Lloyds Banking Group's (LYG) CEO Antonio Horta-Osorio on Q1 2016 Results - Earnings Call Transcript

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Lloyds Banking Group plc (NYSE:LYG)

Q1 2016 Earnings Conference Call

April 28, 2016 4:30 am ET

Executives

Antonio Horta-Osorio - Executive Director and Group Chief Executive

George Culmer - Executive Director and CFO

Analysts

Andrew Coombs - Citi

Michael Helsby - Bank of America Merrill Lynch

Ian Gordon - Investec

David Lock - Deutsche Bank

Martin Leitgeb - Goldman Sachs

Joseph Dickerson - Jefferies

Chris Manners - Morgan Stanley

Jonathan Pierce - Exane BNP Paribas

Raul Sinha - JP Morgan

Arturo de Frias Marques - Santander

Robert Sage -

Antonio Horta-Osorio

Good morning, everyone, and thanks for joining our 2016 first quarter results presentation. I'm going to give a short overview and George will briefly cover the financial results. We will then have some time for questions at the end.

So turning to Slide 1 for those of you following the Web-site presentation, in the first three months of this year we have continued to make good progress, delivering a robust financial performance with stable underlying profit of £2.1 billion and an underlying return on required equity of around 14%, whilst maintaining our strong balance sheet.

Our U.K. focused business model continues to deliver and differentiates us in a challenging operating environment, with our cost discipline and low risk approach providing strong competitive advantages. This cost discipline has allowed us to respond to current market conditions with the accelerated delivery of cost initiatives driving lower operating costs, which have more than offset the marginally lower income and driven positive operating jaws. These actions have also resulted in a further improvement in our cost to income ratio to 47.4%, which remains the lowest of the U.K. major banks.

Our low-risk business model means that we have very limited exposure to troubled sectors and credit quality has remained strong in the quarter, with impairments down 6% and an AQR of just 14 basis points. In addition, there has been a further reduction in impaired loans, which now represent just 2.0% of our lending portfolio.

This financial performance has resulted in strong underlying capital generation of around 60 basis points in the quarter. However, as announced to the market in February, the ECNs redemption has impacted our CET1 ratio, which is maintained at 13.0%, prior to the 2016 dividend accrual.

In the quarter, we have continued to make good progress in our strategic initiatives of creating the best customer experience, becoming simpler and more efficient and delivering sustainable growth. We have the U.K.'s largest digital bank with 12 million online customers and have now surpassed 7 million mobile digital users. In addition, over the last 12 months, we have continued to increase net lending in each of our targeted customer segments.

We also remain focused on delivering on our targets to individuals, business and communities, as set out in our updated Helping Britain Prosper Plan, and have recently launched our SME charter to help small businesses grow and to provide access to funding. Finally, we are confident in the Group's future prospects and we are therefore reaffirming our 2016 guidance.

I would now like to pass the call over to George, who will run through the financials.

George Culmer

Thank you, Antonio, and good morning everyone. As you heard, underlying profit was £2.1 billion for the quarter, with strong underlying return on required equity of around 14%. Total income for three months was down 1% year-on-year at £4.4 billion, with a 3% increase in NII to £2.9 billion, while other income was £1.5 billion.

On costs, operating costs of £2 billion were down 2%, primarily due to the acceleration of our Simplification programme which now delivered £495 million run-rate savings and is ahead of plan. As you have just heard, enabled the Group to positive operating jaws of 1% and further improve our market-leading cost income ratio.

On credit, impairments fell 6% to £149 million, reflecting the low risk nature of our business model. This equates to a 14 basis points AQR, which comprises around 8 basis points of releases and write-backs and an underlying 22 of gross impairments. This is slightly better than expected, although for now, we continue to expect the 2016 full year AQR to around the previously guided 20 basis points.

Looking at income in more detail, the 3% increase in NII was driven by an improvement in the margin to 2.74%, which is 10 basis points higher than in Q4 2015. Lower funding and deposit costs, including the benefit of ECNs redemption, continue to more than offset lower asset pricing. In addition, the first quarter margin includes a one-off 5 basis points benefit from credit cards. And for the full year, we still expect NIM to be in line with our guidance of around 2.70%.

Other income was resilient in the current market conditions and the £1.5 billion for the quarter is broadly in line with our historic run rate and our quarterly run rate expectations for 2016. The year-on-year decrease of 7% primarily reflects lower income from Insurance and continued general pressure on fees and commissions.

Turning to lending, year-on-year growth trends are broadly similar to those at the full year, and over the last 12 months, lending across the key customer segments has grown by 2%. Within mortgages, as you know, the market remains competitive and our focus remains on margin and lending within our prudent risk appetite.

In the past year, the residential mainstream market has grown by around 1%, with our growth just below that, while in the buy-to-let, the market grew at around 11% compared with our 3%, and as a result our overall growth of 1% compares with the market growth of around 2%.

In U.K. Consumer Finance, which now includes unsecured personal lending as well as asset finance and credit cards, we have delivered U.K. loan growth of 10%. This was driven by new business growth of 30% in motor finance, which again benefited from our partnership with Jaguar Land Rover, and while unsecured personal lending reduced by 4% due to lower branch sales volumes, we have delivered 4% growth in credit card balances.

Within SME, we have continued our strong performance, outstripping the market once again, with year on year growth of 5%, while we have continued to grow our mid markets lending in a challenging market.

Looking at the overall asset position, total loans and advances increased by £1.5 billion to £457 billion, with a similar increase in interest earning assets on a spot basis, while average interest earning assets reduced slightly in the quarter to £438 billion, largely reflecting the timing of asset growth in Commercial.

Looking at statutory profit, market movements and the redemption of the ECNs resulted in a £790 million charge in Q1. Market volatility and other items were £334 million, comprising fair value unwind of £47 million, amortisation of intangibles of around £80 million, as well as negative insurance volatility of £163 million, primarily driven by adverse market movements in equity and credit.

On restructuring, the £161 million charge reflects the Simplification severance costs related to the role reductions announced in the quarter and the first costs for the implementation of the Group's non-ring-fenced bank. On conduct, we have taken £115 million during the quarter to cover retail conduct matters. While on PPI, complaints over the three months have been around 8,500 per week on average, which is broadly in line with expectations and no further provision has been taken.

Finally, our tax charge was £123 million, representing an effective rate of 19%. This is below our medium term guidance of around 27%, largely due to the impact of tax exempt gains and capital tax losses not previously recognised. We still anticipate the full year tax rate to be broadly in line with guidance.

Finishing then with a few words on capital. As you heard from Antonio, the business continues to be well capitalised and strongly capital generative, with the CET1 ratio maintained at 13.0% prior to 2016 dividend accrual of 20 basis points. The underlying capital generation in the quarter was around 60 basis points driven by strong underlying profit which in prior years excluded any capital contribution from Insurance. This underlying capital generation was offset by the ECN redemption charge of around 40 basis points as well as a number of other smaller items including the impact of the prudential valuation adjustment and conduct.

Looking forward, the Group continues to expect to generate around 200 basis points of capital per year, and in 2016 this capital generation is likely to be weighted towards the second half of the year, due to items such as the timing of the insurance dividend and movements in RWAs.

Finally, our TNAV per share increased from £0.523 at the full year to £0.552 at the end of March. This increase was again driven by strong underlying earnings but also benefited from positive movements in the cash flow hedge reserve.

So, in summary, the Group's clear strategic focus and differentiated business model has continued to deliver stable underlying profit and strong underlying return from capital generation. The Group is well positioned for future and we are today reaffirming our 2016 guidance.

That concludes today's presentation and we are now available to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question today comes from Andrew Coombs from Citigroup. Andrew, please go ahead.

Andrew Coombs

Good morning. Two questions, both on revenues. Firstly on other income, given what you've seen in Q1 and also your guidance going forward, you've stated about the quarterly run rate being broadly in line with expectations. Usually you see an element of seasonality obviously in this revenue line. It's clearly been a more challenging environment, but are you suggesting you expect that seasonality to be far less pronounced this year? Perhaps you could also just provide a bit more colour on the other income split by the divisions as well?

And then secondly with regards to average interest earning assets, you've seen another small decline there. Even if you exclude the run-off, 427.8 to 427.2, again I know this has been asked beforehand, but when do you expect to reach a turning point in terms of that average interest earning assets trajectory?

George Culmer

This is George. [Indiscernible] We said we delivered £1.5 billion in the quarter, and as you recall, I think we said at the full year that we would hope to get into positive territory this year versus 2015. So last year was £6.1 billion. So that is the sort of full year number. So that is sort of £1.5 billion, you always want for more, but that's why I say we are sort of broadly in line with where we expected to be.

I mean when you look at the comparators, versus Q1 last year we were down £115 million. We don't give detailed divisional splits at Q1 and Q3, but within that, when you look at the contributors, Commercial is actually marginally ahead, I think Retail is in line. Most of it is actually Insurance which is about £70 million down, and that has much to do with Q1 last year where we had benefits from longevity and we also had benefits from transferring some assets into Insurance where we were able to reflect the benefits from within that. So that's really still why we are down versus Q1 last year. Versus Q4, it's more spread across the business. I think we are down about £50 million Q4 on Q1. So that's the position.

So as I said, £1.5 billion, it is tough, but Commercial's been resilient, we're ahead on where we were a year ago and we've got a great franchise and great business to build on, and as markets come back, which they will, we'll be able to play into that. We'll stay relatively tough in Retail. I would hope for more from Insurance. It may be quite lumpy because you've got things like the bulks coming through, but I would hope for Insurance to move forward, and similarly in Consumer Finance where we are growing that business as well. So, it does remain challenging, but [indiscernible] as I said we were shooting to get ahead of the 6.1, we are at 1.5. So it's a reasonable start to the year I would say.

And on the average interest earning assets, we've put a slide in the back, I think it's appendix to the slide deck which just shows the reconciliation and just shows you that on a spot basis, the interest earning assets track the sort of growth in loans. So there's an averaging effect in terms of when that actually came into play. And on the averaging basis, it was slightly down in Commercial, but as I said, I think that actually picked up at the end of the month.

I won't give a prediction in terms of going forward, and part of that is it depends upon how we see the mortgage market and how we respond to that. So at the moment as you know mortgages are emphasising margin over everything else. So I'm not going to give you guidance on that. You have seen them stabilise, you've seen that as the reduction of run-off is slower than elsewhere, but we're into sort of fine movements. But in terms of tipping points, it's dependent upon other factors and the average [indiscernible] assets is more of an output than an input.

Operator

The next question today comes from Michael Helsby from Bank of America Merrill Lynch. Michael, please go ahead.

Michael Helsby

I have got two if I can. First one for you, George. In the past, you have given us very helpfully the SVR balances by brand, the movements that you are seeing and also the yields, but on top of that you have given us your fixed rate deposit balances in those yields. Have you got that data again please?

George Culmer

I do. Do you have a second question?

Michael Helsby

Yes, and then one I guess more broadly for Antonio, and I'm sure the questions that follow will probably focus on a similar theme, but it's clear that the revenue environment is getting a lot tougher in the U.K., competition is clearly very fierce and the rate environment isn't helping. So the performance that you demonstrated in Q1 was very good. You maintained your costs and doing everything that we'd hope that you would do, but revenues are down 2% excluding the card benefit that you referred to, costs were down 1%. So I guess the question is, if the revenue environment gets tougher, to what extent, what levers have you got to pull on costs that you can still maintain that cost-income ratio improvement?

George Culmer

So, on the asset side, on the mortgages, I mean the SVR book is close to about £148 billion which is down from about £153 billion at Q4. Within that, I mean the Halifax which is 3.99% is at sort of £51 billion and that compares with £52.5 billion. The others are all down sort of £1 billion or so in terms of things like the Lloyds, et cetera, Bank of Scotland. So Lloyds is £37.8 billion compared with £39.1 billion.

In terms of attrition rates, I mean it has picked up slightly. So I think we were sort of 8%, we are up to about 9% and we'd expect it to be that, if not tick slightly higher. And one of the things that you are seeing here as people come out of fixed, you've got quite a large number of maturities, some are on lower rates and they now fit into SVR which is a step up, okay, you get a behavioural response to that. So it's picked up a bit and I think we would expect to see it continue in that direction. It's not a dramatic shift, but that's what we are seeing.

On the other side of the balance sheet, on the liabilities side, I mean first up talking generalities, we do have a great advantage of being able to manage the entirety of the balance sheet and manage between brands and products and divisions. And as a simple example, Retail savings are £182 billion, which compares with £185 billion in Q4 and about £194 billion a year ago. And when you look at the Commercial equivalent to those, Commercial is now £129 billion and it was £126 billion at Q4 and £122 billion 12 months ago. And in terms of comparative costs, if Commercial deposits cost me 50 basis points and Retail at 1% plus, you can just see we've got the ability to flex within the balance sheet so within the divisions in terms of sourcing the cheapest bits of funding.

And within the Retail bit, my aggregates and my savings balances are now about 1% in terms of costs and that compares with about 1.06% at Q4 and north of 1.30% again about 12 months ago. And the movement between the 1.06% to 1%, it's just shaving a few basis points. So the fixed, where we have got about £26 billion, it's on average rate of about 2.10% and that was £27 billion and 2.13% in Q4.

Fixed ISA £31 billion and that's 2.01% and that was 2.07% at Q4 when the balances were £33 billion. And similarly instant access with £94 billion, just down from £95 billion in Q4, but the rate we are paying 50 and we were paying 54. So it is more of the same in terms of themes, in terms of flexing within the divisions as I say, within the types of deposits and then looking to shave in terms of the costs of those funds and it's the advantage we have in terms of being able to manage the cost piece.

Antonio Horta-Osorio

And Michael, relating to your second question, the way I see this is very similar to the way we have been discussing in the last few quarters and that we discussed at year end, and we see the economy in a good place. We see interest rates lower for longer, as we discussed at year end results. So we see like a translation of the economic environment and the same structure and in the same direction, and therefore as interest rates are lower for longer as you said, there is more pressure on income and income is not growing as we thought it would grow 18 months ago.

On the other hand, impairments are also lower which is related also to lower interest rates for longer, and our impairments are better than we thought and our NPLs given our prudent risk positioning, our NPLs went down again to 2.0% of our total loans. So you have a natural offset on impairment and there is a difference which we are acting on in an accelerated way through costs and simplification of the business at an accelerated pace.

And to elaborate a little bit on the several points, on the economic environment, we continue to see the U.K. growing well on average, so pending exceptional items, depending on what happens with the referendum. The U.K. economy as we saw yesterday continues to grow at a reasonable pace, 0.4% quarter on quarter and 2.1% year on year, which is in line with expectations.

Therefore, the economic environment is quite benign. It is growing with less debt, which I re-emphasize, is a very important thing because obviously more debt stimulates GDP in the short term and the fact that the U.K. economy is growing with less debt on the household sector which needed it, the corporate sector that did not need was already at a healthy level, and now in the public sector I think it's very positive and will ensure a longer economic cycle than otherwise.

And second, the fact that house prices are growing throughout the country and the mortgage market is not growing very much, that also has a positive impact on the quality of the balance sheet of banks in terms of mortgages. We attract new business at higher prices but most of the business which is the stock gets lower and lower LTVs given house price movement and it's quite positive for the banks as a whole and for us as the leading bank in the mortgage sector.

Therefore, what we are doing in this environment now going into the cost line, as we said at year end, we have accelerated our cost plans last year, and as George mentioned, we are ahead of plan. This year we have continued this acceleration and I would say we have intensified it. Since the beginning of the year, it was clear, given the market turmoil in the beginning of the year that interest rates were even lower than [indiscernible]. And we are ahead of the plan and when we will finish the plan which will finish before the three years, we will give you more news and more initiatives about what we are going to do next. We are strongly committed to providing positive jaws as we have provided in quarter one where we decreased the cost to income again to 47.4%, which is much lower than our other U.K. peers.

Operator

The next question today comes from Ian Gordon from Investec. Ian, please go ahead.

Ian Gordon

Can I have two please? Firstly, just following up on the cost point, it feels like your positive jaws guidance is consistent with a small absolute reduction in costs and you have delivered that in Q1. Can you just talk a bit more specifically on the tailwind you may get in Q2 with relation to the FSCS charge? Can you quantify the amount you charged in Q2 2015, about £0.2 billion I think, and what is your expectation for the timeline of decline of that charge? I think it is dependent on a number of factors, UKAR, et cetera.

And then secondly, can you just talk a bit more on your thinking of front book pricing in the mortgage market? It certainly looks like given where swaps have moved, you've been actually achieving some useful expansion in front book asset spreads. Can you comment on, A, how true that is, and B, how sustainable you see it given the very strong approvals data we saw again for April taking us to the second quarter?

Antonio Horta-Osorio

George will do the first, I will do the second.

George Culmer

Look I mean first of all I will repeat some things that Antonio said around the costs. We do have the ability as I was saying earlier in terms of managing the balance sheet and rates, simply to respond and react to what we are seeing, and we are moving more speedily in terms of expense action within our original plan than we envisaged. So branch closures targeted 200 and we are up to 150 in terms of heads. I think we talked about 9,000, I think which is over 6,000 now. So we are moving more speedily and will continue to do so.

You're right, there is a seasonality step-up in Q2 and that is the FSCS which I don't have the precise number. You are right, it is round about the 200 there, although it depends upon rates and other matters and it can be lower this year. I'm not going to explicitly talk about what income might come along to offset that tick-up, but just to sort of reiterate the point, we do target these positive jaws and we target to maintain that over the year, but I'm afraid I can't divulge into any sort of particular detail as to what income there will be to offset that step-up in costs as we move through that, but it is a seasonal thing from year to year.

Antonio Horta-Osorio

And, Ian, relating to your second question on the front book prices and margin, I mean I would say that the trend in front book prices relating to mortgages has been similar to what we have watched over the last 18 months. There is a progressive pressure downwards on prices based on lower impairments, given the benign economic environment and also on lower deposit costs. And I think that that trend is not very different from what it was six months ago. It depends from player to player, but overall I don't see it very different. And we are assuming, as we said at year end results, that it will continue.

I think we have a competitive advantage in terms of margin management because we follow a multi-brand approach to the market where we have very different customer segments with different needs, and we manage the margin together, so we manage the difference of assets and liabilities which in think is the important margin to address the difference between assets and liabilities and we do it together, we do it on a weekly basis at the top of the organization and together we use this multi-brand approach. I think this is a very powerful element of our strategy, which I think shows in the differentiated behaviour of our NIM versus other banks.

So continuing to the next one or two quarters, which is now only the time that we can foresee given competitors' behaviours, I would expect, Ian, that this downward movement on mortgage prices continues, this slight downward movement, but I continue to expect deposit prices to go down and the U.K. is in a very good position in terms of liquidity and we continue to aim to balance the difference of the two and that's why we are keeping our guidance unchanged at around 2.70% for the full year.

Operator

The next question today comes from David Lock from Deutsche Bank. David, please go ahead.

David Lock

Three ones for me please. First of all on deposits, thanks for the colour on the rates you're getting on the ISAs in particular. Certainly when I look at my own ISA and I look at the ones that are quoted on the Bank of England, I am getting nowhere near 2%. So I just wondered if you could explain the duration of those balances and why you are so much higher than the market average on that. And second question is just on the restructuring charge. It was a little bit higher. Is that just because of the redundancies that have come through this quarter or should we expect a little bit of lumpiness in the rest of the year? And then the third one, I just wondered if you could comment whether since the beginning of April, you've seen any change in pick up in terms of mortgage volumes following the buy-to-let changes around tax? Thank you very much.

Antonio Horta-Osorio

I'll take the first one and George will take the second and third on buy-to-let. In terms of your question [indiscernible], I think as I was saying to Ian Gordon before, I think deposit prices are on a downward trend and I am sure that in terms of our ISA prices, as the season went very well for us, generally speaking we did not increase our ISA prices. They came slightly down.

On the other hand, as you pointed out, and especially through the Halifax brand, we still have higher funding costs, given the heritage of Halifax the Building Society, and it is an opportunity for us to continue lowering those prices.

So I hear both your comments, I think the answer is that I think deposit prices continue to go down and in our case as well, and specifically in the ISA season, we still have higher prices in the Halifax brand than in the market in general which is in my opinion an opportunity to continue to lower them as time goes by.

George Culmer

And on the restructuring, so there are a couple of things on restructuring. One I think as we called out in the presentation, you've got around about sort of £30 million or so of the first of the non-ring-fenced build that's coming through. We are in sort of obviously build phase of that. Now we know what we are doing and we are constructing that.

And then with the severance, yes, we have announced in quarters 2,000 or so redundancies. So that relates to that. Those costs are slightly higher. It's sort of a consequence of going faster that we are probably spending more in terms of exiting people, et cetera, less attrition and we are having to take more direct action. So we will have plenty more. So that's the reason for that.

The buy-to-let, I think we said, I mean markets are running about 11%, 12%. There is a tax element to that and we do expect the market will calm down after tax changes come in. We are at 3%, so we are well inside that from a market share perspective, but we do expect it will calm down.

Antonio Horta-Osorio

And, David, it's interesting, just to add a point of colour here, it's interesting that not only we notice as you were asking a significant increase in buy-to-let due to the stamp tax that was implemented in April, which as George says, now we expect it just to be a translation of volume, so it should be lower now going forward, but we also saw a significant increase in the purchase of second homes which was both buy-to-let and second homes but we see that as a mere translation of volume from later in the year into the pre-stamp duty tax changes.

Operator

The next question today comes from Martin Leitgeb from Goldman Sachs. Martin, please go ahead.

Martin Leitgeb

I have two questions please, and the first touches on the point from George on average interest earning assets. If I look at your domestic retail mortgage book in the U.K., the balance there has been extremely stable pretty much since fourth quarter 2013, obviously excluding TSB at a level of roughly £300 billion. And I am just trying to square out the comments earlier that you are not going to give any guidance in terms of how we should think of this average interest earning assets going forward. With obviously having strong growth in some of the other segments, are you essentially hinting that you would be willing to accept some form of contraction in the total residential mortgage book in order to sustain and protect your margin there?

And the second question is with regards to your branch footprint. I think it's now 1.5 years ago since you announced the current branch reduction target. Just looking at what the competitors have done in terms of their branch footprint over the last two years, average cuts of between 13% and 19%, you seem to have done less in terms of the branch reduction at this point in time. I'm just trying to think going forward, is that an element where you could tweak substantially more in order to address the cost base in case the revenue environment would remain challenging? Thank you.

George Culmer

Look, I think when you look at the trends, I don’t think we break it out by division, but I mean the trends over the last years have been [indiscernible] in terms of average interest earning assets in Commercial has been coming down as we have looked to improve the efficiency and returns of that business have been growing in Consumer Finance. And you are right, the mortgage has been relatively static, it has been round about the £300 billion mark for a while.

I think our strategy on mortgages is quite clear in terms of it is margin over volume. And you know my reason for being hesitant here, that has been the policy and the trade-offs between volume and margin on mortgages, I'm not going to sort of elaborate on because it depends upon the circumstances that we are seeing.

I mean there are other volatile items like things like large corporates and stuff which do bounce around, but would I be prepared to sacrifice a bit of mortgage volume for margin, of course I would, and you see that in the stats that we give today. I'm staying out of buy-to-let, so that's for prudent risk appetite reasons. Mainstream, I am closer to the market but I'm still inside that. And so I am effectively reducing market share and I am emphasising margin over the volume.

Antonio Horta-Osorio

And Martin, we think that is absolutely the right approach in the mortgage market when you have the following characteristics. First, the market is only growing around 2% but all the growth is in buy-to-let. So residential is only growing 1%. So given the market is not growing very much, for us growing a little bit less in the market in terms of market share of the stock is not very relevant. And in terms of risk appetite, we think as the leader in the sector, we should set the standards, the regulator is worried about buy-to-let, we should listen to it and we should set the standards as we are doing.

Secondly, in terms of margin and given internal transfers movements, SVR retention, this is a much more complex game than any other product in terms of new business versus margin and this is clearly the best approach to preserve capital and value for shareholders. And therefore as a whole, we think all the directions point for us to keeping this trade-off which also preserves capital. So we will continue to do that. Of course, the extent to which we will do that will depend on competitive behaviour and on future interest rate movements.

And as George was saying, the reason why we don't want to lead to total guidance in AIEAs is more also due to the fact that large corporates can either borrow or go to the capital markets and they are big so there could be significant movements, and as a consequence we don't target credit growth on large corporates as we have never targeted and therefore we don't give overall guidance on the total AIEAs, but we gave you guidance on the different segments and will continue to do so on the different target segments.

Martin Leitgeb

On the branch network footprint, should we see more optionality here going forward?

Antonio Horta-Osorio

Yes, I think you will. Our strategy in terms of the branch footprint as we have I think discussed last year when we presented the strategy 15 months ago, our plan is that we still think that this has to be carefully considered because still more than 50% of current account openings are done in branch, so client acquisition is still more than 50% than through branches and this is mostly due to AML regulation which asks people to go to branches to verify identification. So that is something which will continue for some time.

Secondly, we think that the better margin sticky deposits are mostly in branches. And therefore the branches are at a minimum value in the cycle given the level of interest rates, where interest rates will eventually increase, the value of the deposits in the branch will substantially increase.

But thirdly, given that our competitors have been closing aggressively and we have been gaining market share just by standing still, to give you an example, the Lloyds brand was five years ago the fourth of the big five and now it is the second just by size, all the others closing branches aggressively. So we have decided to close 200 branches by the end of next year and that would mean that we would at least keep our market share of branches.

We think that the competitors are closing more. We have accelerated our plans as well. So as we said before, we are going to finish this plan ahead of time and then we will present to you additional initiatives and they may include branches as well, given what is happening in the competitive environment.

Operator

The next question today comes from Joseph Dickerson from Jefferies. Joseph, please go ahead.

Joseph Dickerson

George, could you just comment firstly on bulk annuity deals, if there is a pipeline, what it looks like, when such deals might complete just so we can think about the trajectory of fee income over the coming quarters? Secondly, Antonio, I looked at the credit conditions survey from the Bank of England a couple of weeks ago, and if you look at the loan pricing commentary in the credit conditions survey, they were talking about spreads on secured lending to households widening significantly in the first quarter of this year after 13 quarters of narrowing and how lenders expected these spreads to widen further in Q2. Further when I look at your own pricing in non buy-to-let areas, it seems to be going up. So could you just square those data points versus comments around pressure on front books spreads? That would be very helpful to me.

George Culmer

On the bulk annuities, I mean they are obviously transactional in nature. There is a large market out there, multiples of billions, and the largest [indiscernible] come to market each year. We only recognise them when they are transacted. We have an active pipeline, we have secured no deals in Q1, but I can say actually since Q1 we have actually won a number of deals. They will come through. But it will be lumpy in nature. We are targeting a significant financial in number of bulk annuity deals as we move through this year. And as I said, we have already actually in Q2 succeeded. I'm afraid I can't be more specific, but they will depend upon when deals are actually won, so sorry on that.

Antonio Horta-Osorio

Joseph, on the question about the prices, I think you are correct that in Q1 spreads were a little bit better in terms of the Bank of England data. In terms of our prices, you are correct as well. As I was saying, we are the leader of this market. Therefore we set the policy that we think is correct. But as I was saying previously, I would not extrapolate too much quarter on quarter because you have to see the whole picture in terms of applications to approvals to completions. You have to see the swaps movement which was very extreme in terms of Q4 versus Q1, and now up again.

So I mean I was answering my previous question more on a forward looking view for the next two or three months and taking into consideration, if you want, the last four or five quarters, and I think that the general picture which may have small changes from quarter to quarter, but I think the overall picture is the one I was describing, i.e., gentle, progressive pressure on the assets prices given lower impairment levels and benign economic conditions and gentle and progressive downward pressure on deposits given that situation in the U.K. market is quite rich in terms of deposits and therefore deposits come quite easily to banks. And again, as I was saying, the importance is the difference of the two which we manage quite tightly, quite carefully on a multi-brand context and at the top level of the Bank.

Operator

The next question today comes from Chris Manners from Morgan Stanley. Chris, please go ahead.

Chris Manners

So two questions, if I may, both on sort of capital and capital return. The first one was, you have accrued 20 basis points of capital as the dividend in the quarter. By my calculations that gets you to about £0.65. How should we think about that dividend accrual? Would that be sort of your accrual rate for the interim dividend or what you think you're going to be paying for the full year, would that include a special component to it, just what should we read into that pace of dividend accrual?

And the second one was on your 13% go-to capital ratio. When I add up your stack I get Pillar 2A of 2.6, systemic risk buffer of 2.5, countercyclical of 1 and 7% baseline getting you to 13.1. And then I would assume you might have a PRA buffer or management buffer on top of that. To get down to your 13%, we are assuming that Pillar 2A comes down, and if so, just trying to understand what the moving pieces there might be, that would be great. Thanks.

George Culmer

So in terms of capital ratio and capital build, yes, the accrued dividend and how to think about it, I think the short answer is, not too deeply. It is essentially a quarter of last year's ordinary dividend. And as I'm sure you are probably aware, I mean we are required, once one has a dividend policy, you are required under PRA rules to accrue to that policy. So at the moment, we have just accrued one quarter of last year's dividend, but I wouldn't read anything into that. Last year's ordinary dividend, there is nothing around special, there is [indiscernible]. So please, please, please don’t think too deeply about that number. We will obviously talk more about dividends at the half year.

And then in capital stack, I mean obviously Basel continues to produce CPs et cetera. We're always heartened by the last line they talk about, no desire to increase capital and all those sorts of things, and I know that that is very much the stance, not just the words at the bottom of the page, but the stance of the U.K. regulators and we have that confirmed and reconfirmed. And our expectation going forward is that there would be offsets and I would look to manage down things like Pillar 2A within that. So as it stands today, we're going to stick with our sort of 12.1 to around 13.

Chris Manners

Got you. So, am I to take that to mean that you think Pillar 2A is going to come down but that happens when you get inflation from some of the Basel papers, so you would actually have an RWA increase when your Pillar 2A comes down, is that fair to say?

George Culmer

That might be one bit, but there are other elements in Pillar 2A that aren't RWA related. I have got IRBB, I have got pensions in there. So I've got some things that aren't – so I don't think they will get pushed into RWA calculation.

Operator

The next question today comes from Jonathan Pierce from Exane BNP Paribas. Jonathan, please go ahead.

Jonathan Pierce

Three quick ones. Firstly on margin, there is quite a big gap this quarter between banking net interest income and the reported net interest income looks about £90 million which I guess is this insurance and trading deduction. Why has that gone up? That seems to be quite a lot higher than what we have seen in the past. So that is the first question.

The second one is on the restructuring charge again. Could you maybe just give us some feel for where you think that number is going to come out through 2016 and how much you now plan to spend on ring-fencing and structural reform over the next year or two?

And then the third question, I think George you alluded to PVA adjustments within your initial comments that's affected capital in the quarter and I think you said it was something to do with conduct. Could you just flesh that out a little bit, that would be really useful?

George Culmer

So banking, I don’t have the numbers to hand in terms of banking numbers. So there is nothing that I am aware of in terms of the sort of non-margin related NII. So we will get back to you but there is nothing I am aware of in terms of I would particularly want to call out.

The restructuring charge, I guess I'm not going to be very helpful here because the restructuring charge, I expect it to increase and there will be more, but I am not going to give you a number because of what people can infer from that and those sorts of things. That's something that we are going to work on and develop as we move forward. So, apologies for being unhelpful on the second one as well. What was the third question?

PVA, I'm going to be more helpful on this one. So prudential valuation adjustment and it sort of goes into the whole sort of capital volatility point in the sense that what we have applied this time is the new rules have come out from this which we have to apply which essentially I have got my balance sheet values which are a best estimate. I essentially have to overlay for regulatory purposes a prudential adjustment on top of that and it has cost me around about 5 to 6 basis points of capital in Q1. So it's a sort of one-off but I have applied that adjustment and that's what it actually relates to.

Jonathan Pierce

Okay, so it's not actually that material. I was just going to say, on the restructuring charge, are you able maybe within that just to update us on ring-fencing costs because that's obviously an element of this in the quarter?

George Culmer

Yes, that's right, the ring-fencing is about sort of £30 million in Q1. I would expect over the course of this year that would probably be around about £70 million to £80 million I suppose of ring-fencing type cost that I would expect to come through. And overall, it would be around about £300 million or so of ring-fencing and that would incur over the next three years, if that's more helpful.

Jonathan Pierce

Yes, that's useful. Thank you.

Operator

The next question today comes from Raul Sinha from JP Morgan. Raul, please go ahead.

Raul Sinha

Can I have a couple of clarifications and then a broader one on the balance sheet? The first one, George, just going back to discussion on other income that you had previously, can I just clarify that you still aspire to get to positive territory for this year or are you sort of backing away from that, because if I – and apologies it is a little bit semantics, but if I do 1.5 times 4, that gets me to a little bit short of last year's run rate, so if you could clarify that? Especially with some of the bulk annuity stuff coming through I would have thought that you still have a chance of getting there. That is the first one.

The second one is on the NIM. Could you tell us how much more ECN benefit there is still to come on the NIM? And the 2 basis point underlying pick up in NIM in the first quarter, is there any significant moving parts we should think about the next quarter or the quarters going forward where we should actually expect NIM to come down significantly because of any step changes, or is it just a sort of general run-off from here, because if I square the 2.70% guidance or say 2.74%, I appreciate you don't want to get drawn into quarterly NIM dynamics, but if you could give us a little bit more colour on how you expect that, that would be useful?

And the third one is, I saw that your wholesale funding has picked up a little bit on the balance sheet as well and can you tell us if you are going to be running a higher LCR ahead of the referendum and will that have an impact on NIM in the second quarter?

George Culmer

On the first point on OOI, yes, you are being semantic I think. Look, you are right, [indiscernible] as I said at the full year, I expect to move into positive territory and I still hope to move into positive territory, i.e., being in excess of. You are right, so I'm at sort of 1.5, and to your point and to the previous question, I know I've got no bulks in there, I know there will be a contribution from bulks, just to pick one example as I move through the year.

I'm hopeful of Commercial building on their base and developing. It will stay tough in Retail I think, but I'm hopeful of Consumer Finance moving forward as well. So that is not coming off guidance. It remains tough and obviously we will update you as we go through the year, but we are not coming off what we aspired to hit.

On the NIM, a couple of things, ECNs, so ECNs will be about 4 or 5 basis points on the full year. So actually when you look to the sort of 2.64% which was last year to the 2.70%, most of that was actually ECN. So ECN will be also 5 or 6 basis points coming through.

The underlying that is relatively robust. So if I strip out ECNs and I strip out this credit card adjustment we talked about, you will see that the sort of quarter on quarter Q1-Q4, I think we got about 3 basis points from Retail and Commercial deposits, 2 or 3 basis points from wholesale and in offset about 3 from asset finance. So that was the underlying trend.

And going back to some of the earlier discussions, we still think there is more we can do to manage that. So we still remain relatively robust about NIM progression and I don’t want to get too fine as to 1 basis point here or there, but we are still confident of delivering the 2.70%.

And then on wholesale funding, yes, [indiscernible] couple of things going on there. We have done a bit of early issuance, sort of to your question around market disturbance, we have been out early into the market. FX is a factor as well in terms of the pickup in terms of the valuation but we are at a slightly higher LCR, it doesn't have a big NIM impact. We are north of 100 and we are slightly higher than we would normally be, but it does not have a material impact on the NIM.

Raul Sinha

Okay, got it. Thanks so much.

Operator

The next question today comes from Arturo de Frias from Santander. Arturo, please go ahead.

Arturo de Frias Marques

Two quick questions from me please. One, I think you have been very clear and very helpful in what you see in terms of pressure on asset yields versus deposit cost reductions. You have mentioned gradual pressure on the asset side being offset by gradual reductions on the deposit side. I think you have also said that you think the next couple of quarters are going to be pretty much more of the same for what you can see now. So my question is, how many quarters you think you have before you find yourself unable to offset the yield pressure with the additional deposit cost reductions, because we all know that it's more difficult to keep cutting deposit costs versus asset yields. So how many quarters do you think you have? And the second related, very related question would be…

Antonio Horta-Osorio

Arturo, that is a very good question because I have to admit that we have been going on for more quarters than what I said three years ago. We have been progressively managing this better than we felt and sustainably. But the reason why we said in the previous answers, Arturo, for the next two or three quarters is not at all related to any difference on the future, it is just related to the fact, as I think I mentioned as well, that obviously all of this is, we are managers of this Bank, all of this is dependent on what competitors do and how the market environment changes and it is much easier to tell you how we see competitors acting and in the light of the present interest rate environment what is going to happen in the next two or three quarters than to forecast on a longer horizon.

So that is the only reason why I said two to three quarters and you will recall that I have been saying two or three quarters always for the last [indiscernible] years because that's the horizon that we can tell you about and we want to be as always very transparent and very frank with you. And beyond that, it may depend on things that people do tomorrow or in a week.

So we will have to continue discussing this every quarter and we will continue telling you how we see the following two or three quarters, but don't expect anything, number one, steep in any direction in terms of our horizon. And I repeat, the only reason is to be as accurate as possible in telling you how is the largest U.K. retail and commercial bank we see, the interaction of the environment and the different competitor strategies folding out.

Arturo de Frias Marques

Yes, thanks for that. But am I right in thinking that if competitors continue to behave more or less as they have been doing so far, I mean this gradual and gentle erosion that you mention continues more or less unchanged for the next few quarters, am I right in thinking that you wouldn't be able to offset that with deposits for more than these two or three quarters?

Antonio Horta-Osorio

I think the answer to your question is no on both grounds, i.e., first, you are absolutely right that I said maybe a year ago, I said that if the environment would continue with low interest rates for much longer, there would be a progressive erosion on our margin, you are absolutely right. But as we have been commenting at each quarter, we have been able through active management and our multi-brand approach to counteract that, and actually the progressive gentle erosion never happened. And as George just said, we gave you the guidance of the 2.70% which shows an uplift of the ECNs. If you extrapolate the impact of the ECNs out, you have the same margin as last year. So that gradual, gentle erosion that I told you would happen in the future, we have been through active management and multi-brand as such have been able to avoid that from happening, first point.

And to your second point, which is no as well, I don't think if competitors continue to behave as they are that you will see the margin erosion after these two or three quarters I mentioned to you and that's why we were robust when we gave you the 2.70% guidance margin in February and that's why George has told you that we are I would say even more robust now after one quarter that we will achieve that target.

Arturo de Frias Marques

Okay, that's clear. Thank you. The question on costs, you have said also that you will for now execute on that 200 branches reduction by the end of next year. Whether you come back with more, as you said you might do, depends squarely on this NIM performance, i.e., if NIM can be defended, we shouldn't expect additional branch closures, and if NIM cannot be defended, we should expect additional branch closures, it this the right way to think about this?

George Culmer

No, that is a bit narrow. Look we are through 150. I think we did say end of next year, but as I said, we are moving more quickly and it will be done this year. But as Antonio said, there are a number of factors in terms of usage, the embrace of technology, growth in digital, et cetera. So it's too simplistic to say it's NIM.

Antonio Horta-Osorio

I would add only that, Arturo, our branch strategy, as I was answering in a previous question, is more driven by being still more than 50% of client acquisition; second, the value of deposits being higher in branches, they are more sticky and they are I repeat at a low point in the cycle; and thirdly, on what competitors do, and given that competitors have been closing many more branches than they had announced and than what we thought, our market share has increased by going slower.

As George was saying, we will finish the current 200 planned this year, and given everything else including especially the fact that competitors are going quicker, and by the way that customers are also going digital at an exponential pace, we are now over past the 7 million mark in terms of mobile banking users and 12 million in terms of digital users, all the conditions are united apart from our continuous efforts on wanting to be simpler, more efficient in following customers' behaviours, for us to have additional activities in terms of branch closures, which as George said, we will tell you when we finish the current plan. But they are independent from the margin considerations.

Arturo de Frias Marques

Okay, thank you very much.

Operator

Unfortunately, we only have one more question. Investor relations will be in touch with those of you who missed. Robert Sage, your line is now open.

Robert Sage

I have two questions. The first was with respect to Brexit. If you do have any comments about any impact in the first quarter, I would be interested. But my question is more really whether you sense that there might be any pent up demand, possibly among some of your corporate client base or SMEs who might have been delaying investment decisions in advance of the referendum result and whether that could actually lead to some sort of improvement in demand post Brexit, if we vote to remain in? And the second question was just a very quick one. In terms of the conduct charges in the first quarter, could you just give a little bit more colour in terms of what they are and perhaps what the outlook for the rest of the year might be?

George Culmer

Okay, I'm doing the second one first [indiscernible]. I mean it's just a number of items within the Retail division and I can't say what the full year might be. These things when they happen I deal with them and there is no real line of sight in terms of how you go forward.

The Brexit comments, as you know as well as I, I mean you see some impacts in the market in terms of people not participating in the markets et cetera as you move down the various hierarchies of corporate, SMEs, all those sorts of things. SMEs continue to trade and continue to act and transact and draw-down et cetera. You're right, as you go further up, I think maybe some people are standing off, but that's broadly what we are seeing.

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