Lloyds Banking Group's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.13.14 | About: Lloyds Banking (LYG)

Lloyds Banking Group (NYSE:LYG)

2013 Earnings Call

February 13, 2014 4:30 am ET

Executives

António Mota de Sousa Horta-Osório - Group Chief Executive and Executive Director

Mark George Culmer - Group Finance Director and Executive Director

Mark Fisher - Director of Group Operations

Charles King - Director of Investor Relations

Juan Colombás - Chief Risk Officer and Executive Director

Analysts

Chintan Joshi - Nomura Securities Co. Ltd., Research Division

Arturo de Frias Marques - Grupo Santander, Research Division

Chris Manners - Morgan Stanley, Research Division

Sandy Chen - Cenkos Securities plc., Research Division

Jonathan Pierce - Exane BNP Paribas, Research Division

Rohith Chandra-Rajan - Barclays Capital, Research Division

Claire Kane - RBC Capital Markets, LLC, Research Division

Joseph Dickerson - Espirito Santo Investment Bank, Research Division

Ian Gordon - Investec Securities (NASDAQ:UK), Research Division

Andrew P. Coombs - Citigroup Inc, Research Division

Michael Trippitt - Numis Securities Ltd., Research Division

António Mota de Sousa Horta-Osório

Thank you for joining us for 2013 full year results presentation. George will shortly present the financial results in detail, and Mark will then provide an update on our Simplification program. I will start with key strategic and financial highlights in 2013. And then later, I will come back to provide an overview of the trends we are seeing in the general economy and specifically, in the banking sector, together with how we are preparing to grow, taking advantage of our repositioning and of the recovery in the U.K.

We continued to make a substantial progress on the delivery of our strategy to create a customer-focused, low-risk, highly efficient U.K. retail and commercial bank and have now returned core lending to growth in all divisions. We have delivered many elements significantly ahead of our plan, and this has resulted in a substantial improvement in our financial performance, with our group underlying profits more than doubling in 2013.

We continue to reduce risk with our non-core assets portfolio reduced by around GBP 35 billion in the year in a capital-accretive way, releasing approximately GBP 2.6 billion. Our total non-core assets now stands at GBP 63.5 billion, GBP 130 billion lower than 3 years ago, having met our strategic review targets more than 18 months ahead of plan. We've continued to intensify our focus on our U.K. customers and further reduce our international presence, including the sales of our Australian and Spanish retail businesses. We have now exited or announced the exit from 21 countries since June 2011, and this means that we will be in just 9 countries, achieving our target of operating in 10 countries or less, again, ahead of plan.

And we further strengthened our funding position with a GBP 32 billion reduction in wholesale funding and driving the money market funding with maturity of less than a year to a low of GBP 21 billion, around GBP 75 billion lower than 3 years ago. This is why I said during the year that the reshaping and strengthening pillars of the June 11 strategy are basically completed, and we will now focus mainly on the simplification and investing pillars in order to grow and take advantage of the U.K. economic recovery.

Our business is highly capital generative, and our fully loaded core Tier 1 ratio increased 2.2 percentage points in the year from 8.1% to 10.3%, a very strong performance given the additional legacy charges we have taken in the year. I was disappointed that we had to take these additional legacy charges, which were higher than we had anticipated, especially in relation to PPI. But we were also disappointed about the conduct and the incentive legacy issues more broadly.

I would like to emphasize strongly that we remain totally committed to resolving these issues in the right way for our customers. Of these provisions, GBP 3.1 billion related to PPI, of which GBP 1.8 billion was taken in the fourth quarter, as you will hear from George later. Nevertheless, the substantial progress we have made in the year allowed the U.K. government to begin to return the group to full private ownership in September. This strong performance and the confidence we have in the future of the group means that we expect to apply to the PRA in the second half of the year to restart dividend payments, as you saw last week. I will come back to this later.

Turning now to an overview of our financial performance. We delivered significant improvements in profitability and returns this year, driven by progress on all the key lines of the income statement. The income performance was supported by core loan growth and by the substantial expansion in margin to 2.12%. This is slightly ahead of the guidance we gave at the third quarter, mainly thanks to better-than-expected deposits margin trends in the fourth quarter.

We reduced costs by 5%, driven primarily by the further simplification of the business, with continued investments in our core businesses and non-core reductions. Impairments fell by 47%, supported by continued good asset quality in the core and by the further reduction of non-core assets. As a result, profits increased both in the group and in our core business, with group underlying profit more than doubling to GBP 6.2 billion and core profits increasing 24% to GBP 7.6 billion. And this improved profitability meant that despite additional legacy charges, we delivered a statutory profit before tax of GBP 415 million for the year. And increased profits, together with the reduction in non-core RWAs meant that the group return on risk-weighted assets more than doubled to 2.14% while the core return reached 3.26%.

Turning now to the balance sheet. We continue to strengthen and derisk the balance sheet, enabling us to return core lending to growth in a falling market, matched by efficient growth in deposits through our multi-brand strategy. And we made further progress at the group level, with a group loan-to-deposit ratio reduced by a further 8 percentage points to 113%, reflecting the GBP 35 billion reduction in the non-core asset portfolio. And as I have already mentioned, we substantially strengthened our capital position with a fully loaded core Tier 1 ratio increasing to 10.3%. This uplift has been driven by capital generation to core business, including an important contribution from our insurance business, as well as the management actions we took during the year to reshape our business portfolio and reduce non-core assets in a capital-accretive manner.

In acknowledgment of the significant progress we have made in improving the group's capitalization and transforming its financial profile, Standard & Poor's upgraded our standalone rating to BBB+ in December 2013 and affirmed Lloyd's Bank long-term rating credit (sic) [credit rating] at A. And with our credit default swap trading at the lowest level of any U.K. bank, the market is already presuming further upgrades. We've continued to focus on our multi-brand strategy with differentiated offerings to our customers, and our progress is evident in the strong growth in our retail relationship brands, which grew by 6% in 2013, ahead of the U.K. market, which only increased by 4%. The more expensive non-relationship deposits decreased, and this had a positive effect on our margin.

Within our Commercial Banking division, deposits grew strongly in the year with a 13% increase, reflecting growth across all segments. This reflects growth in high-quality deposits I credit to the strength of our customer franchise. Overall, we saw continued deposit growth, despite the low base rate environment, in line with the markets, and while maintaining our core loan-to-deposit ratio at 100%.

Now let me turn to the broader trends we are seeing in our markets and our business. I have said many times that a strong economy requires a strong banking sector; in the same way, a strong banking sector requires a healthy economy. As a consequence, we have a special responsibility to support sustainable economic recovery. Lloyds is the U.K.'s largest retail and commercial bank. Therefore, our future and the prosperity of the U.K. economic recovery are inextricably linked.

In 2013, we continued to deliver on our pledge to help Britain prosper. We were the first bank to access the Funding for Lending Scheme and are its largest participant, having committed over GBP 37 billion of gross new lending. We remain committed to passing on the benefits of this program to our customers and have also continued to support U.K. manufacturing by committing over GBP 1.3 billion of lending by September 2013, significantly ahead of our targets.

The support we are giving to our U.K. customers and the U.K. economy is further evidenced by the growth of our core loan book this year. We have grown core loans and advances by GBP 12 billion or around 3% against a market that has fallen by 1%. We expect to continue to grow in 2014, with special emphasis on the SME sector, where we have grown, on average, by 4% in each of the past 3 years in a falling market. In 2013, we supported around 120,000 business startups and have accelerated our net lending growth to SMEs to 6% compared to a market that has declined by 3%.

For our retail customers, we returned our core loan book to growth in the year, and we expect to continue to grow our core mortgage book in 2014, consistent with the stronger market. We have also increased our lending commitment to new-to-market buyers and helped 1 in 4 to buy their first home. During 2013, we invested around GBP 10 billion, helping more than 80,000 customers get on the property ladder, substantially above our 60,000 target. And our target for 2014 is to help more than 80,000 first-time buyers again.

The growth we are seeing is being supported by the increase in investments in our core franchise to meet the changing needs of our customers. Our strategic cash investment spend in the year, enabled by our Simplification program, totaled approximately GBP 600 million. Simplification has now delivered run rate savings totaling around GBP 1.5 billion to date, which will enable the GBP 2 billion investments we targeted in the strategic review for the periods through -- until the end of 2014. This investment is supporting significant improvements in customer products and services and building growth opportunities for the future.

As a consequence, we have seen a further reduction in customer complaints of around 20% compared to last year, and they are down by more than 50% compared to 2010 levels and less than half those of our major banking peers. With group complaint levels at 1 per 1,000 accounts, we have the lowest complaint level of any major U.K. bank and expect to maintain our industry-leading position, with Halifax now being the leader among all major banks and building societies, as Mark will detail later. Similarly, we are seeing strong progress in the customer satisfaction scores across all branded channels, with Net Promoter Scores for the group increasing 11% over the year and by more than 40% since 2010.

And with that, let me now hand over to George for a more detailed look at our financial performance.

Mark George Culmer

Thank you, António, and good morning, everyone. Beginning with the P&L on Slide 9. As you heard, we've made significant progress on our strategy, and this is reflected in the group's financial performance.

Underlying profitability has more than doubled to GBP 6.2 billion, with profits in our core business improving by GBP 1.5 billion to GBP 7.6 billion while the loss from the non-core reduced by more than half to GBP 1.4 billion. Underlying income of GBP 18.8 billion was up 2% and in line with prior year, excluding SJP, with a stronger contribution from net interest income offsetting a reduction in other income.

Cost reduced 5% to GBP 9.6 billion, in line with our guidance, while impairments fell 47% to GBP 3 billion, with a GBP 2.3 billion reduction in non-core and an GBP 0.4 billion reduction in core. Overall, the group made a statutory profit before tax of GBP 415 million compared with a GBP 606 million loss in 2012, mainly driven by the significant improvement in underlying performance.

Looking at the core underlying performance by division. Retail had a strong year, with underlying profit up 17%, driven by 5% growth in net interest income and 11% growth -- improvement in impairments. The growth in net interest income was driven by a 15-basis-point improvement in margin due primarily to lower liability pricing and the return to growth of the core loan book in the third quarter. Improvement in credit quality reflects a reduction of almost GBP 1 billion in impaired loans, and Retail's AQR is now just 33 basis points compared to 37 in 2012.

Commercial also had a strong year. The focus on disciplined pricing, franchise growth and risk selection driving balance sheet growth, improved profitability and RWA reduction resulted in a 38-basis-point increase in returns on RWAs to 1.74%. Core income grew 5%, led by 9% growth in net interest income, with a 31-basis-point improvement in margin, a 7% increase in core lending and a 13% growth in deposits. Core impairments were down 40%, reflecting improved credit quality and AQR of 39 basis points compared to 67 last year.

Wealth, Asset Finance and International also delivered a strong performance, with underlying profit up 38% to GBP 632 million and returns up 160 basis points to 6.67%. This performance was driven by income growth of 2%, with core loan growth and a significant improvement in the margin led by the repricing of our online deposit business. Costs reduced by 8% as a result of Simplification savings, the disposal of SJP and the optimization of our direct channel customer services in Wealth.

Finally, Insurance has continued to perform well, with underlying profit stable at GBP 1.1 billion and an improved return on equity, which increased to 13%. Income fell 2%, reflecting runoff of our legacy creditor book and changes in intergroup commission, partly offset by an increased contribution from life and pensions. This fall in income was offset by a 6% reduction in costs, driven by the significant synergies achieved from the closer integration of Insurance within the group. And this robust performance enabled Insurance to pay GBP 2.2 billion of dividends to the group during the year while remaining very well capitalized.

Looking briefly at net interest income. Core net interest income grew by 8% to GBP 10.6 billion, and total net interest income by 5% to GBP 10.9 billion, driven by an improved margin and the core loan growth in all divisions. The group net interest margin for the full year was 2.12%, slightly ahead of guidance, due to a strong performance in Q4 of 2.29%, with continued improvement in deposit margins and resilient trend in asset pricing. In 2014, excluding the impact of the TSB disposal, we expect the full year net interest margin to be broadly stable at around the Q4 2013 level. With NIM now in our target range and core lending returned to growth, going forward, the focus is very much on growing overall net interest income.

Moving on to other income. With current economic conditions and regulatory environment, other income remains challenging, and core other income, excluding SJP, was down some 2% on prior year at GBP 6.9 billion. This reflects reductions across most divisions, but includes resilient performances in Insurance and Commercial. The Insurance income was bolstered by strong corporate pensions performance offset by reduced bancassurance volumes and changes to intergroup commissions. In Commercial, other income was up 2% in spite of tough trading conditions, reflecting the successful execution of our strategy, which is led by a strong performance in LDC. Across the group, we expect conditions to remain challenging in 2014, and the outlook for other income will remain subdued over the short term. 2013's results also included some GBP 1.1 billion of income from disposals announced over the course of the year.

Moving to asset quality. We've once again seen a further substantial reduction in impairment charge and a significantly improved asset quality ratio, reflecting the benefits of further non-core reductions and robust credit quality in the core book. Core impairments in the second half were GBP 614 million, making GBP 1.5 billion for the year as a whole a reduction of around GBP 400 million on prior year, mainly due to strong performances from Retail and Commercial. Non-core impairments reduced 61% or GBP 2.3 billion, led by reductions in Commercial, again, and in the Irish businesses.

The group AQR was 45 basis points for the second half and 57 basis points for the full year, bringing us inside our 2014 target range of 50 to 60 basis points a year ahead of expectations. These ratios reflect the accelerated rundown of our non-core and the strong credit quality of our core book, but also benefited in the second half from write-backs and provision releases in Commercial, as well as improved collections in Retail. For 2014, we now expect the group's asset quality ratio to be around 50 basis points.

In terms of impaired loans and coverage, our core [ph] loan portfolio also continues to improve. Impaired loans now stand at 6.3% of total loans, a reduction of 2.3 percentage points over the course of the year. And our coverage ratio is 50% for the group, up from 48% at the end of 2012, with non-core coverage strengthened by 4 percentage points to 55%.

Looking now at movement from underlying to statutory profit after tax.

Asset sales in 2013 totaled GBP 100 million, with a gain on sale of government securities in the early part of the year more than offsetting the losses from the disposal of non-core assets. The prior year comparative of GBP 2.5 billion includes some GBP 3.2 billion of gains on government bond sales compared to GBP 0.8 billion in 2013. Volatile items totaled GBP 380 million, with positive insurance volatility more than offset by banking volatility and fair value unwind. The movement on prior year primarily relates to that fair value unwind, which was a GBP 650 million benefit in 2012 compared to a GBP 228 million charge in 2013, and we'd expect this to continue to be a charge in 2014.

Simplification and Verde costs totaled GBP 1.5 billion. And within this, Simplification was GBP 830 million, bringing costs incurred to date to GBP 1.7 billion, with delivered run rate savings of GBP 1.5 billion. I said at Q3 that we expected further Simplification spend of around GBP 600 million in 2014. We have, however, now identified additional opportunities and are increasing our run rate savings at the end of 2014 target from GBP 1.9 billion to GBP 2 billion. And the cost of delivering this will increase the 2014 P&L charge to around GBP 0.7 billion.

On Verde, we've made good progress in 2013, with TSB launch in September and now operating as a standalone business within the group. The costs associated with building TSB were GBP 0.7 billion for the year, bringing total build costs incurred to date to GBP 1.5 billion. In 2014, we will incur the last tranche of build costs of a couple of GBP 100 million while the dual running and transaction costs will add around a further GBP 150 million, assuming a midyear IPO and deconsolidation.

Legacy charges totaled GBP 3.5 billion and included GBP 3.1 billion for PPI. In Q4, we also provided GBP 130 million in respect of SME interest rate hedging products and GBP 200 million relating to a range of ongoing regulatory matters across Retail, Commercial and WAFI. Finally, the tax charge of GBP 1.2 billion is unusually high due primarily to the write-off of deferred tax assets from the reduction in the U.K. corporate tax rate and our exit from Australia. We expect the effective tax rate from 2014 onwards, prior to any policyholder tax movements, to be in the range of 20% to 25%.

Turning briefly to PPI. As announced earlier this month, in Q4, we increased our PPI provision by GBP 1.8 billion. This increase was mainly driven by an increase in our expectation of future complaints and costs, changes in our assumptions on uphold and response rates to proactive mailings and our expectation on remediation costs. Since the start of the PPI redress program in 2011, we have now contacted, settled or provided for around 40% of all policies sold since 2000, comprising both customer-initiated complaints and actual and expected proactive mailings undertaken by the group. For customer-initiated complaints, volumes continued to fall, and the monthly average run rate in Q4 of approximately 37,000 is around 70% below its peak, having declined in each of the last 6 quarters. And Q4 was 24% down on Q3 2013 and 56% lower than Q4 2012. On our proactive mailings, these mailings target higher-risk customers and are expected to be substantially complete by the end of the first half of 2014.

Turning then to the balance sheet. As you've already heard from António, the shape and strength of the balance sheet continued to improve over the course of the year. Over the last 12 months, we've generated some GBP 57 billion of funds, led by GBP 35 billion reduction in non-core assets and deposit growth of GBP 16 billion. These funds supported the GBP 12 billion growth in core lending and the GBP 32 billion reduction in our wholesale funding, as well as a repayment of our LTRO funding of GBP 11 billion earlier in the year.

The reduction in non-core assets was also the primary driver in the fall of the RWAs. And total RWAs now stand at GBP 264 billion, down 15% or almost GBP 50 billion in the year. On non-core, the portfolio now stands at GBP 64 billion and comprises GBP 39 billion of retail and GBP 25 billion of non-retail assets. We continue to reduce the portfolio in a capital-accretive way, and the GBP 35 billion reduction in assets during the year has contributed to the release of GBP 2.6 billion of capital. We also continue to see the reduction of risk outstrip the fall in assets, and the 47% fall in RWAs is well ahead of the 35% fall in assets.

Given the progress we have made, we will now cease core and non-core reporting and report at total group level, which includes a small runoff portfolio, which we will continue to show separately. This runoff portfolio will comprise the GBP 25 billion of non-retail assets, as well as our Irish and Asian mortgage books and totaled GBP 33 billion at the 2013 year-end. We anticipate that, over the course of 2014, this portfolio will reduce by approximately GBP 10 billion to around GBP 23 billion.

As the remainder of the old non-core, Black Horse, which is a strong competitor in motor loan finance, with a good brand and improved profitability, will become part of the new Consumer Finance division. Also within Consumer Finance will be our Dutch mortgage book, which continues to perform resiliently. Our closed U.K. specialist mortgage book will return to Retail, because while self-serve mortgages remain outside risk appetite, the customer relationships remain core.

Finally, on the group's capital position, as you know, we've made significant progress in 2013. Our core Tier 1 ratio under prevailing rules now stands at 14% while our fully loaded CET1 ratio is now 10.3%, up 2.2 percentage points in the year. This progress has been achieved in spite of additional legacy costs and adverse pension fund movements. These negatives are more than offset by strong capital generation in the core business, management actions, including the sale of SJP and SWIP, the upstreaming of GBP 2.2 billion of capital from Insurance and GBP 2.6 billion from the capital-accretive non-core reductions. Going forward, we will continue to be strongly capital generative. Prior to any dividends, we expect to generate fully loaded CET1 capital of around 2.5 percentage points over the next 2 years and thereafter, 1.5 to 2 percentage points per annum.

That concludes my review. And I would now like to hand over to Mark.

Mark Fisher

Thank you, George. Good morning. I'd like to give you a brief update on the progress on Simplification and our costs. At the year-end, our costs stood at GBP 9.6 billion, in line with guidance, and a 5% reduction on 2012. Overall, total group costs in 2013 reduced by GBP 489 million, mainly driven by in-year Simplification savings of GBP 599 million. In addition, the effect of disposals, such St. James’s Place, further reduced costs by GBP 164 million, with these savings were offset partially by pay and inflation increases of GBP 155 million. Within the GBP 119 million other category is net of reduced non-core costs; increased regulatory costs, including bank levy, anti-money laundering costs, defined benefit pension costs; some core business growth; and some smaller one-off items.

Looking at the Simplification savings at the end of 2013. We were slightly ahead of targets, with an annual run rate of GBP 1.45 billion, an increase of GBP 610 million in 2013, which followed an increase of GBP 605 million in the previous year. As we enter the final year of the program, we now expect to achieve run rate savings at the end of 2014 of GBP 2 billion. This higher exit run rate comes from initiatives that deliver relatively late in the year, so the 2014 in-year benefit is marginal.

Moving to the chart at the bottom of the slide. You can see that total group costs are now 13% lower than at the start of the program. We have beaten the GBP 10 billion cost target we set out in 2011, a full year ahead of the original plan. We continue to forecast total costs of GBP 9 billion in 2014, excluding TSB. This will give us a full GBP 2 billion real reduction in the cost base by the end of the program. The Simplification program is the major driver of this outcome, but it is also down [ph] to strong cost management and more recently, the impact of disposals. This is a real reduction after we've covered the inflationary and regulatory cost increases and with continuing reinvestment in our core business of up to 1/3 of the Simplification savings.

Behind that [ph] line numbers, we continue to make strong progress in simplifying the group. Through our sourcing initiatives, since the start of Simplification, we have delivered GBP 464 million of run rate savings, which is about 14% of the non-labor cost base. We have also further reduced our supplier base to just below 9,100, and that represents approximately a 50% reduction since the start of the program. And you may recall at the half-year results, we're now targeting a figure of 8,500 suppliers by the end of 2014. During 2013, we also made significant progress in reducing the number of legal entities, which are now down to less 1,000, a reduction of over 40% since the beginning of the program, including 37 from the sale of St. James's Place, but achieving our strategic review targets of 1,000 a year ahead of schedule.

As I previously highlighted, Simplification is about improving service, as well as reducing costs. It is central to our strategy of becoming the best bank for customers by making a wide range of improvements to the customer experience. As we enter the final year of the program, we have now delivered over 300 improvements, with a mix of heavy-lifting IT initiatives and a range of smaller but equally important enhancements.

In the digital world, our strong online growth continues, with an increase in net new Internet banking users of over 750,000 in the last 12 months. We have over 4 million mobile banking users, and at the end of last year, we started to see mobile banking log-ons exceed those from the desktops for the first time. It's worth remembering that we had no mobile offering at all at the start of Simplification. In addition to day-to-day transactions, online purchases are also increasing. The 24/7 digital availability is a great advantage for our customers, and this was highlighted in the tax year-end of 2013, where 6,000 ISAs were completed online by customers in the 4 hours leading up to midnight at the end of the tax year.

We have continued to automate and simplify our key customer processes. For example, reducing the time taken for our fixed-term deposit maturities by 85%, improving ISA transfer times and reducing the time taken to settle insurance claims, obviously, particularly relevant at present. In the branch network in 2013, Simplification has removed over 1 million hours of work, giving colleagues more time to spend with customers on value-adding activity. The effectiveness of our operations grows further as we deploy e-based solutions, allowing us to move work within and between our multiskilled sites more easily, increasing the ability to load-balance and to resource volumes.

As you heard from António earlier, customer experience improvements are being reflecting in falling complaint levels and increased customer advocacy. Our FCA report of our banking complaints, excluding PPI, are now down to 1 per 1,000 accounts, 18 months ahead of the original target. And that target has now been revised to 0.9 per 1,000 accounts by the end of 2014. At the brand level, at the end of 2013, Halifax stood at 0.8 complaints per 1,000, Lloyds at 1.1 and the Bank of Scotland at 0.9, all very significantly below other mainstream banks by their most recent scores. As a group, we have the lowest complaint level of any major U.K. bank, and we expect to maintain this industry-leading position.

The net promoter customer advocacy scores continue their open [ph] trend in all 3 brands, now up 1/3 since the start of Simplification.

To summarize, the program continues to deliver on all its objectives. We're now in the final year, but of course, there's still much to do. But we have already achieved a number of the targets we set ourselves at the outset. We are increasing again some of those targets, and we'll keep going, delivering the program, maintaining cost control and improving service to our customers.

Thank you. I'll now hand back to António.

António Mota de Sousa Horta-Osório

Thank you, Mark. Now let me provide you with an update of our business model and how we are investing for growth in the business going forward.

Our strengthening performance is supported by a simple and focused business model, which gives us clear competitive advantages. Our focus on the U.K. where we now have more than 95% of our assets means we are concentrated in a AAA-rated country and also don't have the complexities, the capital trapping or the costs and risks of multiple jurisdictions.

Similarly, our retail and commercial specialization means we don't have the exposure to or increased risk ratings from volatile investment banking activities. At the same time, we have significantly reduced risk by lowering financial leverage, successfully reducing noncore assets and building capital strength. And we are targeting to improve further our leading cost position through the delivery of our Simplification program, which significantly improves our operating leverage. This results in a much lower risk business model with a unique competitive position, which in turn delivers a low cost of equity, and as we saw in 2013, a much lower cost of debt.

In a world where higher capital requirements are the norm, having a lower cost of equity is fundamental in helping deliver competitive advantage and strong and sustainable economic returns for our shareholders. And this puts us in a very strong position as the U.K. economic recovery gathers momentum.

We are seeing clear signs of U.K. economic recovery. The headwinds of household deleveraging, extreme downside risks associated with the eurozone and the government's fiscal consolidation all lessened in 2013. And this has helped to boost consumer and business confidence. Bank of England and government policies like Funding for Lending and Help to Buy were also key to this, in my opinion. And this momentum is being reflected in U.K. economic growth forecasts, which are moving upwards with the latest consensus now on GDP growth in 2014 at 2.7%. And you will have seen yesterday, the Bank of England are now expecting 3.4% growth in 2014. However, risks remain, and we continue to prudently assume that it will take some time for the economy to fully normalize. And therefore, we expect base rates to remain low, longer than the market anticipates despite the recent faster-than-expected reduction in unemployment levels.

As regards to the housing markets, U.K. house prices are increasing, and this is no longer confined to the London area. We are seeing recovery across the country with the Help to Buy scheme supporting better trends in the regions, which have been depressed for some time. As a result, we have seen the number of mortgages approved each month increase.

Halifax has been the largest participant in this scheme to date. And 80% of our mortgages have been approved outside London and the Southeast. Also, the average loan value is less than GBP 150,000, which confirms the data showing that the majority of mortgage lending through Help to Buy is being allocated throughout the country. We are, therefore, seeing this scheme as increasing confidence in the economy and liquidity in the housing market as well as increasing the volume of mortgages available. Moreover, it is supporting the wider U.K. economy through increased activity in the construction sector, one of the main drivers of employment in the United Kingdom.

The next phase of our journey, now that we have substantially finished the reshaping and strengthening of the bank is to grow, taking advantage of the economic recovery and of the reorganization of the business achieved over the past 2.5 years. Going forward, digital technologies will increasingly be a key development area across all our brands. And that's why I have reorganized the bank, making digital a group-wide function reporting directly to me.

In September, we have relaunched the Lloyds Bank brand, building on its 250-year heritage of serving the British public and also brought TSB back to the high street as a new challenger brand. Our multi-brand strategy is supporting efficient and segmented growth in both loans and deposits, as I have already mentioned. And looking ahead, I expect that we will continue to deliver positive mortgage lending growth consistent with the stronger markets and growing areas where we are underrepresented, such as consumer lending, both through the Retail and the consumer finance divisions.

In Commercial Banking, we are continuing to focus on the SME and mid-market businesses, part of our core positioning. We expect to continue to grow lending in this sector, capitalizing on our momentum in SMEs over the last 3 years. We have followed this with growth in the mid-corporate sector in 2013 and increasing our share of wallet of global corporates, driving a significant increase in the core return or RWAs in the division to 1.74%, in line with our target of reaching more than 2% in 2015.

Within insurance, we are supporting our customers to protect for today and to secure it for the future. And we will continue to grow in annuities and general insurance going forward. We have some 17% of the FTSE 350 companies using Scottish Widows for their corporate pension arrangements. And we have been active with many of them over the past year, helping them and their employees make the transition to auto enrollment.

Last month, we also relaunched our Scottish Widows brands, bringing protection and retirement planning to the forefront of our customers' minds and demonstrating our continued commitment to be a leader in the life planning and retirement markets.

Following the reduction in our International footprint, the Wealth, Asset Finance and International division will change its scope and responsibility. The Wealth business will transfer to Retail to sharpen our focus on delivering value-added wealth services to eligible retail customers, while the Asset Finance business will be the foundation of a newly created Consumer Finance division, which will also include our consumer and corporate credit card businesses. Bringing Asset Finance and cards together will increase our focus on growth opportunities in Consumer Finance, continuing our good momentum in asset-backed lending, and with the aim of growing our market presence in credit cards.

The substantial progress we have made to date, our improved financial performance and capital position and the confidence we have in our prospects supports the dividend policy we announced last week.

Following completion of our discussions with the PRA, they have now confirmed that they will treat our applications to make dividend payments in line with the normal procedures for other banks. We therefore expect to apply to the PRA in the second half of the year to recommence dividend payments starting at a modest level. Thereafter, our aim is to have a progressive dividend policy with the aim of moving over the medium term to a dividend payout ratio of at least 50% of sustainable earnings.

In summary, we have continued to execute strongly on our strategy and to beat our announced targets. The reorganization and investments we are making in our franchise are increasingly benefiting our customers, while supporting the U.K. economic recovery. At the same time, we have substantially achieved our reshaping and strengthening strategic targets. And we'll now focus even more strongly on simplifying and investing for the future, building a U.K. retail and commercial bank with unique competitive advantages, a strongly capitalized low cost, low-risk business, which will increasingly take advantage of the U.K.'s economic recovery. I believe this differentiated business model is well positioned to deliver strong and sustainable returns above the cost of equity, which is already a reality in our core business.

Thank you. This concludes our presentation. We would now like to take any questions you may have.

Question-and-Answer Session

António Mota de Sousa Horta-Osório

Okay. Can we start here, please, sorry? Can we bring the microphone?

Chintan Joshi - Nomura Securities Co. Ltd., Research Division

Chintan Joshi from Nomura. I have 2 questions: one on capital and one on NII. On capital, you indicate a 2.5% capital generation over the next 2 years. I'm just trying to understand this. If I look at your current pace, I mean let's pick the midpoint between 1.5 and 2, which is quite close to the 2013 number. You get to about 3.5%, and you've got [indiscernible] coming up for sale. You've got some more noncore to run down. So I'm just trying to reconcile the 2.5% with the run rate that I can see coming over the next 2 years? And then I've got one more.

António Mota de Sousa Horta-Osório

Do you want to ask the second one?

Chintan Joshi - Nomura Securities Co. Ltd., Research Division

Second one is on Slide 12 where you give the breakdown of the deposit of the margin mix. If I look at your Q3 slide versus the Q4 disclosures, the deposit margin mix momentum has fallen quite a bit, but you've seen no asset repricing effects. But the problem I have there is I can't see what contribution we get from wholesale funding reductions in those 2 buckets. So if you could just break it out for us, kind of where is deposit repricing? Where is the asset repricing, and where is wholesale funding within that chart?

Mark George Culmer

Yes. I mean, on the second one, yes. Because at the moment, the way we do it actually, we blend the movements in wholesale funding into those numbers, as you say, into the assets and composite. And you're right. I'll get these numbers wrong. But I think the deposit uptick year-on-year was something like 28 basis points in Q3, it's up to sort of 32 now or something. You are seeing a slowing. And that plays into what we're seeing in terms of the overall guidance. And now what we are saying about in terms of direction of that NIM moving forward. Wholesale funding is coming down. How that bleeds through into those numbers is relatively slow because obviously, it depends upon the churn of that wholesale book. And as you say, we've not been overly active in terms of 2013. We'll not be overly active in terms of 2014. Thereafter, that pace will pick up. But seeing that wholesale, that reduced cost of funds come through is a massive positive to us, but it will just take time for that to bleed through into the numbers. But we can separate out and give you separately in terms of how that factors through into that wall [ph]. In terms of the first part, yes, in terms of capital progressions, I stand -- what you'll see over the next few years is a change in blend in terms of what's sort of contributing to that capital generation over the period as we move from balance-sheet-driven reduction events as we move forward to a much richer mix in terms of underlying profit dropping through into statutory profits driving capital forward. So it's quite hard to look at -- through the rear window and look at sort of historic capital build and try and project that forward. Because so what you've got historically, you've got a -- we will continue to run down the noncore, but you've got a slower pace of delivery. So example, 2013, we talked about reducing noncore by about that GBP 3.5 billion. In the slides I gave today, I talked about a GBP 10 billion, so you'll get a smaller contribution from that noncore. There's also been a big contribution from some of the business disposals, the Australia, the SWIPs, et cetera. We obviously did the RMBS earlier in the year as well. So some of the things, those that have happened, they will drop away as factors in terms of driving capital forward. What they will be replaced by is earnings that will come through -- or they'll push [ph] in 2014, and that will remain slightly messy because again, I was just going through my presentation. In 2014, you've got the sort of the last hurrah from the Simplification. We've got, as you mentioned, the Verde that's both the build and obviously, whatever gain or loss in terms of disposal. I will have a smaller amount from asset losses, given that slower rundown of the noncore. I will have a pickup in the fair value unwind. So the earnings contribution will stay relatively messy in '14, but all becoming much clearer in '15. But some of the things that have driven that capital generation previously in terms of things like, as I said, business disposals, much greater levels of noncore will fall away. So that was probably a relatively long answer and didn't do much help, but that's -- we're seeing a change in mix is the big message I want to give to you.

Chintan Joshi - Nomura Securities Co. Ltd., Research Division

We are looking at your underlying performance, contributes about 1.7% to core Tier 1 based on 2013 numbers. So if I just add that up, I get to a lot ahead. And even if I back out the GBP 350 million of one-offs you've guided, Verde sales should hopefully lead to a profit, not loss. So like it still doesn't get me to 2.5, so that's what I was trying to reconcile.

António Mota de Sousa Horta-Osório

Let me add one thing on your NIM question and wholesale funding, which is quite important, just to call your attention. As George was saying, the fact that our wholesale funding cost went substantially down will progressively have an impact as we are going to renew those wholesale issues as they mature. And I call your attention. I mean you can see when we should, et cetera, because our credit default swap, as I mentioned, is now at 75 basis points, the lowest of any U.K. bank. So the significant benefits we'll have in the future by renewing our wholesale funding needs, which will be less and less, will be very significant. Yes, please? Here, Arturo.

Arturo de Frias Marques - Grupo Santander, Research Division

It's Arturo de Frias from Santander. Two or 3 questions, please. One on this consumer finance unit, which is going to be one of the growth engines as you say. Can we have an idea of what is the profitability of that unit today? I mean you have given us the RoRWA of retail, the RoRWA of corporate -- or commercial. Can we now -- what is the RoRWA of consumer finance, just to have an idea of how accretive to ROE and not only to growth is going to be this unit? That's the first question. The second one is also on RoRWAs. It's on the RoRWA of commercial. You made some remarks at the end saying that you expect that RoRWA to improve to 2%, I think you said by 2015. But still if I tax [ph] that and you saw 12% or 13% core capital ratio. We are talking about a unit that is generating around 15% ROE, which obviously is good. It's well above the cost of equity, but it's substantially below the retail ROE and probably also the consumer finance ROE. Are you satisfied with this commercial ROE? You think it will kind of still improve, and how can it improve, why it's relatively low versus others, is probably one question from several angles. That's it. No, these are the 2.

Charles King

George will take first...

Mark George Culmer

As you said, as we move into 2014, obviously, we've got the reorganizations in terms of -- as António talked about. Obviously, we'll cease the noncore reporting, but there's a runoff. Our intent is to get out pretty quickly pro formas, so you can do precisely as you say. So you can see actually the new organization in that structure. And I'm not sure what the precise timing it is, but we will endeavor get out it there -- I'll look at Charles, very speedy. I don't see why we can't do it in the next few weeks. But we will get out the cut of 2013 in that new structure, so you'll be able to see precisely what you said. But yes, your instinct is right at the end. I mean consumer finance is a very healthily returning business.

António Mota de Sousa Horta-Osório

And relating to your more strategic question about the Consumer Finance division, and I'll go to the commercial as well. I am very positive on this newly created consumer finance division because if you look at Lloyds as a whole and our concentration in the U.K., we have a 25% market share in current accounts x Tier 3. But we only have a market share of around 16% in consumer lending, both through car financing and through personal loans. And in credit cards, we are also around half the market share that we have in current accounts. So we have the contact with the customer, but we have a very strong opportunity of growing our relationship with the customers as we have, for example, and I mentioned that before, in the insurance area. Number two, the Asset Finance division, which is the core part now of the Consumer Finance division, performs, as you saw from George's presentation, very well last year. We have completely revamped what we were doing in terms of keeping the focus on Lex Autolease, which is now in great shape in terms of car fleet financing. And we are now bringing back Black Horse, which was on the noncore side and was also completely restructured, now has return on equity substantially above the cost of equity and the growing market share back to that division in terms of serving the retail sector. And we have growing projects, for example, of coordinating the knowledge we have in the retail division about the current accounts behavior of the customer with our point-of-sale approach when a customer goes to a dealer and asks for example, for a loan for a car, which we are in a unique position to be able to do given we have 25% of the current accounts you see. So we are very positive about this division. We have market shares, which are like half our market share in current accounts. So the growth prospect of economic dynamics are very positive here. On the commercial area, on the commercial division, I think the progress of having increase around 40 basis points the return on RWAs to 1.76% is very positive. The division behaves very well during the year because you have to have in mind that the markets were quite difficult in terms of debt capital markets, in terms of foreign exchange margins. Just to give you 2 examples. And the targets of at least 2.0% of return on RWAs for '15 is now quite close of the 1.76%. So I think the commercial division with a new focus on a customer approach and serving the customer needs, whatever they are, but focus on the customer, not on products, is being very well implemented in the division. And I think the track -- the economic track record is absolutely in line with what the division promised to investors in the investor way -- in the beginning of the year. It will meet the cost of capital, as you say, if it reaches the 2.0%. But I think the underlying and the trends are clearly positive.

Manners, you can go first, Manners.

Chris Manners - Morgan Stanley, Research Division

It's Chris Manners from Morgan Stanley here. So 3 questions if I may. Firstly, would you be able to maybe give us a bit more color on the loan growth by division, and how much core loan growth we might expect. I know that, that's something you've done in the past? Obviously, a strong GDP projections, and total quite positive impact from Help to Buy. Secondly, on the net interest margin, obviously, you printed 2.64% in the core NIM in the quarter. What's the reason that the group NIM can't trend towards the exit rate on the core net interest margin over time? And thirdly, core Tier 1, obviously x dividends, you're saying you're going to build to 12.5 and then build further past then. What do you think the sort of steady state core Tier 1 ratio for Lloyds should be, and what -- where would you be comfortable?

António Mota de Sousa Horta-Osório

Chris, I will take the first question. George will take the second and third. In terms of loan growth per division, so what you have seen throughout the year in quarter 4 was very much in line with what we said a year ago, i.e. we said we would grow mid corporates and large corporates starting on Q2, which we started in Q1 and then has grown sustainably. We said we would start growing retail mortgages in Q3 in line with the market, which we did in Q3 and Q4. And we said we would grow SMEs at at least the same pace as the previous year. We were growing 5% on a net basis until quarter 3. And we have accelerated this, as I said, to 6% in quarter 4 year-on-year, so 6% year-on-year. What can you expect for 2014? I think we've increased in the U.K. economic recovery. I think you can expect our good track record on SMEs to continue for the fourth year running. You can expect mid-corporates to also have positive net lending during the year. On large corporates, it will depend because as I was just saying, we serve them as a customer. And large corporates, as you know, have access to the capital markets, so we will do whatever they want. It depends on the debt-to-capital markets prices versus loan prices. That's -- for us, we don't target loan growth and large corporates. We target is a share of wallet of the customers to serve them as best as possible. And in the retail market, you should expect our mortgage market share to continue evolving in line with the market, so continue being the same. And I would expect the market growth, which according to the latest Bank of England numbers was around 0.7%, I think it will increase until by -- it should be 2% by the end of this year. We will continue to focus especially on first-time buyers as we have been doing. And finally, you should expect our other Consumer Finance activities so the car financing, credit cards and UPLs, as a whole, to start also turning positive and increasing as the economic recovery improves and as we have this refocus approach through the consumer finance division as well, so I hope this gives you a good base for the segments and growth.

Mark George Culmer

And on the second question, first, on NIM, obviously, we've guided to the sort of relatively flat stable in 2014. What's going on there? Well, a number of the factors that have drove -- have driven the improvement in the NIM over the course of this year will persist. So I've got things like the main benefits of being -- or main drivers of being things like liability pricing, the structural shift. What you'll see, though, is those a significantly reduced level of support from those positives. So on the liability pricing, we've been through the -- mostly in SIN Taxes [ph] book. I've got some of the term, which I may still get a benefit from, so that will be a benefit but a reduced level. In terms of the structural shift within the group, that morphed to the core book that you've sort alluded to. As I've already just sort of answered, the move to -- the reduction in noncore will be less in 2014 than it has in 2013. So you'll see -- whilst there will be a benefit, it will be less marked than it has been in 2013. Going the other way, and I know there hasn't been much shift in terms of the asset pricing, going to an earlier question. But we are seeing, it's tougher in terms of new business pricing whether it's on the mortgage, credit card, UPL-type front, so you are seeing asset headwinds come towards you. There's also our starts [ph] and linking back to what we said earlier and what António's been talking about. We want to be looking to increase volumes to grow the book, to target areas where we're under market share. So there's a sort of, a management action on this as well in terms of the volume margin type trade-offs. So that's the first bit. Your second question, obviously, a big question in terms of capital or capital ratios and expectations. Obviously, it's still a bit of a movable fee. Something -- we've had PS-7, 13 or whatever out there, which describes how the PRA are going to approach things. We still have a whole variety sways [ph] of stress tests that still lie ahead of us -- to be gotten through. I would have said, though, in terms of steady state, when I look at our bank and I look at our risk profile and I look at the other banks, I would have thought on the steady-state basis, I would have hoped that somewhere around 11% is a not unreasonable target.

António Mota de Sousa Horta-Osório

Just one thing, Chris, which I didn't tell you, but just to complement. In terms of markets, you know the numbers for the market this year, so SMEs, minus 3%; mid-corporates and large corporates, minus 4%. I would expect -- I told you about the retail market, but I forgot the corporate market. I would expect corporate loan markets in SMEs and mid-corporates to grow from minus 3% and minus 4% towards a positive number throughout the year in line with the U.K. economic recovery, so the market. So we'll continue to gain market share and grow above the market, but I am expecting the U.K. economic recovery, and I think credit is normally, as we discussed many times, a lagging indicator. I expect it to turn positive throughout the year progressively. And our story, as George said, will be more an NII story of growing volumes times NIM than just a NIM story. Magnus [ph], sorry, now to you.

Unknown Analyst

I have a couple of questions, please. Firstly, on NII, I noticed in the release that you talked about the repositioning of the hedge, meaning that you are protected against moves in interest rates. Should we interpret that as meaning you don't have as much sensitivity to a rise in interest rates? And I wondered if you could give us a new quantification of that? My second question is on the ECNs. Following the PRA's release in December, I wondered if you thought the ECNs still provide useful stress test capital for you?

António Mota de Sousa Horta-Osório

Let me just say one introduction and George will take you to the sensitivity and ECNs. Just to be very clear, I mean what we -- our position, as I said, is we are a low-risk bank focused in the U.K. retail and corporates. And so we are normally hedged in terms of our asset liability risk. That's our base position as we were 2 years ago. As I explained sometimes and we have discussed, you and I, in detail, what we thought as a team was that given the -- and plausible low level of interest rates at the certain point in time, as you know during 2012 and in the first quarter of 2013, we thought we should unwind that hedge, and therefore, become much more exposed to a rising interest rate environment than we would have been otherwise. Given that interest rates moved in line with what we thought, we have put back the hedge in place during 2013. So just to let you know that we went back to the position we had 1.5 years ago. And that's why, as George will tell you, the sensitivity is similar to what we said 2 years ago.

Mark George Culmer

You've answered it. As António said, it's an interaction between the level of hedge and also assumptions about how much gets passed through to sort of retail deposit holders. Our sort of presumption at the moment is for the first couple of increases, you won't see a material impact upon our numbers less than GBP 50 million. Once you get after that, for every 25 basis points, as it stands today, we'll be around about the GBP 100 million type level. So that's the -- which I think is relatively consistent to where it has been. In terms of ECNs, yes, as you say, currently yes, they do count. So they count within our stress test that we currently carry out on for the PRA. In terms of go forward, the go forward is much less certain. As you know as well as I, with our DBA [ph], with things like that 5.5% floor. Obviously, we've got the 81s [ph] and the PRA's, 7% conversion level with CRD IV implemented and with capital 2 [ph] rules fixing. As we move forward, I think it is fair to say the continued regulatory compliance of those ECNs for stress test purposes is much less certain. I think that's all I would like to say on the matter.

António Mota de Sousa Horta-Osório

Please. Sorry, you have already -- sorry. Can you say your name?

Sandy Chen - Cenkos Securities plc., Research Division

Yes, Sandy Chen from Cenkos. Actually, I'd just like to carry on with Magnus' [ph] question on the structural hedge, if I may. And see it -- looking at Page 107 on the Reserves Note 23. I was just wondering, is there a link between that GBP 909 million negative movement in change in fair value of hedging derivatives and the movement in the caterpillar hedge as it relates to NIM? And could you talk us through that relationship? For example, as a swap curve steepens, does the reserve loss increase sort of as a counterpart supporting the NIM?

Mark George Culmer

It does relate to that. So it's basically the cash flow hedging. So, there's -- you're right. On that page, there's like GBP 909 million negative on that particular reserve, which does move around. And what that essentially represents is the mark-to-market on the structural hedge. Now that hedge is probably [ph] we have about a sort of 5-year life to that. That's the weighted average life. But what it does reflect is the sort of 30 basis points or so pickup in yields towards the end of last year, but that's what that relates to.

Sandy Chen - Cenkos Securities plc., Research Division

Right. So if that long end, for example, of the yield curve and the swap curve begins to steepen unexpectedly, would we expect to see the sort of combination of a relatively healthy NIM, but on the reserves ticking ahead again?

Mark George Culmer

Well, it's around the shape of the structural hedge. And as I said, the way we govern it internally, we have a strict adherence in terms of what are the applicable funds in terms of non-interest bearing liabilities, but also in terms of the duration of that hedge. As I say, we stick avidly to our 5 years. So that's where the predominant amount of that hedge, so it's actually much more susceptible to those sort of shorter ends.

António Mota de Sousa Horta-Osório

Yes, please. To your side, yes.

Jonathan Pierce - Exane BNP Paribas, Research Division

It's Jonathan Pierce from Exane. I've got 3 quick questions on capital and dividends. The first coming back to the target equity Tier 1 ratio, which you just said is 11%, could you tell us what are your Pillar 2A requirements is, please, like the other banks are starting to do?

António Mota de Sousa Horta-Osório

Give your all 3 questions, Jonathan.

Jonathan Pierce - Exane BNP Paribas, Research Division

I can do if you like. So pillar 2A is the first question. Second question in terms of your capital generation numbers in short- and medium-term, I'm assuming they are net of any RWA growth that you would expect. So can I just confirm that? And can you give us an idea of what RWA growth you're thinking about, both in the short-term and then post 2015? And then the third question is in terms of this up to 3% capital generation number post 2015, I mean, if I simply assume an RWA figure of approaching GBP 300 billion, that's suggesting a GBP 6 billion surplus capital generation per year, which in the context of your earnings, suggests a payout ratio of much higher than 50%. Can I just get your thinking on that, please?

António Mota de Sousa Horta-Osório

Very simple questions, so I'll ask George answer.

Mark George Culmer

What was that again? Right. On the first one, on Pillar stuff, Pillar 2 disclosures, I mean as you're probably aware, the PRA is currently carrying out consultation on Pillar 2 framework, including the disclosure of Pillar 2. And so, no, we haven't disclosed today things like our ICG, [indiscernible] disclose things that are headwinds, et cetera, they're [ph] after things that are currently are privy to us and our regulator. And I think that is our preferred position, and we're going to follow what the developments with the PRA actually are and we'll let that our disclosures. So that's our stance in terms of things like Pillar 2, ICG, capital planning buffer, et cetera. So that's what we decided we're going to do as a bank. To your second bit, yes, it is net of RWA growth. I'm not going to give you a precise percentage in terms of what our RWA growth is. But I think if you link what António has said in terms of what we're looking for in terms of growth across the book, you could factor in what your own RWA growth assumptions might be. Then to your last bit, look, I'm not going to comment specifically on numbers. What I would make is give you a generic comment around this franchise works and we can to the right thing by our customers, we can do right thing by our stakeholders and make very good returns for our shareholders. That is the benefit of the unique focus that we've got on the U.K. on that Retail and commercial franchise. And as I've talked about at different places, what you get as you move out as my below the other line items drop away, as I finished the restructuring of the bank, that underlying profit flows through into statutory profits, drives the capital and drives the options and the opportunities for this bank. And that's the unique advantage and the unique competitive position that we've got. Juan, you want to add?

Juan Colombás

Yes, I want to add the impact of CRD IV that we have seen in other competitors, in our case, is going to be very small. So the number is around GBP 8 billion is our estimate for the impact of CRD IV -- of RWAs, and GBP 3 billion is in the corporate business and the rest is in the centers. So there is more.

Rohith Chandra-Rajan - Barclays Capital, Research Division

It's Rohith Chandra-Rajan at Barclays. A couple, if I could, please. First one on provisions, and particularly on the guidance for next year, so 50 basis points bottom end of the sort of normalized range that you've historically talked about. It looks cautious relative to where you're at in the second half of this year, so 45 basis points at the group level and less than 30 in the core business. I'm just wondering sort of -- about the reason for that caution, particularly given the point that we're at in a strengthening cycle? And why you wouldn't expect below normalized levels to continue? That's the first one. Second, just briefly on OOI, just to clarify George's guidance there, so start point of the continuing business, GBP 6.6 billion. I think you said subdued over the next few years. Should we read that as a continuation of the divisional performance that we've seen in 2013?

António Mota de Sousa Horta-Osório

No, we are a prudent bank, so Juan will answer to you in terms of provision guidance.

Juan Colombás

We [indiscernible] cautious. I take it as a compliment. But yes, we have been cautious. But the underlying trend of our portfolios is positive. As you can see, quarter-over-quarter in 2013, we expect these positive trends to continue. We have been cautious, simply because you should not take the Q4 probably as the reference for 2014, because as António -- as George has said in his presentation, there have been some one-offs both in the commercial with some write-backs and some releases of provisions and in the Retail book more relative with improvements in the collections activities. So -- but all in all, I would say that the positive, the trends of all the portfolios are very positive. The core book is performing very well, as we have been telling you in every presentation, we are very confident that the cost of credit in the coming years will be within the range that we have been telling you from 2010, 2011. And then I would be -- I mean 50 basis points is our reference. It could be taking us through the cycle kind of cost of credit for Lloyds Banking Group. So it will be above or below depending on the economic conditions of the economy.

Rohith Chandra-Rajan - Barclays Capital, Research Division

Can I just ask just on the 4Q. So there's some write-backs, as you say, in commercial and improved collections in Retail. Why given that the economy's improving, would you not expect to see some of that continue?

Juan Colombás

Well, we -- it could happen, but the write-backs happened when it happened -- when they happened. So in any case, some are [ph] write-backs that we have -- had been in the core book as well. We don't expect so many next year because they were some cases that have been with us for some time and the entries into [indiscernible] of the core book in the last quarters have been very low. And so we don't think the write-backs activities in the core book commercial will be recurrent.

António Mota de Sousa Horta-Osório

What we want to tell you is, I mean, 28 basis points quarter 4 in the core book. We don't want you to extrapolate it as a trend, because the trends are positive, but going from 42, which I think was what in quarter 3 to 28 was a big drop. The trend is downwards, but it is not a straight line. That's what we want to tell you. That we see all the portfolios performing better. Also on the commercial bank and the others as you saw, coverage has increased, which is also a good sign. And we are a prudent bank, and that's the way we'll continue to be in terms of DNA, in terms of risk management.

Mark George Culmer

ROI. Yes, we obviously quite deliberately showed the slide, which showed the impact of those business, which we disposed of during the course of the year. They tended to be rather ROI heavy. So I think we came down to about GBP 6.8 billion, as opposed to GBP 6.6 billion. You mentioned, we -- and I talked about subdued outlook for the short term. That was more sort of orientating around the sort of 2014; you said over the next few years. I wouldn't actually put that time scale on it. In 2014 you will see a continuation of some of the factors that have impacted us in 2013. There's been a consumer preference for NII. The evolving conduct agenda is something that I think has impacted things like productivity. You've seen product withdrawals either on a permanent basis, such as investment products or on a temporary basis things like package accounts, et cetera, so it has had an impact on that. Going the other way, the commercial bank in tough trading conditions put in a great performance, and we continue to invest behind that business, and there's still great opportunities in terms of franchise growth share of wallet intend [ph] we'd rather drive that forward, although the environment was still sustained pretty tough there at the moment. Within things like the insurance business, again António talked about our plans for things like the annuity type business, et cetera, which will offset some of the negatives, which we've seen on bancassurance, for example. So the comment that I gave was more orientated around the 2014 than the time period that you have given it and things will state [ph] up, but there are certainly initiatives and actions that are undertaken within the business and I think, thereafter, would drive that ROI growth forward.

António Mota de Sousa Horta-Osório

This is -- it's quite important part in terms of the commercial division and you know how the other banks have performed in terms of some of those product areas. The commercial division has had, as George said, very good performance in terms of market shares, customer, share of wallet development and preparation for the future. But as you saw, the markets move again in terms of margins and in terms of some of the projects and their volumes. So the good work being done in terms of clients' share of wallet, on one hand, and in terms of market shares like in debt capital markets, you don't see it in ROI this year, probably, this time in '14, because the adverse trends you are seeing in terms of margins in the market. But the underlying work is increasing market share and share of wallet in the commercial bank, as I had said previously, and I'm very confident about the trajectory going forward of commercial bank.

Sorry? [indiscernible]

Claire Kane - RBC Capital Markets, LLC, Research Division

It's Claire Kane from Royal Bank of Canada. I have 2 questions on capital and one on asset quality. Firstly, the 11% core tier 1 target, I know you don't want to give the Pillar 2 requirements, but can we deduce that the 100 basis points buffer over the 10% minimum for retailing French banks covers your Pillar 2? And my second question is on the capital generation. Can tell us what you're assuming for the DTA absorption? I think you have 1.9 percentage points coming through from that? And then finally, on asset quality, in Ireland, you saw net write-backs in their Retail book, and your commercial real estate provisions went down 80% H2 over H1. Can you talk us through the outlook for Ireland, please?

António Mota de Sousa Horta-Osório

George will take the first 2 and Juan will speak to you about Ireland.

Mark George Culmer

Yes. As I said, it's not the reasonable hurdle on a sort of steady state basis. 11% would be the number, and that would cover Pillar 1, Pillar 2. That would be my expectations of what the type of the number that you would have to carry, and that would be sufficient to cover capital planning buffers, ICGs, et cetera, et cetera. So that will be our expectation. In terms of DTA usage, again, I won't give a precise number. But again, as the bank returns to profitability, we do get quite a big kick here in terms of utilization, that is DTA's, so on -- I think that's why I give it at the moment GBP 500 million of a profit on current rules because we have about a 12, 13 basis points pickup, but on the fully loaded core tier 1 because of that DTA utilization, that converts into about 18, 19 basis points. And as the bank moves into that sustained profitability, which we will do this year and we will do with a vengeance the years thereafter, you do get a very rich mix in terms of utilizing those DTA's.

António Mota de Sousa Horta-Osório

You have to bear in mind, Claire, that the capital guidance we are giving is in our fully loaded core tier 1 ratio, which is not effective by the DTA's in terms of equities. So the guidance we are giving of capital generation is relating to our fully loaded capital ratio, which I think you were also asking on the DTA question. Right. Is that clear?

Claire Kane - RBC Capital Markets, LLC, Research Division

Yes, sorry. I thought the DTA unwind would benefit your fully loaded ratio?

Mark George Culmer

I mean, it helps, it makes those profits more valuable as we generate those, yes.

Juan Colombás

So in Ireland, you're right. So we have had some write-backs in the Retail portfolio because you know that we sold our portfolio of nonperforming loans in Ireland and that has produced some write-backs in -- which is good indication of the good level of provisions that we have in this Retail portfolio. What we have seen in Retail is -- if you discount the sale of nonperforming loans, the levels would have been flat in the year, so at 23%. And after the sale, we are going to be below 17%. And what we are seeing in Ireland is a positive trend in terms of house prices. So the market has been 6% up in '13. In Dublin, it has been more than 15% and the rest of Ireland is kind of 0. It's flat. So but you can see, clearly, house prices going up in Ireland, which is positive, on our nonperforming loans flat, if you discount the sale. In the commercial book, we continue with running [ph] down this portfolio. We are closed in Ireland for any type of business. And the good news in Ireland is that, in 2013, we have renewed the commercial book from GBP 5.5 billion to GBP 3.5 billion, so at this pace -- and we hope to continue with these reductions in the coming years. This is basically and the level of the impaired loans in the commercial book today is 88% and the level -- and we have increased the coverage in 2013 up to 72, I think, is the number. So I think we're in a -- most of what we have to do in terms of impairments we did last it last -- in the previous years.

Joseph Dickerson - Espirito Santo Investment Bank, Research Division

It's Joe Dickerson from Jefferies. I just have 2 quick questions. Firstly, if I look at your primary liquidity portfolio the government bond component has gone up to about GBP 43 billion from GBP 29 billion. Could you just give us a sense of the duration of the bond portfolio? My second question is, if I look at the ECNs, I mean you said going forward the regulatory compliance was less certain. I mean what would be -- if that was to be called, what would be the impact to NAV? Because I think there is about GBP 1.5 billion derivative asset associated with that. And would you look to replace the ECN with other types of securities to potentially mitigate a [indiscernible]?

Mark George Culmer

I mean, it all depends on price and all those sorts of things, I'm afraid I can't answer the particulars of your questions in terms of what might happen at certain places. It would depend upon the circumstance. I'm sorry, but I can't give you the particulars on that. On the gilt, the average duration of gilt is round about the 10-year type level.

Juan Colombás

But our average duration of our gilt is 5 years, okay.

António Mota de Sousa Horta-Osório

On the primary liquid portfolio, you also have to see that depending on base rates versus gilt levels and the asset swaps. We may change the mix between gilts and Bank of England deposits, right. So the number you quoted may be through the change of mix in terms of the relative yields of Bank of England deposits and then gilts, which we then do the asset swap. But our hedge has a 5-year average duration. Please?

Ian Gordon - Investec Securities (UK), Research Division

Ian Gordon from Investec. I want to ask you 2 questions, please. You referenced the 0.5% drag to capital from pensions in 2013. Looking to 2014, obviously, 4 months ago, you initiated consultation on curtailing final salary pension scheme benefits. Firstly, can you give me some help in understanding the incremental capital benefit, either within Pillar 2A or more generally? And then secondly just to fill in the spreadsheet when you initiated consultation, i.e., conservatively estimated your one-off gain at GBP 400 million, I'm my ballpark, correct or too low?

Mark George Culmer

Right, okay. I mean, pensions per se stays a relatively volatile number actually within the capital numbers. And so lot other questions we've had around capital and trying to project the pensions volatility is much a pain for us internally. So for example, it is something like every 20 basis points in discount rates gives you about GBP 1 billion swing factor. Now what we're doing within the pension scheme in a totality basis is derisking. And that's derisking in terms of asset composition, that's derisking in terms of our exposure to things like interest rate movements. We had a huge exercise going on which will reduce some of that volatility, as I've just talked about, and gives us benefits from the capital positions as well. To the capital and sort of P&L consequences of the actions being proposed, that action is still underway. And there are still consultation processes that are taking place within the company with regards to that. Is it the right thing to do? It's the right thing to do from a sort of risk management perspective in terms of managing the risk, the liabilities, the pensions liabilities, the GBP 30 billion or so that sits on our balance sheet. So it is undoubtedly the right thing for the company to be doing. The precise capital impact and the precise P&L impact is dependent upon what the members of that scheme decide to do and where those pension schemes are at any particular point. So whilst it will produce a benefit in terms of the scheme position, it will only count towards capital to the extent to which the capital scheme is currently in deficit, and that -- and it reduces that deficit. If a got a cap on a scheme that is currently in surplus, then add to that surplus, that does not count for capital add-on. So I can't give you a precise number. Similarly, which I'm going to frustrate you hugely here, is on the P&L side. It depends on the presumption of a successful vote, how many people actually stay within the scheme and how many people are opt out of the scheme, and that has an impact in terms of the P&Ls, the P&L consequence. What I will say to give you some -- you're right, it's a successful consultation period and a successful execution of what we think is the right thing to do in terms of the risk management within this business, would result in certainly a significant P&L plus and there would be some form of capital benefit, although it is very hard to quantify that at this moment in time.

António Mota de Sousa Horta-Osório

Let's take one or 2 more questions. Anymore questions? You please.

Andrew P. Coombs - Citigroup Inc, Research Division

It's Andrew Coombs from Citi. I think my number of questions have been answered. But perhaps a couple of strategy questions. Just firstly with regards to the consumer finance business. You mentioned your market share in credit cards is half that of the current accounts. If I could firstly ask why do you think that is so low and how do you go about rectifying that going forward? And second question with regards to Slide 26, you highlighted the benefit during your presentation of being entirely focused in AAA region without multiple jurisdictions. Osborne's on the record this morning as saying, if Scotland walks away from Britain, it walks away from the pound, so in the event of a yes vote discussion dependence, what would that mean for Bank of Scotland and then more broadly for Lloyds as well?

António Mota de Sousa Horta-Osório

Look, in terms of the credit card market share, the precise number that we have in terms of market share is 15% while our current account market share is 25%, and debt is only 60% of our client market share if you want, so around half, as I told you. The reason why I think it is so low, which is absolutely connected with the reason why we are setting up the consumer finance division is because as you know, credit cards are both sold through the relationship channels as they are sold as a product on a category alone strategy. And we were only participating on the first leg and we now through the consumer finance division are going to participate as well in the second leg, like through co-branded, white labels, different channels and that's where the opportunity lies. The fact that we have the contact with the customer, we know the behavior of the customer in order to offer them differentiated offerings that's according to their needs. And the fact that we were only participating through our Retail division on a relationship-based approach. We can also now explore the other channel, which is also very important, which is the non-relationship branded channel. In terms of our business model, I strongly believe that with the increased regulatory uncertainty and the non-convergence set [ph] of standards globally, the fact that you are in multiple jurisdictions increases your regulatory risk. So I think that's one of the key advantages of the strategy, which shows in June 2011 of simplifying the bank, not only in terms of reshaping but in terms of legal entities. We had more than 1,700 legal entities. We had an internal target, as Mark mentioned, of going to less than 1,000 by the end of 2014, which we reached at the end of last year. We have less than 1,000 legal entities, which is still a lot by the way, but almost half of what we had 3 years ago. We sold, for example, as you saw, our International private banking division. We exited 21 countries. So I think that decreases significantly our regulatory risk apart from the fact those units were small, and therefore, did not have the critical mass to have strong competitive positions to attract the proper talent, et cetera. And so that is an integral part of our low-risk business model, which I'm completely convinced will bring our cost of equity lower and lower as we go through the 5 points I mentioned to you in our presentation. And relating to Scotland, which is obviously a different point, we have a multi-brand strategy, as you know, so we are present in Scotland through the Bank of Scotland brand, and that's our differentiated approach. Lloyds is present in England and Whales; Bank of Scotland in Scotland; and Halifax is a challenger brand across the U.K., until now was not present in Scotland. And as we have announced in December, we are now expanding Halifax into Scotland where we have several customers that were using the brand through telephone and Internet. Relating to the Scottish votes, our position is very clear on that. We absolutely believe as a board that it is up to the Scottish people to decide about their future. And so if in September, there is a yes vote, and given that there will be 18 months between the vote, and in case it is positive, the implementation of separation, we believe we have enough time to then address the consequences and the actions we will have to take should the vote be yes. If -- is there anybody that hasn't asked a question yet. No, so we're to our second question then please. Second no, fourth. The third, the one you had forgotten, okay.

Arturo de Frias Marques - Grupo Santander, Research Division

Yes, it's Arturo de Frias Marques from Santander again. I thought somebody will ask this question. I would like to ask you about competition. Obviously, the economy's picking up, and every bank is also enjoying a lower funding cost. So I guess that means inevitably that we're going to have more pressure particularly on asset prices and you have already shown in one of your slides that there is a 6 basis points, I think, negative impact on the asset side on your margin. So the question is would you expect this to continue? Would you expect this probably to get worse, and in which products you think you are going to see more and more pressure from your competitors?

António Mota de Sousa Horta-Osório

Okay. Well, I think there are 2 main strategic points in relation to your question. The first one is our wholesale funding costs, which as we discussed, we are now at the 75% approximate CDS level, the lowest of any U.K. bank. So the market is anticipating further upgrades in terms of our position because we are now the lowest of any bank in the U.K. That will be quite positive as old maturities like the ones we issued in '10, '11 as they mature over time, and that is a point we covered before, and that is correct. And the second one is in terms of our customers' attitude in terms of loans and in terms of deposits. I think we have also a big competitive advantage here because of 2 reasons. The first one is that we have a multi-brand strategy and a multi-brand strategy is very appropriate in case of Lloyds because our client bases are very different. So the client base of Bank of Scotland in Scotland and Lloyds in England and Whales are very different from the Halifax customer base in terms of segmentation, attitudes, attributes that they value. And therefore, the fact that we are able to offer them segmented offerings integrating, as Mark explains every time we can hear, everything the client doesn't see enables us to have both segmented approach and lower costs from the integration of all back offices systems and single areas. I think that is a big advantage, especially in the low interest rates environment. As I showed you, for example, on what we did last year, all our tactical brands, like Birmingham Midshires, Scottish Widows bank that we use tactically, we have decreased their prices and have improved margin as a consequence. On the relationship brands, Halifax Bank of Scotland, Lloyds, we have increased above the market, and the overall was lower deposit costs because of the segmented preferences versus our strategy. So I think that is a big differentiated advantage. Nobody has it in the U.K. And I think that will continue, and especially relevant, as I just said, in a low-interest rate environment. The second competitive advantage we have is that we manage internally in terms of culture within the Retail division, within the Commercial division, but especially in the Retail where prices change as you know, every week. We manage prices as -- we manage this as -- what matters for us is not asset prices and deposit prices. What matters for us is the difference between the 2, so we manage these combined. We manage all the prices combined in terms of assets and liabilities. We manage them on a weekly basis, which I don't think anybody else does. And we do this at the highest levels of the organization. So this capability of doing this together, with all brands, which makes, I believe, our competitor reaction a bit difficult because they don't see the whole picture. We manage this on a combined basis, on a weekly time, in terms of decision and at the highest levels of the organization, it has produced sustainably good results as the ones I showed you. And my expectation, just to finish your point, for the next 2, 3 quarters, because we will always react to competitive in behaviors if they change, is that the competitive behavior will be very similar to what we have been seeing over the last 3, 4 quarters. And therefore, I foresee our margins to have a similar evolution to what has happened in the last quarter and that's why we gave the guidance that we gave in terms of NIM. Okay, a final question? Please?

Michael Trippitt - Numis Securities Ltd., Research Division

It's Mike Trippitt from Numis. I just wanted to ask you about capital and dividends. I mean we were under the impression, I think, towards the end of last year, there were discussions with the PRA about restarting dividends. And clearly, you've stated now that is -- you will have -- you will be able to reapply in the second half of this year. Macro feels better. Regulation feels a bit better. You've highlighted capital generation coming through. So is it right to conclude it's really PPI and the uncertainty around that, that has delayed a restart of the dividend or are there other factors? And what do you see as the risks in those discussions in the second half of 2014?

António Mota de Sousa Horta-Osório

Well, I will ask George as well to comment. But I just want to clarify that we don't see any delay. I mean, every time I spoke to you here, or that I have had the investor meetings, both George and I, we have always guided investors to the fact that we were very hopeful that we would be able to pay dividends for the results of '14. And we have had discussions with PRA because things they have to see, 18 months ago, there was a series of capital changes, which we wanted to be sure that we have well understood and cleared before we applied for dividends. So now that we are considered a normal bank, like any other bank, what the PRA told us and that was both constructive and positive discussions was, okay, you are clear, now you can apply for dividends like any other bank after you show the results and we will obviously respond to whatever you apply. But the conversations with the PRA went in line with what we were expecting. And we had never given the impression that we were thinking of paying dividends before the results of '14. So I want keep [ph] clear and you know, and investors we spoke to also know I have no [indiscernible] to have anything.

Mark George Culmer

I mean the discussions with PRA, which took place December, January, they were about the earnings direction of this business and what we could achieve, they were about clarifying things like PS-7, -13 et cetera what the requirements were. That formed the basis of the discussions. They weren't about PPI in '13 or whatever. It was where the franchise going and what the evolving regulatory requirements for the U.K. were. That was the basis of the discussions, I mean...

António Mota de Sousa Horta-Osório

I think it would be fair to add because I understand where your question comes from perfectly. But you have to bear in mind that as we started discussions in quarter 3, we did not have the full profitability of 2013, and in the same way in which we had an additional provision much bigger than we could expect in terms of PPI, as I said, in that same way, as you know, in quarter 4, we have beaten consensus on the underlying profit by more than GBP 500 million, which in quarter 3, we were completely unaware of. And at the same time, we finalized the year with GBP 35 billion of non-core reductions, again, much bigger than what we thought. Releasing GBP 2.6 billion of capital, which we have committed to, as you know, just to be capital accretive. And as the year progressed, we had no idea how we would finish the year, so you have to see the whole thing combined. So we are exactly on the stage where we thought we were, and we are very confident that we will apply for this in the second half of the year and are very confident about the capital generation prospects of the bank, and that we'll be a high-dividend-paying stock in the future as per our stated dividend policy.

Thank you very much for everybody. Thank you for coming. And we are available to speak more with you if you want on a one-to-one basis.

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