Lloyds Banking Group Earnings Call INSIGHTS: Piecemeal Expectations, Regulatory Guidance

On Thursday, Lloyds Banking Group PLC ADR (NYSE:LYG) reported its second quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Piecemeal Expectations

Antonio Horta-Osorio – Group Chief Executive: Look, starting by the NIM, as I said at year end results, we expected NIM to go down this year by the same amount as last year and I said it should be concentrated on the first half and then flattening out. So we have exactly the same guidance both in terms of intensity and shape as we have and as you are seeing. How do I see things going further? Well, as I have said then as our core loan to deposit ratio reaches 100%, our wholesome funding costs will progressively decrease and given that we are offsetting the re-pricing of liabilities with the re-pricing of the loans, I believe we will see the name progressively ticking up and my expectation is this should happened by the end of Q1, so around March. You will see a flat name approximately through H2 as we had said the beginning of the year and given that we are now with the ratings outcome of Moody’s and also with different schemes to support growth and we now have access liquidity that as we told you we were holding because of the Moody’s review as an insurance that was costing us money, but we were expecting not to use like an insurance. We will now deploy that excess liquidity, the first of which employments was as George told you the buyback of senior unsecured loans by GBP4.6 billion. Therefore all these factors together lead me to expect that our name will turn up – tick up by around March next year given, I’m not an economist maybe I get it right. On our current loan book and following what I just told you, I expect – first I expect the U.K. economy, as I have told you many times to continue deleveraging, because we have as a country more credits versus GDP than we should. While I expect our mortgage book to continue ticking down a bit because we once as I told you before, to rebalance our market share from 26.5% in mortgages and 23.5% in savings to 25%, which is our natural market share post Verde and which will bring, as I told you, the core loan to deposit to a 100%. So I don’t expect a significance different behavior in the mortgage book over the second half, although I think we will reach what we want by H1 next year. I do expect SME gross lending, net lending to continue to increase. We are now at 4%, up from 3% last year and given the Funding for Lending Scheme and good dynamics that we have inside the Bank, I think we will continue increasing net lending positively in spite of a falling markets of 4%. By the way, we have 20% of that market. So it means the market is falling 6%, while we are increasing 4%, which is 10 percentage points difference, which is very significant. We now want to do two things. First, we want to increase our mid-corps net lending, building on the best practices we got in SMEs, and I think we will achieve that through the second half of the year. So by year end you should see our mid-corp segments to also turn net positive in terms of lending. Given the Funding for Lending Scheme, which we welcomed immediately as it came out and we thought it was the proper thing to do when I told you about the holistic solution of financial stability where we were better in capital supervision and ring-fencing increasing the credibility of recovery and resolution and therefore our liquidity was not, in my opinion, to be super equivalent as well. We are going to use the Funding for Lending Scheme especially to offset the disadvantage that we have in larger corporations, where our funding cost as I told you many times did not allow us to be competitive, not for credit standards, but because of funding costs and therefore we expect those efforts to reverse quickly because you know in larger corporations these things are more quicker, and therefore I think that all of these impacts combined show continued positive SME lending, mid-corps turning positive by December, larger corporations stop shrinking given the elimination of the cost (to its) advantage, and mortgages still decreasing until H1 next year. I think, again with the risk of not being an economist, I think our core book will start increasing by June next year.

Jitendra Shekar – Nomura: (Jitendra Shekar) Nomura. If I can follow-up to all your comments from the previous question, the Bank of England clearly expects that the U.K. banks will grow lending to the economy. From what I’m hearing from you, that’s probably not going to happen, at least until June next year. What kind of pressures would you expect from the regulator if being a large participant you are not able to deliver some stability in your U.K. lending as an aggregate number and whether you’d need to, I mean, react based on what regulatory pressures you may get on the back of that? My second question would be on asset quantity, you have stated that you expect lower impairments than before. Given the actual political outlook I would think that’s quite a brave guidance. You must be seeing something in your operations that gives you that confidence, if you could just elaborate on where some of the quarter-on-quarter half-and-half strengths are coming from?

Antonio Horta-Osorio – Group Chief Executive: Well, on your first question, I strongly disagree with what you said, because the purpose of the Bank of England’s scheme and the objective overall of the regulators in this shifts towards growth is expected to support two segments. First, small businesses which do not have access to other funding sources; and second, first-time buyers in the mortgage market. We are keeping a very strong focus on first-time buyers and although our market share in gross lending in mortgages is 18%, we kept a 25% market share in first-time buyers, where as I said we are giving one out the four new mortgage loans in the (other half). So we will continue the first-time buyer efforts and the reason why our mortgage book is decreasing is because people are repaying their loans, which is up to the customers to decide. On the small businesses, we are probably the only large bank that is increasing SME on a net basis and as I just answered to Chris we are 10% above the markets, so that is absolutely in line with what the economy needs. We are the largest bank in this country and therefore, as I said many times our future, end of the U.K. economy (indiscernible). On mid-corps, irrespective of the funding for any scheme, we are going as I said to replicate the best practices of SMEs and make it grow on net terms by December. So in terms of pre-scheme and after scheme, we will continue to contribute to SME net growth, we will turn positive in mid-corps and the only reason why our core book as a whole will not increase is because customers are repaying their mortgages which is their wishes. Large corporations is less relevant to the economy because as you know they have multiple funding sources. So I think we are absolutely in line with (indiscernible) objectives. We do not do it because of regulatory pressure, but we do it because we think, number one, it is a right thing for our shareholders and secondly, it is a right thing for the economy and again being the largest bank in this country what is right for the economy is right for Lloyds. In terms of the assets quality question, which you are absolutely right in asking, I strongly believe with the caveats I said before about economists that the number yesterday is incorrect and the reason is because everything we see in the bank, old trends in NPLs in all segments continue to trend better than we expected and falling as you saw in George’s presentation and I will ask Juan to comment and give you more color in a moment. Therefore I’m very confident that the economy will be around flat this year, as I said many times and will start recovering next year as CPI comes down given energy prices and some appreciation of the pounds, which will increase people’s disposable income to will allow them to spend a bit more. Nevertheless, I think as I always thought, this is going to be a long and difficult recovery as all debts recessions are – recovery from debt recessions are always long and when I was probably being accused of being too cautious 12 months ago and you are accusing me of being too optimistic and I’m basically saying the same thing. I think the fact absolutely substantiate what I’m telling you also unemployment is lower than people would have thought and is not compatible to yesterday’s numbers. So I think we can be a bit more optimistic than the move obvious to these numbers. Juan can you give some more color on these numbers?

Juan Colombas – CRO: Yes, just to comment on Antonio’s points. To give you some more color, I think if you look at the different portfolios all of them are performing much better, so it’s not asking the portfolio what is growing. The second thing I would say, I think it is very important in our Bank to separate the core from non-core and would recommend you to look at the numbers separating both portfolios and you will see that our position has always been that our core book is a good book and our non-core book is well provisioned. This is how we see the picture in Lloyds in terms of provisioning. The encouraging thing is that the core book – I mean you have seen the new team (per trend) across the whole Bank and all of them are improving as well, which is a very good indicator. (Indiscernible) impairments could be in coming months and a good thing is that in the core book, the level of impairments that we are having in the different portfolios are really good. So look at the quality of this book and we are very confident that the core book that we are building for Lloyds in the future is a very good one.

Regulatory Guidance

Ian Gordon – Investec: It’s Ian Gordon, Investec. Just one question, please. George, you referenced in your remarks the evolving regulatory guidance as the Bank of England that FSA seek to (reversal) for their policy in stakes over the last five years. Specifically, in relation to emerging FSA guidance in relation to liquidity buffers, can you help us with some quantification of the latitude this may give you? Obviously the tender offer which you referenced earlier gives us an indication of the direction of travel. I’m assuming that some of the benefit is wrapped into your margin guidance, but what we can’t yet see from the outside is what level of (differentiation FSI) may be giving you?

George Culmer – Group Finance Director: I’m sorry. We’re going to frustrate you today by not giving you a precise number. Part of that is because precise as you say this is actually evolving regulation. So there was a meeting this week, which didn’t shed too much light on what precisely that meant. So I can’t give you that precise number. Obviously, we do have flexibility in terms of the balance sheet structure, in terms of how we might deploy it to support some of our core lending activities. So I won’t be precise, but the big message is that that optionality is there through all the homework and endeavor of the last 18 months and puts us in a very good position, but sorry, I will not and I cannot give you what a precise pound shilling pence number that equates to.

Sandy Chen – Cenkos Securities: Sandy Chen from Cenkos Securities. I just have one question just going back to impairment, and related to the mortgage book. Looking at the U.K. mortgage book, 40% on a loan-to-value basis is still 80% LTV or above, 23% is still 90% LTV or above. Are your improved impairment assumptions based on relatively flat set of house prices over the next 12 months? Or are you factoring in say the 5% to 10%, 15% house price declines that some economists, as you say, are looking for? If that is – what’s going on in terms of that underlying dynamic (into the) impairment assumptions?

Antonio Horta-Osorio – Group Chief Executive: Well, I have my (indiscernible) first of all, so I cannot comment anything else about the economists, but our forecast in the Group is for reasonably flat house prices which we had – last year we had forecast minus 2%, which actually happened. This year we forecast reasonably flat house prices which are happening, and therefore we focus accordingly. As you saw and as Juan mentioned, the nonperforming loans are trending downwards. We thought in the beginning of the year they would trend slightly upwards as I think I said at that time. So that’s running better than we thought, and the house prices are behaving according to flat house prices. In spite of some predictions, they might fall a lot. I really don’t share that view because I think that in the U.K. as long as interest rates are very low, as you know there is no oversupply because of housing permits and therefore it is reasonable to consider reasonably flat prices and that’s what we consider. I mean we have to provision according to an expected view and not according to the extreme scenario. Of course, we know what would happen in extreme scenarios and we do not think that that would be, as we said sometimes in previous questions in other presentations, very, very significant impacts. But what we think is house price are going to be flat this year, it should continue to be flat for the next foreseeable future and we have been reasonably good in terms of our Chief Economist predictions in predicting house prices. So I’m quite confident about that. You want to add something?

Juan Colombas – CRO: (Indiscernible) on the mortgage book. So in the mortgage book I think you have to analyze it by vintages. So it is a combination of couple of years, three years of bad vintages. The important thing of the book is that these bad vintages ended in the middle of 2008, so they had been in our books for years now, and our expectation is that they are (indiscernible). So the rest of the vintages are of very good quality and you know that the average life of a mortgage for a (season) is four five years, so what we should expect, if the rest of the conditions remain stable that we should start to see an improvement in the (performance).

Cormac Leech – Liberum Capital: Cormac Leech, Liberum Capital. I just had two questions. One on the NIM. I think you guided that from first quarter of next, maybe we see the NIM for the Group start to tick up slightly. Are you making any assumptions about bank of England base rate changes in that forecast? In other words, if we for example saw 25 basis points cut in the Bank of England base rate, will that change the guidance for the Group? I just had a question on other operating income.

Antonio Horta-Osorio – Group Chief Executive: I’m assuming flat interest rates for the rest of our three-year plan, which is a reason why we said in November last year that our guidance in terms of income oriented targets would be delayed beyond ’14, but achievable over time because, 12 months ago the structure of the yield curve was positive as you know, market was expecting interest rate to start increasing six months ago. Now we are assuming interest rates gets 0.5% for throughout ’14 and it is on debt basis that I gave you my assumption. Of course, if there was a cut in interest rates, there would be an impact on NIM.