Aug 1, 2013
Operator
Thank you for standing by, and welcome to the Lloyds Banking Group 2013 Half-Year Results Fixed Income Conference Call. [Operator Instructions] Charles King and Richard Shrimpton will outline the key highlights of the 2013 Lloyds Banking Group half-year results, which will be followed by a question-and-answer session.
[Operator Instructions] Please note, this call is scheduled for 1 hour. Please be advised the conference is recorded today, Thursday, August 1, 2013.
I would now like to hand the conference over to Charles King. Please go ahead.
Charles King
Yes. Good afternoon, everyone, and thanks for joining us for the call.
I'm Charles King, I have been introduced, Head of Investor Relations. I'll start with an overview of the strong progress we've made on our strategy and on our financial performance and the guidance we've given in these half year results.
And then I'll hand it over to Richard, Richard Shrimpton. He's our Group Capital Markets Issuance Director, who will update you on the continued transformation of the balance sheet.
So in the first half of 2013, we further accelerated the delivery of the strategic plan we set out to you 2 years ago. The successful execution of our strategy is reflected in the financial performance that we've reported today.
Compared to the first half of last year, we delivered a substantial GBP 2 billion increase in underlying profit to almost GBP 3 billion, including a one-off gain of GBP 433 million from the sale of shares in St. James's Place.
Similarly, statutory profit increased by GBP 2.6 billion, turning a GBP 0.5 billion loss in the first half of 2012 into a profit of GBP 2.1 billion in the first half of this year. We've seen continued growth in core loans and advances in the second quarter, having return to growth in the first quarter of 2013, and that was ahead of expectations.
And this has resulted in GBP 3 billion of core loan growth across the half as a whole, and this is after a GBP 0.7 billion reduction following the disposal of our core International operations. On net interest margin, we saw further progress ahead of expectations again as it rose to 2.01%, driven by a substantial reductions in deposit costs and an improved funding mix.
We reduced group cost by 6%, as run rate savings from Simplification increased to over GBP 1.1 billion. Group impairments fell by 43%, and noncore impairments fell by 58%.
These significant reductions have primarily been driven by our progress in running off the noncore assets ahead of plan. And as a result of all of these dynamics, group returns increased substantially to 1.95% return on risk-weighted assets and core returns of 3.16% return on risk-weighted assets, and those remain significantly above our cost of equity.
So turning to the outlook for '13, we're on track to meet our existing targets for '13, and we're pleased to be able to upgrade the guidance in 3 key areas. The momentum of the group is strong, with the growth of core lending set to continue, while group margin is expected to improve to close to 2.10% for the year.
As guided in the first quarter results, we now expect total costs to be around GBP 9.6 billion in 2013, and that was GBP 200 million lower than previous guidance and around GBP 9.15 billion in 2014 assuming a half-year of costs from Verde. We now expect the noncore portfolio to be reduced to less than GBP 70 billion by the end of this year, and that's a year ahead of our previous guidance.
Within this, we expect there's be less than GBP 30 billion of non-retail assets by the end of 2013 and less than GBP 20 billion by the end of 2014. Following our full year 2013 results, we will cease separate reporting of the noncore portfolio, in line with our previous guidance for portfolio of this overall size and mix.
Simultaneously, the ongoing prudent management of risk will deliver a substantially lower impairment charge in 2013 as a whole. So this combination of accelerated de-risking and the group's improved financial performance means that we're now targeting a fully diluted core tier 1 ratio of above 10% by the end of this year and will now seek discussions with our regulator regarding the timetable and conditions for dividend payments.
And with that, I'll hand over to Richard, who will cover capital, funding and liquidity in more detail.
Richard Shrimpton
Thanks, Charles, and good afternoon, everyone. And I'd like to spend the 10 minutes or so on taking on the continued strong progress that we've made on the balance sheet.
I want to cover funding and capital actions in the first half of 2013, how this sits in the face of the continued regulatory change that we see and how the strength of that balance sheet positions us well as we adapt to these rules. So firstly, starting with funding and liquidity.
In the first half of 2013, we grew deposits by GBP 8 billion to GBP 431 billion, and reduced noncore assets by GBP 16 billion to GBP 83 billion ahead of plan. As Charles mentioned, we're on track to meet our newly revised targets, and overall business resulted in our core loan-to-deposit ratio of 100%, whilst for the overall group, it fell to 117% from 121% at the end of 2012.
These positive liquidity flows allowed us to execute further debt buybacks in the first half without any material changes to our liquidity buffers. In total, we canceled around GBP 9 billion of wholesale liabilities, in addition to the LTRO redemption of GBP 11 billion.
The overall impact of these actions are seen in our primarily liquidity remained broadly stable at GBP 87 billion, which represents about 2x -- 2.7x our money market funding and about 1.7x our wholesale funding with the maturity of less than 1 year. Secondly, liquidity increased by GBP 11 billion to GBP 128 billion, which means that our total liquid asset portfolio represents over 4x our wholesale funding with a maturity of less than 1 year.
In terms of issuance in the first half, our gross issuance was around GBP 2.5 billion, achieved from a combination of privately placed [indiscernible] and capital activities. This was significantly offset by maturities and the buybacks I've just talked about, resulting in wholesale funding reducing by GBP 13 billion in the first half or by 27% over the last 12 months to GBP 157 billion.
Wholesale funding with the maturity of less than 1 year now stands at 32%, reflecting the lower overall levels of wholesale funding, while short-term wholesale funding remained broadly stable at GBP 51 billion. Over the next 18 months, we're due to see around GBP 30 billion of term funding mature, pretty much evenly split across our 3 main term funding channels: ABS, covered bonds and senior unsecured, although predominantly skewed to euro and sterling.
But overall, there'll be little need to refinance this as it will be largely offset by the continuation of our noncore portfolio reduction. In that respect, as we look ahead to H2, issuance volumes are expected to be similar to the first half, I'll expect much of this will be achieved from private placement in both covered bonds and medium-term notes.
But at the same time, we're conscious that during the last few years, we built up a broad range of funding programs, some of which have not now been used for over 2 years, and these span across fixed, secured and unsecured platforms. Therefore, I wouldn't rule out access in these markets in modest size, if appropriate.
Overall, we'll continue to see further reductions in wholesale funding in 2014, mainly long-term liabilities, as we're broadly comfortable with our short-term money market balances. Looking ahead beyond 2014 to what we may call a steady-state volume, I'll expect from 2015 onwards that the combination of senior unsecured, public and private, covered bonds and ABS, to fill an annual funding need of around GBP 10 billion, materially less than the GBP 50 billion issued per annum during 2009 to 2011.
Therefore for funding, in summary, the combination of a solid deposit base, further reductions in noncore assets and the reduction in wholesale funding, complemented with a broad range of wholesale funding sources, provides us with a great deal of flexibility and optionality when it comes to funding the balance sheet. And that's especially relevant in relation to pricing and access to unsecured markets, which moves us onto capital.
It's obviously been a busy time with regard to capital, and I'll break it down into 3 areas as I talk through these for the next few minutes. But the first area for us will be the group's capital activities that we've undertaken recently.
Then, I'll look over the U.K. regulatory aspects.
And then, broaden this to what's going on Europe and how European regulatory changes affect the group. We continued to remain confident in our capital position and outlook.
Given our strongly capital generative core business, reductions in RWAs and capital accretive disposals, our fully loaded core tier 1 ratio now stands at 9.6%, up 156 -- sorry, up 150 basis points from the end of 2012. On current rules, our core tier 1 ratio improved to 13.7%, and our total capital ratio to 20.4%, already well in excess of the ICB's flat recommendations.
In terms of leverage ratio, the group's fully loaded tier 1 ratio increased to 4.2% from 3.8% at the end of 2012 and to 3.5% from 3.1% on a core tier 1 basis alone. Both of these ratios are well in excess of the Basel Committee's proposed minimum of 3%.
Also, as previously announced, we expect to meet the PRA's capital requirements without issuing equity or additional cocos. We already covered GBP 5.1 billion out of the GBP 7 billion requirement and remain confident in meeting this.
As Charles mentioned, given the progress we've made in the first half of 2013, we now expect a fully loaded core tier 1 ratio of about 10.1% by the end of '13, a year ahead of guidance. Also, during the first half, we continued to focus on optimizing the capital structure.
In May, we raised GBP 1.5 billion of capital from Scottish Widows, which funded a core of lower tier 2 notes issued by Clerical Medical and the cancellation of internal capital between the group and Scottish Widows. This contributed to the improved CRD IV total capital position and the group's rating agency-based equity ratios.
In addition to the Clerical Medical medical call, it was also pleasing in March to be able to call the first eligible banking group capital securities since 2009, a clear sign of the strong capital position the group now has. In addition to the PRA's capital review, we also await the final terms of the Banking Reform Bill, which is currently open to the consultation phase.
This bill covers ring-fencing and core activities, together with definition around primary loss-absorbing capacity, PLAC. In this respect, the previously mentioned, with total capital well in excess of the 17% suggested, the group is well positioned.
And finally, in the U.K., we welcome the recent draft tax legislation surrounding additional tier 1 securities. We think it's a very positive step forward in understanding how the bank's capital stock may look like in the future, although it still remains too early to be definitive on the precise components.
Away from the U.K. and moving into the European landscape.
Looking at European regulatory reform on capital, the 2 main developments saw the capital requirements directive and the resolution recovery directive. We're glad to have seen CRD IV finalized with expected implementation now in January 1, 2014.
But like many of you, we're also working through the final details being proposed by the EBA in that capacity through their Q&A website and but also trying to understand how these will be enforced in due course. We've also seen progress on the resolution recovery directive, which is expected to be finalized in H2, and among other things, focuses on bail-in and the recently introduced new acronym MREL, which is a required minimum eligible liabilities, which is analogous to total capital leverage ratio.
We expect to see the RRD scheduled for implementation between 2016 and 2018. During the crisis, Lloyds approach capital very conservative with respect to building our core tier 1 base.
We've also been very deliberate in preserving and strengthening total capital ratios. The introduction of bail-in, PLAC and MREL places the focus of capital, not just to core tier 1 where the group is now very strong, but also at total capital, which is the overall level of protection in place for senior unsecured creditors and depositors.
You'd expect logically that issuers and investors will both want to see this segregation that Lloyd is well positioned for. As we now move into the transitional phase of CRD IV, there's 3 primary changes affecting capital stack.
Many of you being familiar with this, but 1, certain eligible items will no longer become eligible, such as deferred tax assets; 2, deductions to total capital will shift in the stack and predominantly coming from total capital moving into common equity deductions; and finally, there'll be a gradual elimination of certain capital securities over this transitional phase. We've already addressed points 1 and 2, with our intention to have fully loaded core tier 1 up 10% by year end.
On the third point, the group's total capital ratio is now over 12% -- 20%, with over GBP 27 billion of debt capital only contributing GBP 19 billion to the capital base. The transition to CRD IV will reduce the volume of deductions, principally from the group's insurance operations, and this is expected to release a material proportion of Tier 1 and Tier 2 capital.
And this shift is a good thing, in that we have a fairly complicated capital structure. The combinations of legacy issuing entities and liability management has left us with over 130 capital securities, and it'd be great to simplify this over a couple of coming years.
We have no plans to do anything right now, and if anything, this may be a natural rundown. As I mentioned earlier, we still need to see and understand all of these regulatory changes before doing anything.
But in summary, the group's funding and liquidity positions have transformed beyond recognition since 2009. We have very measured wholesale funding needs.
We have a well-diversified product, currency and investor base, and we also have a capital structure that is anticipated and sits well-within new capital regulations. So that concludes what I was planning to say, and I think we've now like to open this up to questions and answers.
So we welcome anything that you may have to ask.
Operator
[Operator Instructions] Your first question comes from the line of Lee Street of Morgan Stanley.
Lee Street
I appreciate your comments, saying that there's lots of uncertainty about total capital ratios and what it might be, but onset 20.4% if you look relatively harder. I know some suggestions that will come down.
Can you give any guidance on what type of ratio in your mind you're thinking about would be the appropriate level to run Lloyds as you look ahead? And you also referenced a natural rundown.
Could you define what you mean by a natural rundown? Is it calling, just normal amortization?
Just any color there would be very helpful. Thank you.
Richard Shrimpton
Yes, I mean above 20s is high by European standards. I think the European average at the moment is just below 16%.
And I think we've seen some banks just give more specific guidance around future capital stack. We aren't quite there yet.
If I explained a few things here, I mean, we as I say, very deliberate in building total capital ratios. Overall, mine and the group's philosophy has been that it's easier to reduce capital than it is to build it up, and you have uncertainty around markets and future capital instruments.
And this provides us with a glide path of sort to transition and as well as the insurance benefits that I mentioned coming through this deductions, which is from net capital to core tier 1. And we don't have any specific plans.
And what we are waiting on is the PRA interpretation of CRD IV. They're due to consultation paper out in the near future.
And what we also want to understand as a group is to understand the relativity of the proportion of total capital you hold relative to pricing impact to senior unsecured deposits. And so overall, we want to get some -- we got plenty of flexibility to manage the capital base.
I think in terms of the reduction that I talked about, I mean, we have coming up over the next couple of years quite a significant amount of maturities from Tier 2 instruments, but also regulatory amortization coming through from bullet Tier 2 securities. And you, like us are obviously reading the EBA guidance they're putting out, which is, providing more color around the treatment of capital securities.
And so, it may not necessarily be a true calling, but it remains to be the recognition of that capital base will slowly unwind.
Lee Street
Okay. That make sense.
And one second one if I may. On the CNs, can you confirm or just give a bit of discussion around whether they still qualify for stress test capital for the regulator?
Richard Shrimpton
Of course, I mean, it depends on the severity of the stress test, but yes, under severe stress test, they still qualify for stress test capital. But fundamentally, I mean, I think with the core tier 1 ratio as high it is a trigger, under no definition I understand it's going to be a pretty severe stress that best case is, they still qualify as Tier 2 securities, and there's currently no expectation they wouldn't qualify under any of the CRD IV criteria.
Operator
Your next request comes from the line of Robert Smalley of UBS.
Robert Smalley
A couple of quick questions, and I'm referring to the half-year results around -- in the 90s because I want to talk about subordinated debt a little bit, picking up on some of your points and lease points. Bottom of the page, on 91.
Richard Shrimpton
Yes?
Robert Smalley
I'm looking at subordinated liabilities, the total at the half year, 35.3, up from 34.1. I guess from your remarks, that was primarily from private placements?
Charles King
No, that increase, that'll be the Scottish Widows we did in March. It was GBP 1.5 billion there, which offset some other capital measure activities that we did in the first half.
Those will be the element of the changes, there are currency adjustments as well.
Robert Smalley
Good. And reconciling this 35.3 to -- and now, I'm going over to Page 98, the 17.892?
Charles King
Yes?
Robert Smalley
How do I get from here to there?
Charles King
Sure. And well basically, you've got, I guess 3 aspects.
One is the balance sheet number. Then, there's the regulatory capital number and then there's the net capital number.
So looking at balance sheet, if you -- on Slide 91, we have GBP 34 billion of subordinated securities. So that spans Tier 1 and Tier 2.
And then from a regulatory capital perspective, these securities have a number of adjustments. So for instance, there will be a fair value adjustments in different carrying values that we have these on our books that approximately feed through the amount of the regulatory capital, that number is there is GBP 27 billion of regulatory capital.
So GBP 34 billion reduce it to GBP 27 billion with these various adjustments that go into your hybrid net Tier 1 and Tier 2 buckets. That number then further reduced from GBP 27 billion due predominantly to the GBP 11 billion of supervisory deductions we have stemming from our insurance businesses, sorry, not the GBP 11 billion, it's changed.
It's a little bit less than that, but it changes I mean the deductions coming through our insurance businesses, reflecting both the debt and the equity that have between the Banking Group and Scottish Widows.
Robert Smalley
Right. So that's what get us to the 17.9?
Richard Shrimpton
Yes.
Charles King
That insurance deduction will gradually shift towards equity during transition period of the CRD IV.
Robert Smalley
Okay. And that's what you're referring to on 102, as well on the comments, I guess?
Richard Shrimpton
Yes. It was about GBP 30 billion deduction or something like that.
Robert Smalley
Taking up on Lee's point, in terms of just leaving lower Tier 2 securities outstanding potentially as kind of junior funding, if they have low coupons, I know you mentioned the term, and this is something we've discussed, a simplification exercise. Could you speak to just the philosophy behind the idea of leaving lower Tier 2 securities that may not qualify as capital outstanding as funding?
Does that -- where does that stand versus trying to simplify the right side of your balance sheet?
Charles King
Very fair question. I think there is couple of things here.
Obviously, we've got a strong capital position. If we have in the first half as I mentioned, we've called a couple of capital securities, which is the first capital securities we called since 2009.
But obviously, and you get this, we can't tell you what we're going to do on capital securities in the future. I think very much the guidance I would steer you towards at the moment is a case-by-case approach.
But to your question, what are going to be the determinants of how we value calling or not calling capital securities and whether they would it ultimately contribute to regulatory capital, or as you say a junior form, will be I guess steered around finally understanding what the EBA proposals are stemming from CRD IV, and then ultimately how the PRA will interpret this and how they will implement the CRD IV package with regards to capital instruments. And then, we need to I guess understand what the debt from the cost is of new instruments and look at bonds on a case-by-case basis with regard to the back end cost versus the alternatives.
And then overlaying that with things like PLAC and MREL and trying to understand what value is of holding anything like that. So there's a lot of factors that will influence how we look at core policy in the future and how we treat these securities.
But it is still a bit too early to actually give too much guidance on how we would approach. I mean, suffice it to say, what we try to do over the last 3 or 4 years despite many occasions there has been relatively tight do the right thing.
Operator
Your next question comes from the line of James Hyde of Pramerica.
James Hyde
My question's relate more to Scottish Widows and to any further dividend upstreaming. And I was wondering, I mean, you've given the ITD surplus GBP 10 billion.
But I was wondering, can you tell us of about where you would be in terms of how comfortable should the rating agencies are with the level of capital? I mean, for instance, S&P's got a negative outlook on the whole Lloyds group and is there anything you can do with capital sort of at the level of Scottish Widows to prevent them downgrading?
And in general, are the current tendencies of Scottish Widows there? Do they change your assumptions of how much you're going to be dividending up?
Richard Shrimpton
Sure. I mean some of these questions we may need to take offline.
But I think, primarily, Scottish Widows is a separately run business with its own board and obviously regulatory oversight. It does, however, obviously, consider the upstreaming of dividends on a regular basis as part of its ordinary course of business.
I think that we, as a group, we are very cognizant of rating agencies, and we work very closely with the rating agencies in understanding any aspect of our business, how that may impact rating agencies reaction, and our into our thinking on several occasions over the past few years. We obviously can't comment about future dividend payments and Scottish Widows report on an annual basis, not semiannual basis so we can't give you too many specific updates in terms of the performance, and the current surplus sitting within the insurance division.
But as António mentioned on the equity call this morning, we do look at it, and ensure that there is a prudent level of capital in that company, and to ensure it satisfies a number of stakeholders, and obviously one of those stakeholders is rating agency management.
Operator
[Operator Instructions] You now have a question from the line of Gildas Surry of Citi.
Gildas Surry
Following up on your answer to lease question on the transition to add new format of capital. Can you just comment on your approach on the optionality you have in the valuation and distribution of some tier 1?
I'm thinking of [indiscernible] perhaps if you can, for example, reduce the coupon and make the tier 1 security tier 2 regarding to the terms and conditions of the bonds?
Richard Shrimpton
Sure. Sorry.
It's a really bad line. But if I heard, understood you correctly, you're saying, are there any tier 1 securities where we can modify the terms to make them manageable as Tier 2?
Gildas Surry
Yes, and the coupons down grade under the substitution and valuation clauses?
Richard Shrimpton
Yes, I mean, obviously, some of our bonds include elements such as substitution and variation. And it's -- it's basically a poor answer my friend, but I mean it falls into the camp we're still waiting on a few answers coming from the EBA and then understanding how the PRA would interpret it.
But obviously, something like that is one of the options that we have. It doesn't extend to many bonds if I recall rightly.
But yes, there's a handful of tier 1 securities that do have substitution variation clauses as long as it's not detrimental to investors in there, and we'll obviously need to take note of that.
Operator
[Operator Instructions] As there are no further questions at this time, that does conclude our conference for today. If you have any further questions, please e-mail or telephone Investor Relations.
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