Lloyds Banking Group Management Discusses 2013 Results - Fixed Income Call Transcript

Feb.13.14 | About: Lloyds Banking (LYG)

Lloyds Banking Group (NYSE:LYG)

2013 Fixed Income Call

February 13, 2014 9:00 am ET

Executives

Charles King - Director of Investor Relations

Andrei Magasiner

Analysts

Lee Street - Morgan Stanley, Research Division

Robert Smalley - UBS Investment Bank, Research Division

Corinne Cunningham - Autonomous Research LLP

Louise Pitt - Goldman Sachs Group Inc., Research Division

Jacqueline M. Ineke - Morgan Stanley, Research Division

James Hyde

Richard Thomas - BofA Merrill Lynch, Research Division

Christy Hajiloizou - Barclays Capital, Research Division

Operator

Thank you for standing by, and welcome to the Lloyds Banking Group 2013 Results Fixed Income Conference Call. [Operator Instructions] Charles King and Andrei Magasiner will outline the key highlights of the 2013 Lloyds Banking Group results, which will be followed by a question-and-answer session. [Operator Instructions] Please note this call is scheduled for 1 hour. I must advise you that this conference is being recorded today, Thursday, the 13th of February 2014.

And I would now like to turn the conference over to Charles King.

Charles King

Hello there, and good afternoon, everyone, in Europe and good morning in the U.S. Thanks for joining us for this fixed income investor call. I'm here with Andrei, as we've just heard.

First, what I'll do is I'll just briefly highlight -- recap on the highlights of the results that we announced today, and then Andrei will update us on the latest views on capital funding and liquidity. And I'll finish off with a quick summary and our guidance going forward just before we turn to Q&A.

So first, let's have a look at the 2013 highlights. And as you heard from António this morning, we continue to make substantial progress on the delivery of our strategy to create a customer-focused, low-risk, highly efficient U.K. Retail and Commercial Bank. We've now returned core lending to growth in all our divisions.

We've delivered many elements significantly ahead of 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 asset portfolio reduced by around GBP 35 billion in the year in a capital-accretive way, releasing approximately GBP 2.6 billion of capital. And we further strengthened our funding position, with a GBP 32 billion reduction in wholesale funding and driving our money market funding with a maturity of less than 1 year to a low of GBP 21 billion.

Our business is highly capital generative and -- as you'll hear from Andrei. And our pro forma fully loaded common equity Tier 1 ratio increased by 2.2 percentage points in the year from 8.1% to 10.3%, a very strong performance given the additional legacy charges totaling GBP 3.5 billion, which were mainly for PPI that we took in the year. 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, for those of you who saw that announcement.

So looking at an overview of our financial performance. We delivered significant improvements in profitability and returns this year, driven by progress on all key lines of the income statement. The increase in income of 2% to GBP 18.8 billion was supported by core loan growth and by the substantial expansion in margin to 2.12% from 1.93% last year. This is slightly ahead of the guidance we gave at the third quarter, mainly thanks to better-than-expected deposit margin trends in the fourth.

We reduced costs by 5%, to GBP 9.6 billion, driven primarily by the further simplification of the business, the continued investment in our core businesses and non-core reductions. Impairments fell by 47% to around GBP 3 billion, supported by good asset quality in the core and by the further reduction of non-core assets.

Group's AQR is now 57 basis points, inside our target range for 2014 of 50 to 60 basis points, so 1 year early in reaching that target range. And as a result, profits increased in both the group and in our core business, with group underlying profit more than doubling, as I've just said, to GBP 6.2 billion, and core profits increasing 24% to GBP 7.6 billion. This improved profitability meant that despite the additional legacy charges totaling GBP 3.5 billion, we delivered a statutory profit before tax of GBP 415 million for the year. And these increased profits, together with a 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%.

So with that brief summary, let me hand over to Andrei, who'll look at the balance sheet in more detail.

Andrei Magasiner

Thanks, Charles, and good afternoon, everyone. Good morning to those in the U.S. I will just spend the next 10 minutes or so updating you on the strong progress that we've made during the year with the balance sheet. Over the course of 2013, we've made further progress in strengthening the balance sheet and reducing risk, while continuing to manage down our wholesale funding. We have also made significant progress despite our legacy issues in improving our capital position and profitability in a sustainable way.

I will now talk in more detail about the group's progress, focusing on capital liquidity funding, structural hedging and rating agencies. So beginning with capital, the regulatory framework has obviously taken time to develop but is now nearing completion with the publication of the policy statements PS7/13 by the PRA in December last year. Additionally, and as you know, regulators have continued their focus on bank capital over the past year, and the PRA and Financial Policy Committee are undertaking a review of the capitalization of the U.S. -- of the U.K. banking sector.

As Charles mentioned earlier, we have significantly strengthened the group's capital position in 2013. Our core Tier 1 ratio on current rules is now 14%, and we have grown the group's pro forma fully loaded common equity Tier 1 ratio by 2.2% to 10.3%. This was obviously achieved through the successful delivery of a number of management actions that strengthened our capital position. These include the sale of the remaining stake in St. James's Place, the recently announced disposals of Scottish Widows investment partnership and Heidelberger Leben and the sale of a U.S. residential mortgage-backed security portfolio. We also improved capital efficiency in the group by upstreaming around GBP 2.2 billion of dividends from Scottish Widows to the group, still leaving the Scottish Widows Group well capitalized.

Now, capital position was further enhanced through underlying profits in the core business and capital-accretive deleveraging in the non-core portfolio. Our continued focus on capital management and the actions discussed previously enabled the group to exceed the PRA's capital requirements and deliver on our core equity common equity Tier 1 targets despite the legacy charges of GBP 3.5 billion, obviously, primarily from PPI.

Another key metric in the new regulatory regime is the leverage ratio. Last month, the Basel Committee published the final definition of leverage ratio. We anticipate that CRD IV will be aligned with this definition, and indications from the PRA support this position. The group has a strong leverage ratio of 4.5% on this pro forma Basel III basis, which includes the grandfathered Tier 1 capital, or 3.8%, including only common equity Tier 1. This is obviously well in excess of the proposed minimum of 3% that is scheduled for implementation in 2018.

Going forward, we will continue to be a strongly capital generative business, and excluding the impacts of any dividends, we would expect to generate fully loaded common equity Tier 1 capital of around 2.5 percentage points by the end of 2015, with further annual growth thereafter between 1.5 and 2 points.

Looking into 2014, we expect ongoing regulatory developments in the form of EBA stress testing, the formulation of the U.K.'s own stress testing framework and a review of the Pillar 2 framework, which will provide greater clarity around the calibration of our capital structure.

Moving on to liquidity. We continue to maintain a strong liquidity position, with primary liquid assets comprising cash guilds and treasuries of around GBP 89 billion at the end of the last year. We have secondary liquid assets of GBP 105 billion, including retained securitizations in whole loan portfolios, which represent access to funding from central banks and other similar liquidity facilities. There has been a significant reduction in money market funding, as Charles alluded to, now below GBP 22 billion and an overall reduction in wholesale funding of GBP 32 billion.

Primary liquid assets now represents approximately 4.2x our money market funding with a maturity of less than 1 year, and primary liquid assets represents 2x our short-term wholesale funding total, providing a substantial buffer in the event of market dislocation. Liquid assets, including the secondary liquid assets that I've just referred to, now represent approximately 4.4x our short-term wholesale funding with a maturity of less than 1 year.

On the regulatory side, the liquidity coverage ratio will become the Pillar 1 standard for liquidity in the U.K. for 2015. The European Commission is to adopt further legislation by the 30th of June of this year to specify the definition and calculation of LCR for implementation in 2015. We expect to meet these new requirements ahead of the implementation dates.

Moving from liquidity to funding. The transformation of the group's funding position has been completed. The core business is now 100% deposit funded, with wholesale funding only used to fund the non-core portfolio and the liquidity portfolio. Customer deposits grew by 4% to GBP 438.3 billion, matching the renewed loan growth in the core business and, therefore, maintaining the group's core loan-to-deposit ratio at 100%, which the group achieved in the first half of 2013. As Charles stated earlier, non-core assets fell by around GBP 35 billion, allowing the group to reduce its overall wholesale funding footprint all the way down to GBP 138 billion and improve the group's overall loan-to-deposit ratio by 8 percentage points to 113%.

This strong funding position has enabled us to undertake a number of funding-related actions during the course of the year. In May 2013, the group repaid in full the GBP 13.5 billion that it had drawn from the long-term refinancing operation of the ECB. In addition to this, during 2013, the group repaid other term funding totaling GBP 12.6 billion and in total, term funding maturities totaled GBP 19.4 billion for 2013.

In light of the strengthened credit position of the group, recovery in the U.K. economy and improving market conditions, we have seen a material reduction in term issuance costs due to a narrowing of the spreads on all of our outstanding securities. In the fourth quarter of 2013, after an 18-month absence from the benchmark space, we priced GBP 1 billion at mid swaps plus 63 and USD 1 billion at treasuries plus 100. These levels represent an improvement to the approximately 200 basis points from the last time we accessed these markets in 2012. This reduction in price underlines our progress in strengthening and de-risking the balance sheet.

As regards Funding for Lending, we were the first bank to access this scheme and are its largest participant, having committed over GBP 37 billion of gross new lending. Total drawings under the scheme in 2013 amounted to GBP 5 billion. And in January this year, we drew a further GBP 2.2 billion, which under the FLS rules, will actually count as funding from the 2013 scheme. And this takes our aggregate total drawings to over GBP 10 billion and we remain as committed as ever to passing on the benefits of this low-cost funding to our SME customers in 2014 to help our customers and Britain prosper.

Looking to the year ahead, we will continue to have a modest wholesale funding requirement and anticipate that in 2014, this will require in the region of GBP 5 billion to GBP 10 billion of public issuance. We regard wholesale markets as a key funding tool and wish to maintain market access to allow us greater flexibility and offer diversification in meeting our funding requirements.

We have come a long way since 2011 when our aggregate wholesale funding was in excess of GBP 250 billion. We have achieved our objective of a core loan-to-deposit ratio of 100% and overall wholesale funding will fall further in 2014, as the group continues to reduce the non-core portfolio. The combination of a strong balance sheet and access to a wide range of funding markets, including all the government schemes, provides the group with a broad range of options with respect to funding the balance sheet in the future.

Turning quickly to structural hedging. In terms of structural hedging, in line with the group's aim to be a low-risk and simple bank, the group has a structural hedge in place to reduce the volatility in net interest income from short-term changes in prevailing market interest rates.

During the course of 2013, the group has further increased its level of protection against volatility in net interest income. However, we do remain modestly positively exposed to rising interest rates. Guideline NII sensitivity numbers will be disclosed in the full annual report and accounts in early March.

Finally, on the topic of rating agencies. We continue to work very closely with our major rating agencies. And in acknowledgment of the significant progress that we have made in improving the group's capitalization and transforming its financial profile, Fitch and Standard & Poor's upgraded Lloyds Bank's stand-alone rating to BBB+ in September and December 2013, respectively, and affirmed our long-term credit rating at A. This is in line with other long-term credit ratings of A2 and AA (low) from Moody's and DBRS, respectively.

In summary, the group's funding and liquidity positions have been transformed. We now combine very modest wholesale funding needs with strong market access. The strengthening of the group's capital ratios leaves us well positioned to continue growing our core business as we support our customers and, in turn, the U.K. recovery. Although uncertainties remain with respect to Pillar 2 and stress testing, the de-risking of the balance sheet will result in lower buffers going forward.

In line with our risk appetite, we expect to maintain structural hedging materially in line with today's position, and we look forward to the continued de-risking and return to sustainable profitability being reflected by the rating agencies.

I will now quickly hand you back to Charles for some closing remarks and some guidance for 2014.

Charles King

Thanks, Andrei. Let me just sum up with the guidance first. So just to recap on what some of you may have seen in our news release, our guidance for net interest margin is that it will stabilize at around our Q4 '13 level of 2.29% in the full year '14. On costs, we'd expect those to reduce to around GBP 9 billion for 2014. That's from GBP 9.6 billion in 2013, and that excludes the TSB running costs. We've guided that our impairment charge as a percentage of average advances to reduce to around 50 basis points for 2014. That's against 57 in 2013.

And as you've probably seen, we'll now stop the non-core -- the core and non-core reporting, which you are familiar with. We're now going to report on a total group level with a small run-off portfolio, and that reflects the progress we've made with the non-core. So we'd expect this run-off portfolio, which comprises the remaining non-core, non-retail assets and certain non-core retail assets, to be around GBP 23 billion at the end of 2014, and that's a reduction of around GBP 10 billion from where we are now or where we were at year-end 2013, and the non-retail portion will be around the GBP 15 billion mark.

For capital, we've guided that our fully loaded core equity Tier 1 ratio, common equity Tier 1 ratio will grow around 2.5 percentage points over the next 2 years and that after that, we expect this to grow further by further 1.5 to 2 percentage points per annum, both before any dividend payments. And the substantial progress we've made to date, and the improved financial performance and capital position of the group and the confidence we've got in our prospects support the dividend policy that we announced last week.

Following completion of our discussions with the PRA, they've now confirmed that they'll treat our applications to make dividend payments in line with their normal procedures for other banks. And we expect to apply to the PRA in the second half of this year to recommence dividend payments, starting at a modest level. And we aim thereafter to have a progressive dividend policy and move over to medium term to a dividend payout ratio of at least 50% of sustainable earnings.

So to sum up, we've continued to execute very strongly on our strategy. The investments we're making to improve our products and services are increasingly benefiting our customers while supporting the U.K. economic recovery.

At the same time, we've made rapid progress in strengthening, de-risking and simplifying the business, creating a more profitable, strongly capitalized, low-cost, lower-risk business. And the differentiated business model we've created is well positioned to deliver strong and sustainable returns above the cost of equity.

So thanks very much. That concludes the formal part of the call. And we'd now like to take any questions that you might have.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Lee Street from Morgan Stanley.

Lee Street - Morgan Stanley, Research Division

I have 3 questions here, if I may. So this morning, there seems to be a bit of a change in tone as regards to ECN's causing a stress test catalyst as we look ahead which, I guess, is [indiscernible], given what the EBA said about the hurdle rate in the adverse scenario. So I was just wondering, given the likely loss of treatment, stress test capital and the focus on efficiency of the capital structure, which you detailed on Page 70, I was just wondering what role you think Lloyds might play -- what role ECN might play in Lloyds having an efficient book [ph] of capital structure as you look ahead. That was my first one. The second one will be in terms of future senior subordinated issuance. Should we be thinking about that coming out of the group entity or is there still a role for paper coming out of the bank entity and are you getting any guidance from the regulator on this? And finally and a somewhat technical, based on your reading of the EBA pronouncements, do you believe that your role -- do you believe your dollar preferred shares could also be counted as fully compliant to capital post the expiration of the grandfathering period in 2021? And do you see any difference to those with near-dated calls, as opposed to those with longer-dated calls? Those are my 3 questions.

Charles King

Okay. Well, those sound like ones for Andrei, and I'll give him a moment to have a think about them. Andrei, do you want cover them all?

Andrei Magasiner

Yes, absolutely. I'll tell you what, I'll cover them in the order that you asked them. ECN loss a stress test capital qualification. Yes, certainly an important question. I think it's probably first worth pointing out that as you look at our business model and if you look at 2013 and 2014, clearly -- as you look at 2013, we generated around 2.2% of core Tier 1 in 2013, obviously, net of GBP 3.5 billion of legacy provisions, which just talks to the capital-generative ability of this business. And as you look forward, clearly, you're seeing line of sight on profitability of around 1.5% to 2% of capital every year. Obviously, over the course of the next couple of years, we're guiding to around 2.5% net capital generation over '14 and '15. That's in the context of a complete change in the capital rules, right? Obviously, during -- beginning of 2014 saw the removal of the old capital regime in the United Kingdom and the sort of implementation of the European capital regime in the form of CRD IV, and that was a huge change. And there's obviously a still -- a huge amount of uncertainty that exists when you look at what's going to happen from a capital regime perspective. The 2 biggest developments from our perspective is, although we did get the capital structure outlined to us or made clearer to us as a result of PS7/13, the way to calculate and the calibration of the sort of Pillar 2A buffer is still a piece of work that needs to be done, which we're looking forward to the PRA implementing during the course of -- consulting on during the course of 2014. And in addition to that and more relevant to your question, I promise I'm going to get to an answer, the SPC and the PRA, obviously, are hard at work, trying to design what the U.K. stress testing will look like in 2014, what the past marks will be in how they will actually design the test. Going back to some of my -- to the comments I've just made, as part of the CRD IV implementation in the United Kingdom, the guidance that we've received from the PRA, specifically as it relates to leverage ratios, has been only an instrument that it's fully loaded -- has a fully loaded 7% conversion trigger will count as 81 for the purposes of the PRA's own leverage ratio, and that's obviously a pretty important data point. And as you rightly pointed out already, the EBA has come out with a 5.5% pass mark for their stress test and obviously, our ECNs only use a 5% definition -- 5% trigger definition and that's obviously on the old rules. Ultimately, the decision as to whether to use the regulatory par call is actually a management decision, and will be based upon our conclusions and our decisions as to whether we think these things count for the stress test or not. At this point, given all the uncertainty, and what I was trying to get across to you with this long-winded answer is that, there is still just a great deal of uncertainty out there. But I think it's sad to say, and I'm just going to line up with what George said this morning, there is just a significantly higher probability in our minds that these instruments will not count for stress testing as part of the stress testing frameworks that are developed and announced in the near future. So I think the answer to the question is I don't know the answer. But as I look at the landscape, as I look at what happens, as I look at the rule changes, as I look at what's coming, as I look at what the PRA is working on, it's just that the level of sort of risk that we've got with these instruments don't count for capital. Certainly, stress testing capital going forward has gone up materially over the course of the last 12 months, and that's probably the answer to question 1.

Lee Street - Morgan Stanley, Research Division

Sorry, just quickly on that -- just 1 quick point there. From what you said, you're definitely not ruling out regulatory par call. I think it's quite clear from what you're saying they probably won't want it [ph], but you're not ruling out regulatory par call, which you said, that would be a management decision. Is that a fair takeaway?

Andrei Magasiner

Yes, I think that's right. I think -- look, to be honest, I don't know whether the -- as I said, the decision to actually do the regulatory par call rests with management. Right now, we don't -- right now, these instruments, and certainly during 2013 are still accounted for stress testing, but we have escalating levels of uncertainties that they will continue to count as part of the stress testing regime. If they don't count as part of that stress testing regime, in our opinion, then it will be a management decision as to whether we exercise the right par call or not. And in terms of future issuance, that's a great question. Certainly, structural reform agenda, ring-fencing and so forth is significantly under way in the United Kingdom, as the regulators and the resolution authorities look to try and simplify bank corporate structures as a way to making resolution simpler. We are -- if you look at Lloyds, and António talked about this in quite some detail this morning in one of his answers, if you look at us, we're basically a single country entry -- entity now or a single country group. We've effectively disposed of or exited most of the countries that we existed in, and we've basically become a U.K.-centric. Almost all of the balance sheet of this group is basically inside of the United Kingdom. That lends itself to an SPE, single point-of-entry, structure. And so it's reasonable to assume that, as you're indicating, that most of our issuance will occur as a holding company going forward. I think it's really, really important to differentiate between loss-absorbing or bail-in-able securities, or certainly the securities that we would look to meet any bail-in requirements from regulators and resolution authorities versus senior unsecured and senior secured funding. It is -- we've said this consistently for years now. It is our intention as a group to endeavor to meet any kind of bail-in or loss-absorbing requirement using common equity, preference shares and other forms of hybrid capital, and leave our senior unsecured bondholders and senior secured debt holders sort of differentiated as it relates to loss-absorbing capacity and bail-in eligibility and so forth. So I think you can look forward. The message is, I think we'll run a differentiated strategy to the extent that we're allowed to. I think it's reasonable to assume, obviously, equity comes out of the group but subordinated debt will, in all shapes and sizes, will, in all likelihood, be issued from the group holding company, whereas senior unsecured and senior secured will probably come from the bank operating entity. And lastly, you asked a highly technical question about the EBA and all the Q&A around our dollar press. I mean, clearly, we don't know the answer to that. All we have to look at, at the moment is the EBA Q&A and so forth on websites, just like you do. It's our reading of those that, to your point, they will likely count as Tier 2. But to be honest, the EBA Q&A is not lower in reg, it's just guidance, and we look forward to clarity on that -- those matters over time. But right now, to your point, it is our management's base case assumption that they will continue to count as Tier 2.

Operator

Your next question comes from Robert Smalley from UBS.

Robert Smalley - UBS Investment Bank, Research Division

Just one follow-up on the ECN and then a couple of other questions. I understand the regulators are looking [indiscernible] from a capital point of view, but just the idea that a regulatory par call might actually cost the bank a fair amount. Does that come into the equation at all? Can you give us an idea of what that cost would be to the bank and how that would be born if that might happen?

Andrei Magasiner

Yes, sure. Do you want to ask all your questions, or should I just answer that one, or then you want to go through the...

Robert Smalley - UBS Investment Bank, Research Division

Yes. The events are operational as opposed to...

Andrei Magasiner

Okay. Let me answer that one first then. Yes, I mean, look -- as I said, there's a great deal of uncertainty around the future of the ECMs. As I said, to reiterate, the risk of a regulatory par call -- sorry, the risk of them not accounting for stress testing has certainly escalated, but there's still a great deal of uncertainty. In terms of answering your question, therefore, there are a number of different ways in which one could choose to deal with them. Management could obviously decide not to do anything with them and leave them outstanding. We could choose to reg par call them. The biggest -- certainly, as you know, as you guys have followed, there's obviously an embedded accounting derivative on the balance sheet that results from these instruments. That over time is going to ebb away to nothing anyway. And so from a shareholder value perspective, that's just an accounting timing difference. And anything else we do in the greater -- in terms of structure potentially probably leads to some cost, but it's probably fairly modest. I think people are fairly heavily focused on the ECM derivative, but I sort of view that as an accounting asset which is really just a timing difference from a shareholder value perspective. The premium will depend ultimately on how we choose to do it if we choose to do anything at all. Going back to the capital generation of this entity, I think it's been fairly clear from calls and the results and so forth, 2.2% of capital generation in 2013, 2.5% capital generation net of -- over the course of the next 2 years is the guidance, 1.5% to 2% of capital generation line of sight going forward. This is a highly capital-generative business, and you should view any loss that you think we might take in that context.

Robert Smalley - UBS Investment Bank, Research Division

Okay, that's very helpful. Second question, I was looking on Page 48 of the release today on LTVs across the retail mortgage portfolios, and development year-to-year, it's very apparent that real estate values have gone up dramatically in the U.K. on the back of government programs. These programs were originally put in to kickstart and support a market. If you look at [indiscernible] numbers and other numbers that we've seeing coming out of the U.K., it looks like they have gone further than that and really almost distorted retail prices. Do you -- when I look at this, I have to say to myself -- my question is, what's the bank doing in order to keep up with it, pace this, or have you changed any of your lending practices, lending policies on how you look at LTVs, for example, in order to keep up with what's been a skyrocketing recovery in the mortgage market?

Charles King

Okay, I'll take that one, shall I, Andrei? I mean, look, I think skyrocketing is too strong a word. We've clearly seen a fair bit of buoyancy in the U.K., in the London market, but that's not being replicated until quite recently in the regions. And actually, we give a pretty good chart on Slide 27 on the results, which gives you the trend in U.K. house prices which are still substantially below the peak and have only recently overall become to show some, what I would call on average, fairly modest recovery. So -- but you are right, the improvement in the LTVs in our book has shown substantial improvement. That's partly because, actually, there were a bunch of mortgages that have at December 12 were only very slightly over the 100% mark in terms of LTV. And those are obviously now, with that modest recovery in house prices, gone below that. There is also some churn in the book that helps in that effect as well. So what we've got is a book that is -- has benefited to some extent from that relatively modest improvement in house prices. In terms of lending practices, there's a metric on that very page which should give you comfort, that the average LTV for new mortgages in 2013 was 63.6%, and that's only very slightly up from 62.6% in 2012. So it's one metric and one metric only. But let me tell you that as regards other metrics, whether that's income coverage or just the creditworthiness of our borrowers overall, we operate within a prudent risk appetite, and those lending practices have not changed. Within that, we are clearly focused on supporting the housing market through programs like Help to Buy and through our long-term support for first-time buyers in the housing market as well. And you'll see that we exceeded our targets for first-time buyer lending last year, and we have renewed that target at the -- at a higher rate this year to support 80,000 first-time buyers in the market, but I stress, within a prudent risk appetite.

Robert Smalley - UBS Investment Bank, Research Division

Final question. Do you think that similar kind of programs in the small and medium enterprise sector will result in -- will end up with the same results? Are you worried about too much capital flowing into that sector as well, not enough, too fast, too slow?

Charles King

Well, I think if you speak to an SME in this country, they might well say this is too little. Again, I would contrast ours very strongly with the market. And actually, again, we've talked about our lending to SMEs, which has averaged on -- the average growth in our SME lending over the last 3 years has been about 4%, and actually we did 6% in 2013, and that contrasts with a market that's down about 3% or 4% per annum over that period. So again, we're outperforming the market. We're supporting the SME sector. And I think you can tell from the impairment charts that we showed you within our presentation this morning, that again, we're doing that within a prudent risk appetite and within a way that we believe is appropriate for the group. But again, the SMEs are, along with first-time buyers being an engine of the housing market, SMEs are a key engine of the U.K. economic recovery and of employment in the U.K. And as António said this morning, our fortunes and the fortunes of the U.K. economy are inevitably and inextricably linked. So it is clearly, absolutely appropriate for us to be supporting that sector strongly.

Andrei Magasiner

Yes. The other thing to look at is the changes that the Bank of England, obviously, with the government's blessing, made to the Funding for Lending Scheme for 2014. So that was a Funding for Lending Scheme which was obviously very generally applicable across the sort of U.K. sterling lending space for non-financial institution. And in 2014, I narrowed it explicitly down to the corporate space and specifically applied a multiplier of 10 and 5 -- I can go to the details offline if you want-- rather, to give banks significant capacity to lend to small and medium-sized enterprises at a cost of effectively 25 basis points over LIBOR. That's 4-year contractual funding. So I don't think that the government or the Central Bank feels like the funding facilities are the issue here. Suppliers of lending is not the issue. This is very much a demand issue in terms of getting the lending going.

Operator

Our next question comes from the line of Corinne Cunningham from Autonomous.

Corinne Cunningham - Autonomous Research LLP

You've answered most of my questions, actually, but maybe just one more on PLAC. Are you targeting 17% of PLAC is, I suppose, the intro question. We calculate that you've got an awful lot more than that. And as you've said, you also expect it to be quite capital generative going forwards. So should we be thinking about actions that you could take to retire debt more broadly, particularly the subordinated debt that's issued at the bank level?

Charles King

That's a good question. I mean, I think to be honest -- to provide you with a definitive answer, I'm overgoing with PLAC is incredibly difficult. The structural reform agenda is under way and we look forward to developments on that front as we go. Certainly, we look at the ICB reports as being the sort of only real indication in print that we've received on where sort of total capital or loss-absorbing requirements are in the United Kingdom in print. And that's obviously where the 17% comes from. To your point, our total capital ratio, they were running at the end of the year was around 20.8%, so to your point, significantly ahead of that 17%. Who knows where they're going to end up from a calibration perspective? We're certainly in conversation with them. There are discussions that, that PLAC requirement will be higher than 17%. So the indication -- that's the rhetoric we're hearing. The rumor -- that's not -- we're not getting that from regulators. We're just getting that from newspapers and so forth, just like you are. Against the 17% requirement, and now I'm going to take you back to a speech that I did in the third quarter, I think it was in September last year. Against the 17%, we certainly have a significant excess. I think one of the reasons why we have this excess is obviously the insurance deduction, the deduction that we used to have to run for the insurance company, which used to be against Tier 2, has obviously shifted down below the lines of core Tier 1. And therefore, with the disappearance of that deduction and with the build of the core Tier 1 to meet the insurance requirements of the core Tier 1 level, we obviously have significant excess level of total capital. So I think the answer is, I'm fairly uncertain now as to what the destination is. We will be working with regulators and government and so forth to work that out. If the answer does settle at 17%, which, again, just to reiterate, is the only thing that we've seen in writing at this point, then yes, we have significant amounts of excess hybrid capital, which we will look to optimize as we go forward.

Operator

Your next question comes from the line of Louise Pitt from Goldman Sachs.

Louise Pitt - Goldman Sachs Group Inc., Research Division

I know you've answered a lot of questions on these ECNs, but I just want to clarify a couple of points that I think you made. I understand that you say the capital generation may offset any accounting negatives, but a par call from a regulatory basis could materially impact secondary and new issue spreads, especially given the success you've had in tightening your senior spreads. Is that at all a factor of management when considering whether or not you would carry out a par reg call across all of the asset class?

Charles King

Yes, of course, it is, right? I mean, Lloyds has -- we've always tried to operate -- I wouldn't call myself investor friendly, but I would call myself fair, and I don't see myself deviating from that adjective anytime soon. So -- however, going back to -- if management ends up making a decision that, in fact, these instruments do not count for stress testing, then we almost have a fiduciary duty as a management team to our shareholders to consider the economic value that is created by the triggering of that option, and we will obviously have to assess that. I can't -- I think you'd have to be blind and deaf not to know that there was a regulatory par call option in these instruments. There's been so much written about it over time. I think investors, bondholders and so forth who hold these instruments at this point are well aware of the risks that they're running holding these instruments, and that is also relevant. But again, we seek to be fair, and that's a model that's worked for us through the crisis. And we want to make sure that we treat our investors fairly, that we have a good relationship with them and that is important to us.

Louise Pitt - Goldman Sachs Group Inc., Research Division

Okay. Just a couple more. In terms of the regulatory requirement to replace that capital, it is still good capital under Basel III, and I hear your comments on the excess Tier 2 that you may have, albeit that the rules are moving targets. But do you think that would be at least some regulatory requirement to replace some of that Tier 2? And given that you haven't given a target for Tier 2 issuance, can you give us more thoughts on that? I assume the GBP 5 billion to GBP 10 billion you mentioned was senior funding for this year.

Charles King

Yes, that's right. The GBP 5 billion to GBP 10 billion is certainly senior secured and unsecured wholesale funding and private placements and so forth. I think, given that we're running access right now, I think I've got to balance there against maintaining market access and ensuring that we maintain Lloyds as a name in the hearts and minds of our investor community. So we balance market access and the need to remain fresh from a market issuance perspective against those total capital levels and those accesses. That's not very easy to do. Obviously, the fact that we're running accesses right now probably bias us towards less rather than more issuance, which, obviously, will make sense to you. But I wouldn't rule out any issuance as we attempt to maintain our name in the markets, but, obviously, factor in significant amounts of access against requirements and, therefore, not really having a need to do that. We would do that again to maintain our relationships with our investors, which is clearly very important as we look to manage this function strategically over the medium term.

Louise Pitt - Goldman Sachs Group Inc., Research Division

Okay, great. Just a couple more, guys, if you have some time. I just want to clarify, in terms of the ECN's reg par call and on a stress test basis, there's no requirement to call all of them at the same point in time. You have full discretion to call any or all at any point in time, after which you would determine that, that option is available, is that correct?

Charles King

That is 100% correct.

Louise Pitt - Goldman Sachs Group Inc., Research Division

Okay. And then just 2 different questions that you'll be thankful for. But the HBOS whole call [ph] entity from a funding perspective, obviously, still both trades and CDS has securities out there. From what I understand, it is unlikely that you would be issuing new debt from that entity. Is that correct?

Charles King

Yes, that's right. The HBOS entity is actually a subsidiary of Lloyds Bank, yes, so we would -- there's no need to issue anything from that.

Louise Pitt - Goldman Sachs Group Inc., Research Division

Okay, great. And then the final question is just, given that a couple of the U.K. banks are in the European stress test, can you just comment on what preparation you may have to do for that that's different from anything you're doing for PRA or Bank of England?

Charles King

No, I don't think it would be materially different. We've -- as a bunch of U.K. banks, we have become incredibly good at doing stress testing. We -- I can't tell you the number of stress tests that we've done over the last number of years. We have people who are dedicated to doing stress testing as their day jobs. We collect this data routinely as part of our normal financial planning processes and in any ICAP [ph] processes that we run. So I think that the basic conclusion is, stress testing is part of our DNA these days, it's part of our business-as-usual processes, we have all of the necessary governance in place. And the information that we're expecting to need to provide as part of that stress testing materially speaking looks and feels similar to what we already do as part of our core business. Yes, I think it's probably worth calling out, which I'm sure you know, that, obviously, the pass mark for that stress test is 5.5% using transitional rule. And with a fully loaded core Tier 1 ratio of 10.3%, and a current transitional rules, apples to apples, with a 5.5% ratio of 14%, I think we're feeling pretty good about where we are against that stress test.

Louise Pitt - Goldman Sachs Group Inc., Research Division

Okay, great. And I just want to clarify. You're saying that it's your decision as a management team whether or not to call the securities if they are not being stress test capital, it's not your decision as to whether they count, right?

Charles King

It's certainly our decision as to whether to exercise the option assuming that it is available. Yes, I think that's probably -- I think you're probably right, to be honest...

Louise Pitt - Goldman Sachs Group Inc., Research Division

So the PRA will tell you guys whether or not they are going to allow them to be counted within the stress test capital. Is that correct?

Charles King

I think that's unlikely, yes.

Operator

Your next question from Jackie Ineke from Morgan Stanley.

Jacqueline M. Ineke - Morgan Stanley, Research Division

I've got a couple of questions. The first question is on your Pillar 2A requirements. Obviously, we all saw the Barclays results earlier this week. Are you going to give more color on Pillar 2A for Lloyds? And secondly, just on the stress test, obviously, we're hoping for a PRA statement about the stress test and what the stress test capital is. I think originally, we were hoping for that mid-February. But do you have any better idea when that might be coming out? I've got a feeling it's probably delayed.

Charles King

Yes. On the Pillar 2A requirement, I think George was fairly clear on this morning's call. We tend to keep things like ICG, Pillar 2A and so forth bilateral between ourselves and our regulator. The regulator errs on the side of preferring that we don't publish that information. Clearly, they're not going to stop you from publishing the information. I think in the case of the institution that you mentioned, clearly, they felt like they wanted to publish that information. From our perspective, there is so much uncertainty around the calibration, the size and so forth of Pillar 2A buffers at this point, given the fact that the PRA is actually going to specifically enter a consultation phase on how -- on the methodology to actually calculating Pillar 2A. We just don't feel like it makes any real sense to enter into discussions with people on where our Pillar 2A buffers are right now, given that they're all likely going to be thrown into the air during the course of 2014. So we look forward to coming back to you over the course of 2014, probably the end of '14, maybe even early '15, around that topic. On stress testing in terms of timing, we don't have any definitive answers similar to you. It's our read internally that it is unlikely that it will be in February. It's likely to be later than that. And so I think your assessment that that's delayed versus February as an expectation is probably about right.

Jacqueline M. Ineke - Morgan Stanley, Research Division

Have you got a feeling for how delayed? 1 month? 6 months? Anything?

Charles King

I don't -- I mean, my gut tells me it's probably in H1, but probably the back end of H1, but this is just one man speaking out of turn.

Operator

Your next question comes from the line of James Hyde from Pramerica.

James Hyde

Corinne already asked my main PLAC question. But as a supplementary to that, if the BRRD adopts this 8% minimum required eligible liabilities ratio, would you be looking to keep that same commitment regarding not having senior unsecured in there that you have for PLAC -- or not commitment but preference? And secondly, not related to that, but on Scottish Widows, I note that the -- on Page 31, that you showed a new capital surplus, which is exactly unchanged x of GBP 1 billion dividending up at GBP 2.9 billion for Pillar 1 and GBP 2.7 billion for IGD. Does that call for further scope for dividending up, or do you have to keep a buffer like that given solvency, too, and all the other uncertainties?

Charles King

Yes. Good question, good question. The 8% MREL. The definition of MREL is about as subject to change as pretty much everything at this point. I mean, obviously, we've seen indicative definitions and indications of what calculations might look like. We are obviously still working through sort of some of those numbers. I would like to say yes to your question that we obviously would -- and given our capitalization level, we don't think it's an issue today, making the commitment that, in fact, we will be able to meet the 8% MREL out of -- without recourse to senior debt, and that would be our default position. But given the definitions aren't final yet, I'm going to reserve making that commitment. On the Scottish Widows, that's a good question. I mean, clearly we run, as an organization, significant excess capital in the insurance business. As you've pointed out, the sort of externally disclosed IGD ratios and so forth. Solvency ratios indicate that there is significant excess capital in those entities. I think that probably the guidance for you and guidance for bonds -- Scottish Widows bondholders are, we're probably at the right -- from an internal management perspective, from a risk-appetite perspective in terms of what we run in those entities, we're fairly comfortable right now with the capital position. It still meets the definition of well-capitalized sort of in our internal frameworks rather than just adequately capitalized, and we'd like to keep it at well-capitalized. And that means that we've probably taken out as much -- we've optimized the capital structure to where we want it to be. Clearly, that's a highly capital-generative business. It makes somewhere between GBP 800 million and GBP 1 billion of -- generates GBP 800 million to GBP 1 billion of capital every year out of that business. And we will, obviously, look forward to receiving that sort of a magnitude of earnings stream being dividended up to the group over time, which obviously contributes and is factored into all of that capital guidance that we told -- which we've given you earlier in this call.

Operator

Our next question comes from Richard Thomas from Bank of America.

Richard Thomas - BofA Merrill Lynch, Research Division

I just wanted to follow up on actually one of Louise's questions on the regulatory treatment of the ECNs and the disqualification of the ECNs as capital. And just to be absolutely clear, who makes the decision to disqualify them as capital?

Charles King

I think ultimately, management does. I think what you get from your regulator is clarity around how the stress testing works and, on the back of that, management makes a decision as to whether they count or not and then management obviously has an obligation to inform the markets immediately that we feel like we have that -- the regulatory par call option is now live, and then there's a second round of decisions by management on whether that gets exercised or not.

Operator

The next question comes from the line of Christy Hajiloizou from Barclays.

Christy Hajiloizou - Barclays Capital, Research Division

All my questions were mostly answered, so I'll just ask one on core capital, please. So it's very obvious that Lloyds is very capital generative, and that was proven in the 2.2% of core capital generated last year. So the guidance for the next couple of years is for 250 basis points in the pre-dividend. I'm just thinking about the guidance, I mean, what happened last year, 2.2%, and also relative to consensus estimates for the next couple of years, the 250 basis points does seem to be quite a lot lower than what consensus suggests you could get during that period, and that's even sort of assuming no further deleveraging and adjusting for all the one-offs that you've already flagged, like Verde and other restructuring costs. Is there something here that you could be -- some sort of contingency that you could be factoring into the guidance over the next few years that's some sort of impact to equity or some sort of spend that could be offsetting any organic accretion that we could be thinking about here? Or am I just reading too much into it and consensus is too high?

Charles King

I think, honestly, we've given you guidance that fairly reflects what we believe we can deliver over the next couple of years, which is the obvious point. I mean, I think you heard -- probably those of you who heard the call this morning or the presentation this morning with George, you would have heard him talk about the change in the contributors to that capital generation over time. So clearly, a lot of the generation we've seen historically has been driven by the restructuring process, as we've been through the RWA reductions, the dividending of surplus capital out of the insurance business, for example, as well as, obviously, the underlying profitability of the business. And actually, if we haven't had the legacy charges in '13, the actions that we've taken, which include also some disposals from the core business, like St. James's Place and SWIP, and all of those other things together would've driven us nearly to 12%, right? There was -- that was '13, though, if you like. And then as we go forward, what we'll see is more and more contribution from profitability and less and less from those restructurings. And the obvious example around that is we did GBP 35 billion of non-core reduction in '13. Our guidance is to roughly around GBP 10 billion in '14. So that just gives you an idea of quantum is changing and the mix effect is changing, and the contributors to our capital build. And I think you're absolutely right. There will be -- '14 will still have some elements that will be drags on that contribution of profitability to capital build. You called out a couple there, Verde and Simplification, obviously, will have a negative fair value on one charge, as well as we had in '13, that will probably be slightly larger in '14 than in '13 in all likelihood. We're a little difficult to predict that one with certainty, but that's our current view. And inevitably, there will be some other below-the-line items that come through. So I think it is -- and then as we go through into '15 those Simplification and Verde charges obviously fall away. And we get into more where we want to be on a stand-alone, on a go forward basis, and that gets us to our 1.5% to 2%. So we're confident in that guidance. It fairly reflects our expectation.

Christy Hajiloizou - Barclays Capital, Research Division

Okay. So just then in that context, you referred to the accounting derivative to ECNs really just keeping an accounting timing difference is not something that you're taking into too much account. Does that ever get included in your capital guidance or in your internal calculations when you're thinking about capital accretion?

Charles King

I mean, there's amortization of Basel III [ph] over time, right?

Christy Hajiloizou - Barclays Capital, Research Division

Right, as opposed to assuming it sort of can fall off in one go...

Charles King

Correct.

Christy Hajiloizou - Barclays Capital, Research Division

Within -- okay, that's great.

Operator

Thank you. There will be 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. For those of you wishing to review this conference, the replay facility can be accessed by dialing within the U.K. on 0 (800) 953-1533; the U.S. on 1 (866) 247-4222; alternatively on the standard international number on 00-44 1452 5500-00. The reservation number is 34415692#. Thank you for participating. You may all disconnect.

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