected.
REVIEW OF PERFORMANCE (continued)
Total costs, including remediation, of £6,788 million were 6 per cent higher than in the prior year and stable in the third quarter of 2023 versus the second. Operating costs were up 5 per cent to £6,654 million, with higher planned strategic investment, new business costs and inflationary impacts, partially mitigated by continued cost efficiency. The Group’s cost:income ratio for the first nine months of 2023 was 49.5 per cent, compared to 50.1 per cent in the prior year. Consistent with previous guidance, operating costs are expected to be c.£9.1 billion in 2023.
The Group recognised remediation costs of £134 million in the first nine months of 2023, largely in relation to pre-existing programmes (nine months to 30 September 2022: £89 million), with £64 million in the third quarter. There have been no further charges relating to HBOS Reading and the provision held continues to reflect the Group’s best estimate of its full liability, albeit uncertainties remain. Following the FCA’s Motor Market review, the Group continues to receive complaints and claims and is engaging with the Financial Ombudsman Service in respect of past motor commission arrangements. Discussions are continuing, with the remediation and financial impact, if any, remaining uncertain.
Asset quality remains resilient with credit performance across portfolios largely stable in the quarter and remaining similar or favourable to pre-pandemic experience. The underlying impairment in the nine months was £849 million, (nine months to 30 September 2022: £1,045 million), including £187 million in the third quarter, resulting in an asset quality ratio of 25 basis points. The charge is after a net £69 million multiple economic scenarios (MES) release in the first nine months (nine months to 30 September 2022: £513 million charge), including a £74 million release in the third quarter, given modest revisions to the Group’s economic outlook. Reflecting the portfolio resilience, the Group now expects the asset quality ratio to be less than 30 basis points in 2023.
The pre-updated MES impairment charge was £918 million in the period (nine months to 30 September 2022: £532 million), equivalent to an asset quality ratio of 27 basis points. This reflects only modest deterioration from a low base, primarily in legacy variable rate UK mortgage portfolios and higher charges on existing Stage 3 clients in Commercial Banking. It also includes the impact of higher discount rates on future recoveries, as well as the expected credit loss (ECL) allowance build from Stage 1 loans rolling forward into a deteriorating economic outlook. The pre-updated MES asset quality ratio of 23 basis points in the third quarter includes a calibration benefit from the resilient performance in unsecured portfolios relative to expected adverse impacts from higher unemployment and affordability pressures.
In UK mortgages, new to arrears are broadly stable in the third quarter. Increases in flows to default driven by legacy variable rate customers have also slowed, but remain slightly above pre-pandemic levels. Unsecured and Commercial Banking portfolios continue to exhibit stable new to arrears and default trends broadly at, or below, pre-pandemic levels. The Commercial Real Estate portfolio is demonstrating resilience and is well diversified with no speculative development lending. Committed drawn CRE lending stood at £11.0 billion as at 31 August 2023 (net of £3.4 billion exposures subject to protection through Significant Risk Transfer (SRT) securitisations).
Stage 3 assets at £11.0 billion, have increased slightly in the third quarter, although remain broadly flat relative to year end (31 December 2022: £10.8 billion). Stage 2 assets have reduced in the year to £62.9 billion (31 December 2022: £65.7 billion), with 92 per cent of Stage 2 loans up to date (31 December 2022: 93 per cent). Movements in staged assets include the impact from the exit of £2.5 billion of legacy Retail mortgage loans in the first quarter, including a reduction of £0.9 billion in Stage 2 and £0.4 billion in Stage 3.
Restructuring costs year to date are £69 million (nine months to 30 September 2022: £69 million) and include costs relating to the integration of Embark and Tusker. Volatility and other items were a net loss of £266 million for the first nine months of 2023 (nine months to 30 September 2022: net loss of £1,528 million). This comprised negative market volatility and asset sales of £145 million, £53 million for the amortisation of purchased intangibles (nine months to 30 September 2022: £52 million) and £68 million relating to fair value unwind (nine months to 30 September 2022: £90 million). Market volatility and asset sales included negative impacts from insurance volatility, partly offset by positive banking volatility. Volatility and other items in 2022 included an exceptional charge under IFRS 17 from contract modifications in Insurance, Pensions and Investments, predominantly in the second half, following the addition of a drawdown feature to existing long-standing and workplace pensions as a significant customer enhancement.
The Group’s statutory profit before tax for the first nine months of 2023 was £5,728 million, up from £3,725 million in the same period in 2022. Statutory profit after tax was £4,284 million (nine months to 30 September 2022: £2,941 million). In the third quarter of the year, statutory profit before tax was £1,858 million and statutory profit after tax was £1,420 million, both up on the second quarter.
REVIEW OF PERFORMANCE (continued)
The return on tangible equity for the first nine months of 2023 was 16.6 per cent (nine months to 30 September 2022: 9.6 per cent), reflecting the Group’s robust financial performance. The Group expects the return on tangible equity for 2023 to be greater than 14 per cent. Earnings per share were 5.9 pence in the period (nine months to 30 September 2022: 3.7 pence).
Tangible net assets per share as at 30 September 2023 were 47.2 pence, slightly higher than 46.5 pence at 31 December 2022. The increase resulted from higher profits, along with a reduction in the number of shares following the share buyback programme, announced in February 2023, partly offset by a negative market impact on the pensions accounting surplus, combined with distributions. Tangible net assets per share were 1.5 pence higher than at 30 June 2023 given the higher profits, the reduction in the number of shares and movements in the cash flow hedge reserve, partly offset by pensions surplus changes and distributions. The share buyback programme in respect of 2022 completed on 25 August 2023, with c.4.4 billion (c.7 per cent) ordinary shares repurchased.
Balance sheet
Loans and advances to customers fell by £2.8 billion in the first nine months of 2023 to £452.1 billion, as a result of the exit of £2.5 billion of legacy Retail mortgage loans (including £2.1 billion in the closed mortgage book) during the first quarter. Excluding this, loans and advances to customers were broadly stable, with £3.7 billion growth in other Retail lending (principally unsecured and the European retail business) as well as £1.3 billion growth in Corporate and Institutional Banking lending. This was offset by a net reduction of £0.9 billion in the open mortgage book, £1.4 billion in the closed mortgage book and a £3.5 billion reduction in Small and Medium Businesses, largely from repayment of government-backed lending. During the third quarter, loans and advances to customers grew by £1.4 billion with increased balances in the open mortgage book, Retail unsecured and the European retail business and foreign exchange movements in Corporate and Institutional Banking.
Customer deposits at £470.3 billion decreased by £5.0 billion (1.0 per cent) since the end of 2022. This includes decreases in Retail current account balances of £9.4 billion as a result of tax payments, higher spend and a more competitive savings market, including the Group’s own savings offers. In Retail savings and Wealth, balances have increased by a combined £5.2 billion, partly from transfers from the Group’s current account customer base. Commercial Banking deposits were stable during the first nine months of 2023, albeit with some move towards higher rate paying accounts. The trend of deposit mix change in a higher rate environment was evident again in the third quarter and is likely to continue in both Retail and Commercial Banking. Overall, customer deposits in the third quarter increased by £0.5 billion, predominantly from flows into Retail savings, from both Retail current accounts and new customers.
The Group has a large, high quality liquid asset portfolio held mainly in cash and government bonds, with all assets hedged for interest rate risk. The Group’s liquid assets continue to significantly exceed regulatory requirements and internal risk appetite, with a stable and strong liquidity coverage ratio of 142 per cent (31 December 2022: 144 per cent) and a strong net stable funding ratio of 130 per cent (31 December 2022: 130 per cent). The loan to deposit ratio of 96 per cent, stable on 2022, continues to reflect robust funding and liquidity and the potential for lending growth.
Capital
The Group’s CET1 capital ratio at 30 September 2023 was 14.6 per cent (31 December 2022: 14.1 per cent pro forma). Capital generation before regulatory headwinds during the first nine months was 165 basis points (54 basis points in the third quarter), primarily reflecting strong banking build, partially offset by risk-weighted asset increases (before CRD IV model changes) and the full year payment (£800 million) of fixed pension deficit contributions made to the Group’s three main defined benefit pension schemes. Regulatory headwinds of 36 basis points largely reflect an adjustment for part of the anticipated impact of CRD IV model updates. These are not yet finalised. They also reflect the end of IFRS 9 static transitional relief and the reduction in the transitional factor applied to IFRS 9 dynamic relief. Capital generation after the impact of these headwinds was 129 basis points. The impact of the interim ordinary dividend paid and the foreseeable ordinary dividend accrual equated to 65 basis points. The acquisition of Tusker utilised 21 basis points of capital.
The Group continues to expect 2023 capital generation to be c.175 basis points after in-year regulatory headwinds (comprising CRD IV and transitional headwinds).
REVIEW OF PERFORMANCE (continued)
Risk-weighted assets have increased by £6.8 billion during the first nine months of the year to £217.7 billion at 30 September 2023 (31 December 2022: £210.9 billion). This includes the adjustment noted above for CRD IV model updates. Excluding this, lending and market risk increases, a modest uplift from credit and model calibrations and other movements, were partly offset by capital efficient securitisation and other optimisation activity. The CRD IV model updates reflect a further iteration of model development. The models remain subject to further development and final approval by the PRA. On that basis final impacts remain uncertain and further increases are likely to be required. The Group’s risk-weighted assets guidance remains unchanged at between £220 billion and £225 billion at the end of 2024.
In July 2023 the Group’s countercyclical capital buffer (CCyB) rate increased to around 1.8 per cent (from 0.9 per cent) in total following the increase in the UK CCyB rate to 2 per cent (from 1 per cent). As a result, the Group’s regulatory CET1 capital requirement is now around 12 per cent. 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.
Pensions
Lloyds Banking Group has substantially agreed the triennial valuation as at 31 December 2022 for the Group’s three main defined benefit pension schemes with the Trustee. After allowing for the fixed contribution of £800 million in the first half of 2023, there is a residual aggregate deficit of £250 million. The Group has agreed to pay off this deficit by the end of March 2024. Thereafter there will be no further contributions, fixed or variable, for this triennial period.
