Lloyds Banking Group plc (LON:LLOY) has announced its Q1 2023 Interim Management Statement.
“The Group has delivered a solid financial performance in the first quarter of 2023, with strong net income and capital generation, alongside resilient observed asset quality.
The macroeconomic outlook remains uncertain. We know that this is challenging for many people. Our purpose driven strategy, alongside our financial strength, means we can continue to support our customers across the country, helping Britain prosper. We are also making good progress on our ambitious plans to transform the Group. Our experience over the last year reinforces our belief that continued strategic delivery will create a more sustainable business and deliver increased returns for our shareholders in the medium to longer-term.”
Charlie Nunn, Group Chief Executive
Robust business performance, supporting continued strong capital generation
• Statutory profit after tax of £1.6 billion (three months to 31 March 2022: £1.1 billion), with higher net income, partly offset by expected higher operating costs. Strong return on tangible equity of 19.1 per cent
• Net income of £4.7 billion, up 15 per cent, reflecting ongoing recovery and the higher rate environment
• Underlying net interest income up 20 per cent, primarily driven by a stronger banking net interest margin of 3.22 per cent in the three months to 31 March 2023, stable on the fourth quarter of 2022, and increased average interest-earning assets
• Other income of £1.3 billion, 6 per cent higher, reflecting continued recovery
• Operating costs of £2.2 billion, up 5 per cent compared to the prior year, based on higher planned strategic investment, cost of new businesses and inflationary effects. Low remediation charge of £19 million
• Underlying profit before impairment up 28 per cent to £2.5 billion, largely driven by strong net income growth
• Asset quality remains resilient and the portfolio is well-positioned in the context of cost of living pressures. Underlying impairment charge of £0.2 billion and asset quality ratio of 22 basis points continue to reflect robust observed credit trends
• Loans and advances to customers at £452.3 billion, down £2.6 billion in the first three months of 2023, including the £2.5 billion legacy mortgage portfolio exit, an additional reduction of £0.6 billion in the open mortgage book and repayments of government-backed lending in Commercial Banking, partly offset by growth in other Retail lending
• Customer deposits of £473.1 billion down £2.2 billion in the first three months of 2023, including a reduction in Retail current account balances of £3.5 billion, partly driven by seasonal customer outflows, including tax payments, higher spend and a more competitive market. This was partly offset by Commercial Banking deposit increases of £2.7 billion, including both targeted growth in Corporate and Institutional Banking and some short term placements
• Loan to deposit ratio of 96 per cent continues to provide robust funding and liquidity, alongside potential for growth
• Strong and stable liquid asset portfolio with all assets hedged for interest rate risk
• Strong capital generation of 52 basis points, based on positive banking performance. Includes the accelerated full year £800 million payment of fixed pension contributions for 2023
• CET1 ratio of 14.1 per cent, after 21 basis points for ordinary dividend accrual and 18 basis points for the Tusker acquisition, remaining ahead of the ongoing target of c.12.5 per cent, plus a management buffer of c.1 per cent
Financial guidance maintained, delivering higher, more sustainable returns
Based on our purpose driven strategy and business model, as well as our current macroeconomic assumptions, for 2023 Lloyds Banking Group continues to expect:
• Banking net interest margin to be greater than 305 basis points
• Operating costs to be c.£9.1 billion
• Asset quality ratio to be c.30 basis points
• Return on tangible equity to be c.13 per cent
• Capital generation to be c.175 basis points1
1 Excluding capital distributions. Inclusive of dividends received from the Insurance business.
REVIEW OF PERFORMANCEA
Robust business performance, supporting continued strong capital generation
The Group’s statutory profit before tax for the first three months of 2023 was £2,260 million, £716 million higher than the same period in 2022. Higher income, partly offset by higher operating expenses and the impact of an increased impairment charge, led to an improved result. Statutory profit after tax was £1,641 million (three months to 31 March 2022: £1,145 million).
The Group’s underlying profit was £2,220 million, compared to £1,745 million in the prior year. Growth in net income was partly offset by higher operating costs and an increased impairment charge. Underlying profit before impairment for the period was up 28 per cent to £2,463 million, as a result of strong net income growth.
Net income of £4,652 million was up 15 per cent on the prior year, with higher net interest income and other income, partially offset by a continued low, albeit increasing charge for operating lease depreciation.
Net interest income of £3,535 million was up 20 per cent on the prior year, driven by a stronger banking net interest margin of 3.22 per cent (three months to 31 March 2022: 2.68 per cent, three months to 31 December 2022: 3.22 per cent) and higher average interest-earning banking assets. Relative to the prior year, the net interest margin benefitted from UK Bank Rate increases and structural hedge earnings from the rising rate environment, partly offset by lower mortgage margins. Average interest-earning banking assets were up 1 per cent compared to the first three months of 2022 at £454.2 billion, supported by growth in the open mortgage book, Retail unsecured and the European retail business. The Group continues to expect the banking net interest margin for 2023 to be greater than 305 basis points.
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. As at 31 March 2023, the Group’s structural hedge had an approved capacity of £255 billion (31 December 2022: £255 billion). The nominal balance of the structural hedge was £255 billion at 31 March 2023 (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. The Group generated £0.8 billion of total gross income from structural hedge balances in the first three months of 2023, representing material growth over the prior year (three months to 31 March 2022: £0.6 billion).
REVIEW OF PERFORMANCE (continued)
Underlying other income of £1,257 million was 6 per cent higher compared to £1,182 million in the prior year. This reflected growth in Retail, Commercial Banking and Insurance, Pensions and Investments, partially offset by reduced income from the Group’s equity investment businesses. Retail other income was up 15 per cent on prior year, including improved Lex performance and increased credit card and current account activity, alongside a gain from the exit of legacy Retail mortgage loans. Commercial Banking other income was up 24 per cent versus the prior year, primarily reflecting improved trading conditions. Insurance, Pensions and Investments other income was 26 per cent higher than the prior year, through higher contractual service margin and risk adjustment releases to income from 2022 adjustments. The general insurance business contribution also increased, with benign weather in the first quarter of 2023 versus adverse weather experience in the comparative period of 2022. Other income from the Group’s equity investments businesses, including Lloyds Development Capital, was lower than the prior year, reflecting more normalised market conditions in the first quarter of 2023.
The Group delivered good organic growth in Insurance, Pensions and Investments and Wealth (reported within Retail) assets under administration (AuA), with combined £2 billion net new money in open book AuA over the period. In total, open book AuA currently stand at c.£165 billion.
Operating lease depreciation of £140 million increased by 49 per cent compared to the prior year, reflecting expected softening of used car prices and the impact of a recovering Lex fleet size.
Total costs of £2,189 million were 4 per cent higher than in the prior year, with increased operating costs of £2,170 million (up 5 per cent). This reflects higher planned strategic investment (expected to peak in 2023), new business costs and inflationary effects. The Group’s cost:income ratio for the first three months of 2023 was 47.1 per cent, compared to 52.3 per cent in the prior year. The Group maintains ongoing cost discipline, in part mitigating inflationary pressures. Consistent with guidance, operating costs are expected to be higher in 2023 at c.£9.1 billion (2022: £8.7 billion), given the Group’s planned strategic investment and inflationary effects, partially mitigated by continued cost efficiency.
In the first three months of 2023 the Group recognised remediation costs of £19 million in relation to pre-existing programmes (three months to 31 March 2022: £52 million). There have been no further charges relating to HBOS Reading since the year end 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 is engaging with the Financial Ombudsman Service in respect of historical motor commission arrangements. The remediation and financial impact, if any, is uncertain.
Asset quality remains resilient with impairment levels low. Due to the ongoing inflationary pressures on affordability, the Group has observed modest increases in levels of new to arrears in some portfolios and flows to default, although levels remain at or below pre-pandemic experience. Underlying impairment was a net charge of £243 million (three months to 31 March 2022: £177 million), resulting in an asset quality ratio of 22 basis points. This charge is after a £79 million multiple economic scenarios (MES) credit (three months to 31 March 2022: £27 million charge), as a result of the slightly improved economic outlook in the first quarter. This reflects a pre-updated MES charge of £322 million in the period (three months to 31 March 2022: £150 million, three months to 31 December 2022: £383 million), equivalent to an asset quality ratio of 28 basis points. The increase reflects the expected credit loss (ECL) allowance build from Stage 1 loans rolling forward into a more adverse economic outlook, as well as increased flows to default primarily driven by legacy UK mortgage portfolios and charges on existing Stage 3 clients in Commercial Banking.
Modest observed deterioration has translated to a small underlying net increase in Stage 3 balances within UK mortgages (when excluding the impact from the exit of £2.5 billion of legacy Retail mortgage loans). Unsecured flow to default rates are essentially flat. Stage 2 loans and advances to customers decreased to £60.9 billion (31 December 2022: £65.7 billion) largely as a result of the updated economic outlook, with 92 per cent of Stage 2 loans up to date (31 December 2022: 93 per cent). Stage 3 assets were £10.4 billion as at 31 March 2023 (31 December 2022: £10.8 billion). The Group continues to expect the asset quality ratio to be c.30 basis points in 2023.
Restructuring costs remain low at £12 million (three months to 31 March 2022: £24 million). Volatility and other items were a net gain of £52 million for the first three months of 2023 (three months to 31 March 2022: net loss of £177 million), comprising £92 million of positive market volatility and other statutory items, partly offset by £40 million relating to the amortisation of purchased intangibles and fair value unwind (three months to 31 March 2022: £57 million). Market volatility included positive banking volatility of £106 million. This compares to volatility losses during the first three months of 2022 of £120 million, largely resulting from negative insurance and banking contributions.
REVIEW OF PERFORMANCE (continued)
Tangible net assets per share as at the end of the quarter were 49.6 pence, up from 46.5 pence at 31 December 2022. This is as a result of accumulated profits, a reduction in shares from the ongoing ordinary share buyback, cash flow hedge reserve movements and pensions remeasurement.
The return on tangible equity for the first three months of 2023 was 19.1 per cent, reflecting the Group’s solid financial performance and positive market volatility in the first quarter (three months to 31 March 2022: 10.7 per cent). The Group continues to expect the return on tangible equity to be c.13 per cent in 2023. Earnings per share were 2.3 pence (three months to 31 March 2022: 1.4 pence).
The Group has commenced the share buyback programme announced in February 2023, with 0.8 billion shares repurchased as at 31 March 2023.
Balance sheet
Loans and advances to customers fell by £2.6 billion in the first three months of 2023 to £452.3 billion. This largely resulted from the exit of £2.5 billion of legacy Retail mortgage loans (including £2.1 billion in the closed mortgage book), an additional reduction of £0.6 billion in the open mortgage book and repayments of government-backed lending in Commercial Banking, partly offset by £1.2 billion growth in other Retail lending, principally unsecured.
Customer deposits at £473.1 billion decreased by £2.2 billion (0.5 per cent) since the end of 2022. The reduction in the first quarter included a decrease in Retail current account balances of £3.5 billion from seasonal customer outflows, including tax payments, higher spend and a more competitive market, including from UK Government National Savings and Investments offers and the Group’s own savings rates. This was partly offset by Commercial Banking deposit increases of £2.7 billion, including both targeted growth in Corporate and Institutional Banking and some short term placements which are expected to reverse in the second quarter. Retail savings increased slightly during the quarter, capturing some of the movements from elsewhere in the deposit base.
The Group has a strong and stable 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 strong and stable liquidity coverage ratio of 143 per cent (31 December 2022: 144 per cent) and a strong net stable funding ratio of 129 per cent (31 December 2022: 130 per cent) as at 31 March 2023.
Capital
The Group’s CET1 capital ratio at 31 March 2023 was 14.1 per cent (31 December 2022: 14.1 per cent pro forma). On 1 January 2023 IFRS 9 static transitional relief came to an end and the transitional factor applied to IFRS 9 dynamic relief reduced by a further 25 per cent, resulting in an overall reduction in capital of 15 basis points. Excluding this, capital generation during the first quarter amounted to 52 basis points, primarily reflecting strong banking build, partially offset by the accelerated full year payment (£800 million) of fixed pension deficit contributions made to the Group’s three main defined benefit pension schemes. As usual, this represented an efficient utilisation of capital generated in the first quarter, whilst not altering the total contributions to be paid for the year under the current agreement with the Trustee. The Group has accrued a foreseeable ordinary dividend of 21 basis points, based upon a pro-rated amount of the 2022 full year dividend. The Group continues to expect 2023 capital generation to be c.175 basis points.
As previously announced, on 21 February 2023 the Group acquired Tusker, which together with its subsidiaries operates a vehicle management and leasing business. Approximately 18 basis points of available capital has been utilised for the acquisition.
Risk-weighted assets have remained flat during the first quarter at £211 billion at 31 March 2023. This largely reflected capital efficient securitisation activity and other optimisation, in addition to a reduction in threshold risk-weighted assets, offset by the growth in Retail unsecured lending and other movements. CRD IV model changes reflecting the revised regulatory standards introduced in 2022 remain subject to approval by the PRA with the resultant risk-weighted asset outcome dependent upon this. Further clarification is expected later this year. The Group expects an increase in risk-weighted assets from this clarification, however the Group’s 2024 risk-weighted assets guidance, provided in February, remains unchanged.
The current sum of Lloyds Banking Group’s regulatory CET1 capital requirement and capital buffers remains at around 11 per cent. This is expected to increase to around 12 per cent from July 2023 due to the planned increase in the UK countercyclical capital buffer (CCyB) rate to 2 per cent, which will increase the Group’s CCyB rate to around 1.8 per cent in total. 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.
