Lloyds Banking Group's (LYG) CEO Antonio Horta-Osorio on Q4 2016 Results - Earnings Call Transcript

| About: Lloyds Banking (LYG)

Lloyds Banking Group Plc (NYSE:LYG)

Q4 2016 Earnings Conference Call

February 22, 2017, 04:30 AM ET

Executives

Antonio Horta-Osorio - Group Chief Executive and Executive Director

Juan Colombas - Chief Risk Officer and Executive Director

George Culmer - Chief Financial Officer and Executive Director

Analysts

Christopher Manners - Morgan Stanley

Raul Sinha - JPMorgan Chase & Co.,

Andrew Coombs - Citigroup

Claire Kane - Credit Suisse

Jonathan Pierce - Exane BNP Paribas

Joseph Dickerson - Jefferies & Company, Inc.

Martin Leitgeb - Goldman Sachs

Fahed Kunwar - Redburn Partners LLP

Andrew Hollingworth - Holland Advisors

Rohith Chandra-Rajan - Barclays Capital

Thomas Rayner - Exane BNP Paribas

Christopher Cant - Autonomous Research

Robert Noble - RBC Capital Markets

Diarmaid Sheridan - Davy Research

John Cronin - Goodbody

Ian Gordon - Investec

David Lock - Deutsche Bank

Antonio Horta-Osorio

Good morning, everyone, and thanks for joining us this morning. I will cover the key highlights for the year, economic trends and progress against our strategic priorities; and provide an update on our guidance. George will then cover the financial results in detail, after which we will take your questions.

Starting with the highlights of the year. We made significant additional strategic and financial progress in 2016, which is made possible by our simple, low-risk, UK-focused multi-brand business model. We have delivered strong financial performance, with statutory profit more than doubling to £4.2 billion, driven by stable underlying profit and a substantial reduction in below-the-line charges in spite of the lower level of interest rates following the referendum.

Our capital generation is also strong, and we have delivered around 190 basis points during the year. Our pro forma CET1 ratio stands at 13.80% at the end of 2016, to include the retention of around 80 basis points of capital to cover the impact of the MBNA transaction. We also remain committed to supporting the people, businesses and communities in the UK through our helping Britain prosper plan.

And in 2016, we have continued to deliver against our key targets, increasing net lending to SMEs, continuing to be the largest lender to first-time buyers, supporting 121,000 start-ups and helping 10,000 clients to start exporting. We are also a major contributor to UK tax revenues and were ranked as the highest payer of UK tax out of the large 100 businesses in the most recent PwC total tax contribution survey, paying £1.8 billion in 2015, which has increased further in 2016 to £2.3 billion.

In December, we announced our intention to acquire MBNA's prime UK credit card business. As our first significant acquisition since the crisis, this transaction represents a milestone in the transformation of the Group and is fully in line with our strategy to grow in attractive segments where we are underrepresented. And as a result of our progress, the UK government has been able to further reduce its stake in the Group to less than 5%, at a profit, returning over £18.5 billion to the UK taxpayer in the last three years.

Finally, our confidence in the Group's future prospects is reflected in the increased dividends we have announced today and the strong financial targets we have set, which I will cover in detail shortly.

Turning briefly to the financials. The Group delivered good underlying profit of £7.9 billion. Income was marginally down, with stable net interest income and slightly lower other income, but operating jaws were once again positive, with our continued focus on cost management delivering a 3% reduction in operating costs.

Our market-leading cost-to-income ratio therefore improved further to 48.7%. Credit quality remained strong with an asset quality ratio of 15 basis points, and we are seeing no signs of deterioration in the portfolio. As already highlighted, our statutory profit before tax more than doubled to £4.2 billion in the year, with below-the-line charges reducing significantly given lower PPI provisions.

And this strong statutory profit has translated into strong capital generation, which has enabled the Group to fund the MBNA transaction, increase the total ordinary dividend by 13% to 2.55p per share and return surplus capital through the payment of a special dividend of 0.5p per share. I believe this reaffirms the strength of our differentiated business model.

Indeed, this low-risk and simple model provides us with significant competitive advantages, as seen in the consistently high and stable underlying profit the Group has generated over the last few years, where lower income, given lower interest rates, the sale of toxic assets and a more prudent funding strategy, were more than substantially offset by lower nominal costs and much lower impairments. The Group is now translating that underlying profit into strong statutory profit and capital generation, with the gap between underlying and statutory profits narrowing and we would expect these trends to continue into 2017.

Our low-risk, competitive advantage has also been affirmed by the PRA's decision to lower our PRA buffer going forward, and this reflects the significant de-risking the Group has undertaken in recent years. However, we regard this as a buffer against expected future regulatory capital developments rather than a permanent reduction in required capital and have therefore decided to continue to target a CET1 ratio of around 13%.

Going forward, we anticipate our ongoing capital generation to remain strong and now expect to generate between 170 basis points and 200 basis points of CET1 capital per annum pre dividends.

Looking at the UK economy. UK economic performance remained strong in the fourth quarter, with consumer spending particularly robust since the referendum; and GDP growth of 2% for 2016, which compares strongly to most other major developed economies.

Unemployment has also continued to track lower; and now stands at 4.8%, its lowest level for over 10 years. Whilst a period of economic uncertainty is to be expected as the UK leaves the European Union, forecasts from both the Bank of England and the IMF suggest that the UK's GDP growth will continue in 2017. When combined with the longer-term trends of significant consumer and business deleveraging since 2008, the UK economy enters 2017 from a position of strength.

With inflation now forecast to rise, rate expectations have increased from their very low levels back in September, although our internal assumptions and margin guidance do not assume any base rate increase in 2017. The rising swap rates in the fourth quarter does, however, mean we have taken the decision to start reinvesting the structural hedge. And this validates our strategy of building up liquidity during the earlier parts of the past year.

Now for a few comments on unsecured lending, which has received some coverage recently. While unsecured lending has grown in recent years, this growth follows a period of significant contraction between 2008 and 2013 as households deleveraged. For example, card balances as a proportion of household income are below their pre-crisis levels, having fallen from 6.5% in 2005 to 5.2% only in 2016.

Also, throughout the recent period of unsecured lending growth, mortgage balance growth has remained very low. As a result, household indebtedness has improved significantly since the crisis, with unsecured debt as a share of disposable income well below the levels prior to the crisis. In addition, low interest rates mean that households' total debt repayment levels are the most affordable for 15 years.

Turning now to the progress we are making in our strategic priorities. Starting with creating the best customer experience. Our multi-brand and multi-channel distribution model enables us to address the needs of different customer segments effectively while ensuring our customers have complete flexibility in terms of how they choose to interact with us.

Our branch network is the UK's largest, with around 2,000 branches. And while counter transactions continue to reduce, the branches are increasingly being used to advise customers with more complex financial needs. In addition, we continue to deliver our Commercial Banking client relationship model with over 3,000 client-facing colleagues across the SME, mid markets and other Commercial Banking coverage teams.

We are a trusted partner of the intermediary distribution market with a strong proposition and are rated number one for mortgages in our net promoter survey, while in Scottish Widows, we recently won two star service awards for our intermediary propositions. And we operate the UK's largest digital bank, with around 12.5 million active online customers, of which around 8 million access the bank via their mobile. And we had over 2 billion customer logons in 2016, which is up 24% compared to 2015.

Looking at our digital progress in more detail. Digital is a critical element of our multi-channel distribution model and also increasingly a competitive advantage. We have seen significant growth across the channel. And in terms of simple customer needs met, we are now at 61%, which is up from 41% in 2014. Our new business market shares demonstrates the attractiveness of our digital propositions, with the Group's overall digital market share 21% and strong market positions across our major digital product categories.

We do expect this rapid growth in digital users to continue as our customers' behaviors evolve; and we make additional significant progress in simplifying our key customer journeys, including an increase in the proportion of approved mortgage applications which proceed to offer within 14 calendar days, increasing from 37% to 55%, and a simplified SME on-boarding process, which has gone from 15 paper application forms down to just one digital form.

Looking to 2017, we are targeting further progress, which will see the vast majority of account-opening journeys in branch fulfilled via tablets and completed in less than 30 minutes across current accounts, savings products, credit cards and loans, where previously those would have required a 60-minute appointment.

Looking now at how we are becoming simpler and more efficient. As you have heard me say many times before, one of the key differentiators of our business model is our rigorous and proven cost management process. Our market-leading cost-to-income ratio is delivered through our relentless focus on costs, and its sustainability requires the right cost culture to be fully embedded in our organization.

While we are currently ahead of our major UK peers in terms of cost efficiency, we are not complacent. And we will continue to focus on becoming even more efficient, as we believe this is a strategic key feature in the context of the banking industry's ongoing digital transformation.

In response to our customers' changing behaviors and the lower rate environment, at the half year, we announced a £400 million increase to our simplification run rate savings targets. We are now targeting £1.4 billion by the end of 2017. And we are on track to achieve this, having delivered over £900 million of run rate savings to the end of 2016. Given this outlook and in spite of lower interest rates than when we announced our strategic plan in late 2014, we are reaffirming our target for a 45% cost-to-income ratio exiting 2019, with reductions every year.

Turning now to sustainable growth. The acquisition of MBNA is an opportunity to acquire a prime UK credit card business with a strong brand and complementary capabilities. It is in line with our strategic goal to grow in consumer finance, with strong economics that will enhance our future capital generation. The transaction was agreed at attractive multiples, including a six times price-earnings ratio. And importantly, we are not taking any additional PPI exposure following the acquisition.

The transaction will therefore create significant shareholder value through strong financial returns, including a 5% EPS accretion by end of the second year; and a return on investment of 17%, substantially above our cost of equity. This was only made possible by our simple business model and superior cost management capabilities, which enable us to enhance financial returns for our shareholders given we transfer the acquired business cost structure into our own.

Looking more specifically at loan growth. Over the past 12 months, we have continued to support the UK economy with loan growth in our targeted key customer segments. In SMEs, we have once again outperformed the market, growing net lending by 3%, with total SME and mid markets net lending growth of around £2 billion, in line with our helping Britain prosper £2 billion annual targets.

In mortgages, we remained committed to supporting first-time buyers and continue to be the largest lender to this customer segment. We have continued to balance margin and risk considerations with volume growth and have therefore continued to track below the market, especially in the buy-to-let segment, resulting in a reduction in the open book mortgage balances of 1.6%. This reduction has slowed down in the second half of 2016, and we now expect our open book mortgage balances to be broadly stable in 2017.

Our UK consumer finance business delivered strong organic growth within the Group's low-risk appetite. Net lending growth was 8% in 2016, comprising a 20% increase in motor finance and a 4% increase in credit cards. Our vehicle leasing business, Lex Autolease, also grew its operating lease assets by 17%, which means in total UK consumer finance customer assets grew by £2.8 billion. And this is ahead of our £2 billion targets for the year. The acquisition of MBNA will allow us to build on this strong organic growth going forward.

Turning finally to the outlook. We have been successfully executing against our strategic priorities and have delivered strong financial performance and capital generation in spite of the lower level of interest rates following the referendum. Our cost discipline and low-risk business model continue to provide competitive advantage.

Looking forward, the UK enters 2017 from a position of strength and possesses structural advantages that mean it will remain competitive in the long-term. For the Group, 2017 will see us focused on delivering the final year of our current three-year strategic plan; as well as preparing our next strategic update for the period 2018 to 2020, which we will announce to the market around the end of the year.

Finally, our confidence in the Group's future prospects is reflected in our strong financial targets. For 2017, we anticipate our net interest margin being greater than 2.7%; and an asset quality ratio of around 25 basis points, higher due to the lower anticipated write-backs. Both of these targets exclude the impact of MBNA. On costs, on the other hand and as mentioned earlier, we are reaffirming our target for a cost-to-income ratio of around 45% exiting 2019, with reductions every year.

In terms of returns, we now expect a return on required equity of between 12% and 13.5% in 2019, a slight reduction from our previous guidance to reflect the changed environment. This represents a return on tangible equity of between 13.5% and 15%. Finally, on capital generation, we now expect to deliver between 170 basis points and 200 basis points per annum pre dividends, which is made possible by our simple, low-risk, UK-focused multi-brand business model.

I will now hand over to George, who will run through the financials in more detail.

George Culmer

Thank you, Antonio, and good morning, everybody. Looking briefly at the financial highlights. As you've heard, underlying profit was £7.9 billion, with total income of £17.5 billion, which was slightly down on prior year; a 3% lower operating costs, which delivered positive operating jaws; an improved cost income ratio of 48.7%.

On credit, impairment performance remains very strong with a net AQR of 15 basis points, with the increase on prior year due to the expected lower releases and write-backs. The underlying return on acquired equity was also a strong 13.2%, and return on tangible equity an equally strong 14.1%, with the movements on prior year primarily due to the movement in underlying profit and the impact of the banking surcharge.

Looking at income. Net interest income was stable at £11.4 billion, with an eight basis point increase in the margin to 2.71%, offset by slightly lower average interest earning assets. The improvement to the margin once again reflected lower asset pricing more than offset by lower deposit and funding costs, where we've continued to reduce our more expensive tactical savings and wholesale funding, replacing this with relationship retail and commercial deposits.

Our loan-to-deposit ratio was 109% at the end of 2016, consistent with 12 months ago and within our target between 105% and 110%. In terms of Q4, the net interest margin was 2.68% for the quarter, but included only one months benefit of the deposit rate changes that came into effect in December.

Moving forward, we will see the full benefit of this repricing in the coming months. We will continue our focus on margin optimization. As a result, we now expect the full-year margin in 2017 to be greater than 2.70%, and this is before any benefit from MBNA. In terms of other income, which at £6.1 billion was slightly ahead of expectations for the year, driven by a better Q4 performance that was 1% ahead year-on-year and up 8% on Q3.

The quarter-on-quarter increase was primarily due to increased client activity within commercial banking and high insurance income in the quarter following year-end assumption updates.

For the full year, the 1% fall in other income includes a 5% increase in operating lease income from Lex Autolease that continues to grow strongly, a 17% increase in insurance new business income and gains from the optimization of the liquidity portfolio, as well as a favorable impact from the timing of dividends from of our strategic investments.

Offsetting this was continued pressure on fees and commissions, including the impacts of the interchange fee cap on cards, lower returns in the insurance in-force business and reduced income from the runoff portfolio.

Looking at total income by division. In commercial banking, income was up on prior year, driven by high-quality deposit growth in pricing, while group treasury benefited from the gains on sale within the liquidity portfolio and dividend timings, as just mentioned.

Retail again performed strongly with income of £7.6 billion, benefiting from a resilient margin, including the reduction in the tactical deposits, while fee income was adversely impacted by lower ATM, packaged bank account and debit card interchange fees.

In consumer finance, NII was resilient, with increased new business volumes within higher quality lower-margin lending, while fee income was marginally down 2% due to the interchange impact on credit cards more than offsetting the strong growth in operating lease income.

And finally, in insurance, as mentioned, we saw an increase in new business income driven by growth in planning and retirement and protection. This was more than offset by lower existing business income due to adverse economics.

Turning now to costs. Operating costs of £8.1 billion were down 3%, with efficiency savings from our simplification program more than offsetting the increased investment in the business and the impact of increases from pay and inflation. Our relentless focus on costs and proven cost management capability allowed us to reduce absolute operating cost every year since 2010 and in total by around £2 billion while continuing to invest in the Group's strategic priorities.

This track record of delivery gives us confidence that even in this low rate environment we can maintain our previous cost guidance. And we are reaffirming our commitment to deliver a cost-to-income ratio of around 45% as we exit 2019, with reductions in every year.

On credit, as you've heard, our asset quality remained strong with no signs of deterioration in the portfolio. The charge in the year was £645 million, with a stable gross AQR of 28 basis points and a net AQR after write-backs and releases of 15. The quality of the Group's loan portfolio has continued to improve. And impaired loans as a percentage of closing advances now stand at just 1.8% compared with 2.1% at the end of 2015 and nearly 9% back in 2012.

The loan-to-value profile of the mortgage portfolio has also continued to improve, with an average LTV of 44%. And the percentage of the portfolio, with an LTV of less than 80%, now stands at nearly 90% compared with around 60% of the portfolio back in 2012.

In 2017, we again anticipate the gross AQR remaining stable, reflecting the strong credit quality of the book, while the lower level of releases and write-backs means we expect a net AQR of around 25 basis points.

Moving on to statutory profit. Statutory profit before tax has more than doubled to £4.2 billion, reflecting the good underlying profit and lower below-the-line charges. As you know, these charges include the £790 million we took in Q1 for the redemption of the ECNs.

Market volatility and other items total a charge of £132 million. And this includes the £484 million gain on the sale of visa, offset by other items, including the fair value unwind of £231 million and the amortization of intangibles of £340 million.

On restructuring, the £622 million includes costs related to the simplification program, the rationalization of our non-branch property portfolio and work on implementing the UK ring-fencing requirements. And on PPI, as you know, the Group took a charge of £1 billion in the third quarter, but no further provision has been taken in Q4. The unutilized PPI provision at year-end was around £2.3 billion; and reflects our interpretation of the FCA consultation paper, with a time bar coming into force in mid-2019.

Other conduct was £1.1 billion for the year, with £475 million recognized in the fourth quarter. Charge for the year included £280 million in respect of packaged bank accounts, £260 million for arrears-related activity on secured and unsecured retail products and £94 million for insurance products sold in Germany, as well as other conduct risk provisions across the Group.

Finally, our tax charge was £1.7 billion, representing an effective rate of 41%. This high rate reflects the impacts of the banking surcharge, restrictions on the deductibility of conduct provisions, the impact of net deferred tax asset changes in the UK corporation tax rate and movements in deferred tax assets in insurance. Going forward, we continue to expect a medium-term effective rate of around 27%.

Looking briefly at the balance sheet. As mentioned, average interest-earning assets, excluding runoff, were broadly stable at £426 billion, with growth in consumer finance and SME offset by lower mortgage lending.

Going forward, the Group's average interest-earning assets will benefit from the inclusion of MBNA's £7 billion of balances following completion. Runoff continued to manage down and reduced by a further £3 billion in the year to £11 billion.

Risk-weighted assets reduced by £7 billion during the year as we continued to derisk the balance sheet. This has been achieved through a range of actions including securitizations, disposals and a continuation of the portfolio optimization in Commercial Banking. This proactive balance sheet management in commercial has been a key driver of the 8 basis point increase in the return on risk-weighted assets, which was 2.44% for the year and means we have met our 2.4% target one-year ahead of schedule.

Finally, on capital. Again, as you've heard, the Group continues to be highly capital generative and remains well capitalized, with closing ratios of 13.8% for CET1, 21.4% for total capital and 5% for leverage. In the fourth quarter, the Group delivered around 80 basis points of CET1 capital, with full-year capital generation of around 190 and ahead of our guidance primarily due to strong underlying profit and RWA reductions in the final quarter. This level of capital generation has enabled the Group to fund the MBNA transaction, pay an increased ordinary dividend and return surplus capital through the payment of a special dividend.

As you heard, we were also recently notified that, following annual review, the PRA has reduced our PRA buffer to reflect the significant derisking that the Group has undertaken in recent years. As you know, we have – a number of future regulatory capital developments expected, including the introduction of the systemic risk buffer. And as a result, the board will continue to target a CET1 ratio of around 13%.

Finally, on net tangible assets, TNAV per share has increased by 2.5p to 54.8p. This was driven by statutory profit and positive reserve movements totaling 5.4p, partly offset by the 2015 full-year and 2016 interim dividends.

So to sum up. In 2016, the Groups made further good, strategic progress and delivered strong financial performance. Our differentiated business model is delivering. Our cost discipline and low-risk approach are providing competitive advantage, while the investment in our multi-brand and multi-channel distribution platforms is enabling us to create the best customer experience.

The business also delivered strong statutory profit and capital generation, as the gap between underlying and statutory profit narrows. 2017 will see us focus on delivering the final year of our current strategic plan. And our confidence in the Group's prospects is reflected in the increased dividends we announced today and the strong financial targets we have set.

That concludes my review and today's presentation, and we're now available to take any questions.

Question-and-Answer Session

A - Antonio Horta-Osorio

Right, so who would like to ask questions? And let's take three at a time, so maybe starting with Chris, Raul and then Andrew. If you could just identify yourselves for the room, please.

Christopher Manners

Good morning, everyone. It's Chris Manners from Morgan Stanley. And so just two questions, if I may. The first one was just trying to square the circle on your capital generation and your return on tangible equity target. If I look at your 13.5%, 15% return on tangible, that looks to me it's, given £39 billion of tangible equity, a £5.3 billion to £5.9 billion net income number. On £315 billion of RWAs, that means you're doing 2.5 billion to 2.7 billion – 2.5% to 2.7% of earnings to RWAs. If you're only going to generate 170 to 200 basis points a year that does imply a fairly rapid RWA growth. Is that right? Or am I sort of missing a piece on that?

George Culmer

What was the conclusion to all that math, Chris?

Christopher Manners

Just the conclusion was, if you can do almost £6 billion of net income, your RWA is at £215 billion, your capital generation should be a lot stronger than 170 to 200 bps.

George Culmer

So the question was does it imply strong or not strong RWA growth. Was that the question?

Christopher Manners

Yes.

George Culmer

I mean, as you've seen, RWAs have been coming down, as we'll expect as we move toward, particularly given what we're saying on things like open book on mortgages and stuff like that. In terms of RWAs from existing business, you may not see that rate of decline. What we will, though, do is remain extremely focused on RWA optimization. And you've seen a lot of that in Q4. You will continue to see that as we move forward. So I'm not expecting to see strong RWA inflation as we move forward, if that was the – was that the commensurate conclusion of your maths, or was it a different...

Christopher Manners

Well, so the way I come to it is that you're going to – if I look at your net income forecast versus your RWAs, you're going to be generating more than 200 basis points a year, so you need to have strong RWA growth to actually bring the capital generation to the 170 to 200. So either there's some RWA inflation or something else is what it looks like to me.

Antonio Horta-Osorio

We're also acquiring MBNA as well.

Christopher Manners

All right, bringing a piece of MBNA.

Antonio Horta-Osorio

There will be MBNA as well in the RWAs as well.

Christopher Manners

Got you. And second question, if I may, is just on the cost base for MBNA. I guess you've given us the pro forma £333 million of costs for 2015. And you told us you can take £100 million of cost savings out. What should we have as the run rate costs that Lloyds take into the P&L in sort of 2017, 2018? Am I right in saying it'll leave some costs with Bank of America out of that £333 million?

George Culmer

Yes, that's right. So they had a cost base of around about £300-odd million, but within that there's a large slug of that, that will stay with Bank of America. So you're down to net – so these are round numbers, around about the sort of £200 million total. So after you take the £100 million, your total net is about £100 million is the number that comes through.

Antonio Horta-Osorio

Which was the half I was mentioning in between my speech, yes.

Christopher Manners

Thanks.

Antonio Horta-Osorio

Okay. So, Raul?

Raul Sinha

It's Raul Sinha from JPMorgan Caz. If I can stay on the topic of capital generation that Chris was talking about. I think what he was trying to say is that your 170 to 200 is conservative, but even if we take that 200 as a given, it looks like that 200 basis points capital generation would be worth somewhere around 5.5p to 6p of cash flow. And that's probably what drives the ability to pay dividends.

Now where you are today at 3p in terms of the total dividend, there's quite a big gap between the two numbers, and so my question really is, what is the balance that you would look to strike between growth and acquisitions and dividends to shareholders? Because if we take the 200 or 170 basis points of capital generation, that would imply that you have the ability to pay 5p, 6p of dividends this year.

Antonio Horta-Osorio

I'll just make some comments about acquisitions, and then George will answer you about the dividend policy and how they matters, because, as you correctly are saying, we have held around 80 basis points this year to totally funds – pre-funds the MBNA acquisition. I mean, the MBNA acquisition, as we have been saying all along, we said all along since we announced our second strategic plan that we wanted to grow in consumer finance. We are growing quite well organically. And we said, if any portfolio of good quality, low risk would come to the markets, we would look at it to basically grow faster in an area where we are underrepresented.

And this was clearly the case of MBNA. So it's an 11% market share. We were able to completely limit the risk, not taking any additional PPI liability. And given to Chris's questions that we are able to have the cost structure from Bank of America go into our cost-to-income, it's both provides the best price for Bank of America; and a 17% return on investment for our shareholders, which is substantially above our cost of equity. In which other areas are we underrepresented? In SMEs, where we have been growing 5% a year for the previous five years; and 3% last year, slightly lower post referendum.

In the last six years, we grew 30% our net book in SMEs, taking our market share from 13% to around 19%. So we are growing organically quite well and sustainably. And also, on car finance within consumer finance, we have only a 13% market share, but we are growing organically 20% basically based on the Jaguar Land Rover representation, which as I told you many times in the previous four years, all gross businesses is net business.

So we are growing very well in those areas. Should additional portfolios come up in the market in those areas, we would look at them as we looked to MBNA, but we are not seeing anything in the markets that we are aware of in those areas. And we are growing organically very well. So you should consider the MBNA transaction as basically a one-off transaction. It's not a change at one's strategy. We had already flagged, if this would happen, we would look at it. And we were able to do it because it was in very good condition for our shareholders and without any risks in terms of taking any additional PPI liability.

George Culmer

And in terms of capital, I mean, a few points to make. I mean, look, this business has been and will continue to be strongly capital generative. So a simple fact, one. I mean, in terms of the precise amount, I think 170 to 200 is the right range to be targeting. I mean, within that, when you look at the components, there are elements I would point to that I think are going to be consistent, strong, pretty predictable. When you look at this year's capital generation, you've got sort of 2.2 from underlying. You've got 0.2 from Insurance. I mean, I think our underlying profit is going to be a pretty predictable, stable number. So I've got a relatively secured base of 2.4.

Then on deductions you've got things like conduct. I do expect conduct to be on a downward trajectory that will come against that. There are other elements such as things like pension fund movements, below-the-line movements, et cetera. We also know from experience that there tends to be one-offs that one has to deal with and accommodate. And we've got things like IFRS 9 out there et cetera that we have to work through as well.

So I think this business is strongly capital generative. We will continue to be so. There is a core to that, which I think it's strong, stable, consistent. There are uncertainties. I think what we've demonstrated this year is that, when we confront those, we will seek to manage through those the best interests of shareholders. And I think we've demonstrated that in today's results. So that is the challenge that we'll face each year as we come. But the key is, I think, that we have been and continues to be strongly generative.

Raul Sinha

Thanks. It’s very clear. Can I have maybe one more, António, just on the branch? Just because you've given us this new slide with all the branches and the strategy around branches. If you look at the last slide on the pack, which shows the branch presence for all the big brands, one thing, one conclusion, maybe I'm nitpicking, is that you can draw is that you have lagged other peers in terms of branch reduction, if you look at the big brands or if you look at the Scottish brands, you have more branches in Scotland than RBS does. Is there anything that's been holding you back in terms of branch reductions? That's the first point. And secondly, should we think that as a static number? Or is that going to drive the cost saves?

Antonio Horta-Osorio

We look very much at this slide because, as you know, we are very focused on our multi-brand strategy. So there are no Lloyds Banking Group branches there, branches per brands. And this is the way which we look at the market. We look at the Scottish market on one hand, where we compete with Bank of Scotland. That's a geographic segmentation. We look at England and Wales, where we compete through the Lloyds Bank brands. And then we have a challenger brand, which is Halifax, across the UK. And we put there the three major segments and how our branch network competes with each of the peers in those segments.

The second conclusion from that slide, I think, is that, as you say, we were – five years ago, in terms of Lloyds Bank, we had the third largest branch network. And given others close branches much more aggressive than us, we now became the second largest branch network on Lloyds brands alone. As I have always said, we really like our multi-channel approach. We have the largest digital bank. We have the largest branch network as a whole. And several of our clients can use the others branch network in order to do counter transactions, which is helpful. So we are focused on the multi-channel approach in which customers contact with us however they want.

Digital bank, 21% market share; branch network, around a 22% market share. Are we going to close more? I mean, we have a plan announced. We only started closing branches, as you know, with the second strategic plan. That's why others have closed much more than us. And what we are doing here is not a cost matter. What we are doing here is to follow our customers' behavior. So given that our customers are growingly accessing us through mobile or digital, so transactions are exponentially growing, and as I told you, simple needs now are met more online than with all the other channels, we obviously have to adapt our physical branch network to whatever they want to do. And we will continue to do that. So the trends will depend on our customers' behavior.

We don't look at it as a cost measure and then we try to influence customer behavior. We look at how customers want to interact with us. And we adapt our multi-channel approach, including the branch network, to their needs. For example, in Scotland and in the UK, outside the big cities, we are now having a significant program of mobile vans in order to cover the small locations that we leave and we have less banking done. And in order to serve the clients that don't use digital, we are having the service of mobile vans to cover those cities a certain number of hours a week for them to be able to do banking with us. So we look at this from a customer perspective and not from a cost perspective.

Raul Sinha

That’s very clear. Thank you.

Antonio Horta-Osorio

Andrew?

Andrew Coombs

Good morning. It's Andrew Coombs from Citi. I have three questions, but I promise to be quick. The first one, George, you've been kind enough in the past to provide the instant access, fixed ISA and timed deposit rates outstanding during the quarter. It would be great if you could provide that again for the fourth quarter.

The second question will just be your guidance on the mortgage open-book balance, down £4.5 billion in 2016. You're guiding to broadly stable in 2017. That's despite, arguably, quite a challenging industry environment. So would love to know what gives you the confidence there on that guidance.

And then the final question, thank you for the extra slides on digital. Just on that topic, you had a DDoS attack in January. So it was, I think, a two-day outage. So just with that in mind, how much of your focus goes towards cyber? How much of the annual IT budget is on that? And is that something you're investing in?

George Culmer

So I'll do the first one. Yes, so the instant access, which is about sort of £96 billion sort of funds. And within that, the rate at that of Q3 was about, I think, 42, 43. The rate of Q4 is 23, so you can see the action that we're taking. And so, I mean, things like the variabilized, where we've got about £31 billion that was 53 at Q3. And it's now about 35. And the fixed is down. We've got about 27 billion of that. That's pays about 164. It paid about 175. So we talked at Q3, and we've talked about the action we've taken to offset the impact of those base rate cuts on mortgages. As I said in the presentation, we've seen the start of those come through. And as those come through for the full-year, that's when we get the benefit in 2017. And that's a key part of underpinning our margin guidance.

Andrew Coombs

And to be clear: Is that the blend over the quarter, or is that the end of the quarter.

George Culmer

No, that was the end rate, yes.

Andrew Coombs

Perfect.

Antonio Horta-Osorio

Okay, Andrew, on the mortgage guidance that you asked. So I mean I agree with you. I don't see the mortgage market different, in terms of competitiveness, than what it was six months ago or a year ago. So this change of guidance is not a result of any assumption, different assumption about competitiveness. This is a result of the fact that, as we told you in previous quarters, we have had an abnormal influx of deposits following the referendum vote, especially on the Lloyds brands and on the commercial division.

I think I've mentioned to you we had £6 billion of additional deposits, which lowered our loan-to-deposit ratio in the summer from 109%, where it was, to 107% and then to 106% in the third quarter and because those deposits continued to come. And it was unexpected, positively unexpected, because Lloyds Bank commercial deposits have, as you know, lower prices in the market than retail deposits in general.

And as I told you, we would recycle not those. We would recycle our deposits in order to come back to 109% loan-to-deposit ratio. So that was an additional lever we have at our disposal in order to prune high-cost deposits on tactical brands, for example, or on wholesale funding. And at the same time, we have the TFS, as we mentioned, from the Bank of England. And therefore, we were able during the second half of the year to go back to the 109% loan-to-deposit ratio that we told you we would go to. End of December, we had it 109%.

And that provides us lower cost of deposits and, therefore, a buffer, if you want, that we could invest on the mortgage markets and therefore, it enables us to tell you now that our open book will be reasonably stable during the year because of the great work that we were able to do in terms of mix and size of deposits in the bank, which has enabled us to go back to the same loan-to-deposit ratio and invest additionally in terms of, if you want, market share in the mortgage market. So our view is that it is prudent to be stable in the mortgage market.

We continue to think that given the uncertainty out there, given the buy-to-let reservations of the regulator and given that prices have risen significantly, we think it is prudent to be below the market in terms of growth in the mortgage market. We also continue to believe, as we've told you many times, that given the specificities of the mortgage markets, this is not a straightforward breakeven equation between new business and margin. It is much more complex than that given retention, SVR, et cetera.

And given everything taken together, we think this is the right strategy. In the last six years, in the last six months, given the abnormal influx of deposits and given we manage the margin, as you know, as the difference between assets and liabilities, we were able through great work and in terms of mix to have an additional buffer, if you want to invest more on mortgages. So it's not at all an assumption on easier conditions on the mortgage market going forward.

Juan Colombas

I will say that on the cyber one, I will say that you're right. So cyber is one of the key risks of the financial industry, I will say, of any industry. And we take it very seriously. We have been investing heavily, particularly in the last four years. And we are talking in the high hundreds of millions of investment program.

Antonio Horta-Osorio

Thank you, Juan. Another set of three questions. Maybe we can start there. And I will go to the other side of the room then Jonathan and then Joe, please.

Claire Kane

Hi, there. It's Claire Kane from Credit Suisse. Two questions, please. The first is a follow-up on your mortgage strategy comments just there. Can you tell us, have you seen much change in your SVR attrition rates since you cut the rate for borrowers? And is your outlook for stable volumes around a reduction in attrition versus net new lending? And also, if you intend to change some of your product offering, for example, offering residential mortgages to limited companies, which I don't believe you currently offer on a mainstream basis.

And then my second question is just another way to look at the capital generation guidance. Before the EU vote, you had around 200 basis points of capital generation. Since then, as you said, the underlying profitability is broadly stable. And you've now announced the MBNA acquisition, so really could you maybe give us a bit more detail about where the uncertainty is coming from to bring back that range of 170 to 200; and if it is around more below-the-line items like the restructuring charges, if you have an update there on what we can expect? And also, IFRS 9, if you have any quantitative numbers for us. Thank you.

Antonio Horta-Osorio

Okay. So thanks, Claire. George will answer the first one; Juan, the second; and George again, the third. On the mortgage strategy, SVR attrition.

George Culmer

The SVR attrition. So I mean, it actually remains remarkably constant. So for example, the Halifax, well was 3.99%, is now about 9% for the year. And I think that's remarkably flat through the course of 2016. And I think it went up 1% at most, I think, as the sort of intra-quarter variation. So I think that's the scale.

Juan Colombas

We don't do residential mortgages for a company, but we do buy-to-let for companies. And it is part of our SME business, and we have been doing it all the time. So it's a small portfolio compared with the buy-to-let for individuals that we do in the Retail space.

Claire Kane

Would you maybe offer those through your Midshires and [indiscernible] brands? I think that's why you're not offering the limited companies and where the share has been taken.

Juan Colombas

I mean the strategy for buy-to-let for portfolios, after the last regulation that came up, is still – we have until September to define it. At the moment, we are restricting the buy-to-let for only individuals through the retail space. We do something for companies through the SME business.

Antonio Horta-Osorio

And on the capital generation, George, too.

George Culmer

Yes, capital. I mean, if you go back a year ago, Claire, I mean, when we sort of set targets then, we were talking about capital of around 200 basis points. And we talked about returns on required equity of sort of 13.5%, 15%. The backdrop at that time was if we looked at the sort of 2018, 2019, I forget the precise number. The base rates were assuming the sort of 2.5% type, 3% or whatever. That was the backdrop. The numbers that we've sort of talked about now in our assumptions is that we don't expect any base rate action in 2017, and we're sort of assuming that base rates still are below 1% by about that equivalent time period.

Now that does have an impact upon us. And it's obviously incumbent upon us to manage the book in trying to respond to that. And I think you can see that in the way that we've – despite that deterioration in the sort of base economics to our cost income ratio. And so we can respond to that, but I can't offset in full. And that changed economic environment is key in terms of what you've seen as the slight reduction in our risk weight, our return on ROE guidance.

But also, as we've said, in terms of capital, we sort of came in at 200 a year or so ago at this equivalent point with that backdrop because you're right. Post Brexit, when it actually occurred, we talked about we think it's going to be – we just gave a qualitative-type statement. We thought it could be slightly less. We're now further on. We've got better visibility. We've been through another planning round et cetera, and we've sort of replaced that qualitative with the 170, 200 range, which you see now.

Yes, MBNA helps that, but I'm still up against fundamentally different economics, but I think what we're saying in that environment is, even if I'm assuming, as I am assuming, the base rates now stay below one rather than three, I can still make a decent – well, I think it's a very good capital return and a good return on equity. But I can't entirely immunize myself from that change.

Antonio Horta-Osorio

And as you know, we had said at the time, it's the same position, we are very positively exposed to rising interest rates. So having now interest rates less than 1% versus previously, around 2.5% to 3%, that makes a very significant difference in terms of impact should rates go again to the 2.5%, 3% which we are no longer assuming in the guidance we are giving you. Jonathan?

Jonathan Pierce

Thanks very much. It's Jonathan Pierce from Exane. Three questions. The first one is on gains from the gilt portfolio. I can't see there's been any recycling from AFS, so I assume maybe there were some sales on the held-to-maturity stuff on the transfer, but maybe you can tell us how big those were. Or is it pretty much all of the 300 in treasury that you alluded to? And maybe as a broader question on this: Non-interest income for 2017, can you give us any steer there? It's the first question.

George Culmer

Okay. Sorry. Were you saying – you mean non-interest. You don't mean other income?

Antonio Horta-Osorio

You meant in OOI.

Jonathan Pierce

Yes. Sorry.

George Culmer

You mean OOI, okay. I'll change my answer, okay. So on gains, I think, as I said in the presentation and we said in the release, we've been essentially optimizing the liquidity portfolio. And as I said at the time, I think we were sort of a net seller of gilts. The gains is more like about 100 million, is the number in 2016, of which about, I think, 26 million or so was in Q4. And that's both through things like cover bonds, et cetera, as well as a bit of gilts within that.

OI, look, yes, as we said, the year we had is slightly stronger than we thought at a certain point, and that is not just about gains. We saw a strong performance from CB, slightly strong from Insurance. As we sort of move forward, I know I've said this before, but it will stay tough. Generation of fee income products will stay tough. Within our businesses, I would expect CB to move forward. And I think that's based upon the momentum they've got, the investments we've made, the positioning of the commercial bank now within its market and the capability, so I would expect to see that move forward. In terms of OOI, I would expect, I think, consumer finance to move forward.

Again, you've seen the momentum. You've seen the balance sheet growth. And we're hopeful that translates into positive OOI. Insurance will stay tough. It's very heartening to see the growth in new business income. That's the future of the business and the stuff within our protection, on planning; good work also within our corporate pensions. The back book is impacted by economics, predominantly the swap rates, about a 15-year swap rate in terms of that's the sort of the critical indicator there. And that will still be a drag.

So Insurance could be on the cusp. Retail is likely to be down in 2017. And that's a combination of things through ATM usage in terms of lower sales of packaged bank accounts, with value-adds within there. So if I jumble all those up, I'm going to fall short of giving you the precise target, I think we're doing a good job to get close to sort of 2016's total this year.

Antonio Horta-Osorio

Okay, Joe?

Joseph Dickerson

Thank you. It's Joe Dickerson from Jefferies. Just on the matter of interest rates. Could you provide us with the interest rate sensitivity at the end of 2016, say, versus 2015? Because I couldn't find that in the release today. And then secondly, given your comments on the open book of mortgages, could we expect average interest-earning assets to actually grow this year? Thank you.

George Culmer

I mean, our sensitivity in chart, well, I mean I think largely we were about sort of 25 basis points. It was about £150 million, so I think it was about 600% and then slightly higher, I think it's about £175 million, I think, for the equivalent number in terms of sensitivity. And then AIEAs, yes, you're right. I mean they've been – when you look at them, I think I'd call them broadly stable order, excluding runoff. And within that, as we talked about, you've got growth in CF, growth in SME, all the things that you know. But within that, I've also got about a £9 billion, £10 billion reduction in the mortgage book.

Now within that, about £2 billion of that comes from essentially the closed book. And you will see that continue to just run off in the sort of if-type book. But the balance, the delta is from the open book. And you would hope that, if we commit to what we're talking about in terms of open book participation, then that should essentially disappear as we move into 2017. So as that's the main drag, you will be hopeful of a small amount of growth in average interest-earning assets.

Antonio Horta-Osorio

Okay. So let's take the line behind – on the row behind, yes, please.

Martin Leitgeb

Thank you. Good morning, Martin Leitgeb from Goldman Sachs. Two questions, please. The first one, I was just wondering if you could confirm the share in gross mortgage lending you had during the year, the numbers seem to imply a range of roughly around 16%, which would compare to your new open book stock of roughly 19%?

And the second question is to follow-up on your mortgage strategy going forward and if you could just clarify, obviously I understand in 2017, I think you're signaling, you could retain the same margin within the mortgage business as you get the benefit of cheaper deposits coming in. Going further out in terms of your strategy, would you focus as previously on maintaining margins rather than stock if competition were to intensify or would your focus now go more towards retaining the stock you have? Thank you.

Antonio Horta-Osorio

All right, so the mortgage was...

George Culmer

So the mortgage, I mean yes, I think gross sale was about £38 billion, which is you're right. It’s about 16% is the market share.

Antonio Horta-Osorio

But Martin, obviously to see the growth of the open book, you cannot look at the gross margin only because, as I was explaining previously, you have to look at SVR, retention, internal transfers. It's a much more complex book than just looking at gross margin. On our mortgage strategy, the mortgage strategy is exactly the same. So we did not change any strategy.

We have been telling you and I just repeated in the previous answer that we continue to think that in the current macroeconomic environment and in a market, which does not grow, except mainly in the buy-to-let segment. It is prudent to focus on risk, capital and margin, except and instead of focusing on volume growth.

That's what we have been doing since around 15 months ago in order to do that strategy, which we are now doing for 2.5 years. We gave up some growth on the open book, as we just discussed. And we now think that we can continue to execute the same strategy with a stable open book, as simple as that.

And for the future, we will consider what competitors do and how to best respond within the same strategy, which as long as the macroeconomic conditions continue and as long as the growth of the market continues, I think it is exactly the right one. There is very different strategies, what we do for example on car finance, where given we are underrepresented. The return on risk weighted assets is the highest of all of our portfolios within prudent risk appetites. We are growing significantly market share and are decreasing somewhat the margins, exactly the opposite strategy because it's a very different environment. Please?

Fahed Kunwar

Hi, it’s Fahed Kunwar from Redburn. Just a couple of questions and following up on that Consumer Finance point. I mean your growth is very strong 11%, but the margins were down 75 basis points year-on-year. So I mean is the answer much likely during the last few years that it's either margin or growth and the end point is NII is kind of flat to modestly down going forward unless asset prices start to rise?

I mean we've seen from other market participants that competition is very tight in unsecured and capital keeps flowing into it as well. So I was wondering. What is the outlook on NII rather than margin and growth on the Consumer Finance book?

And the second question is just on your ROTE target of 13.5%, 15%. I mean you did an underlying ROTE of 14.1% in 2016 and you've got I think, a base rate right about, what 75 bps out to 2019. So why is your overall ROTE target so low considering the current ROTE and you've got base rate rises in your numbers? Thanks.

Antonio Horta-Osorio

George will take the second question. I just like your point, so low. But if you compare to general guidance, it doesn't look to me so low, but anyway, just George will take the second question. On the first question, I mean I think you're right on what you said, but I think there is an important point, which happened in 2016, which we do not anticipate in 2017, which is we fund the Consumer Finance portfolio partly with German deposits.

And given what happened with interest rates in Europe in the past year, where they went very negative, there was an especially negative impact there. That's also why we have substantially reduced that book during the year. That is part of the tactical brands and as you saw in George's slide that was where we reduced most of the portfolio. So that was a bit one off effect, which is not related to the Consumer Finance lending side, if you want. It's related to the way we fund it. So I would not expect that to happen in 2017.

You are right on your considerations. I repeat it's our highest return on assets portfolio with prudent risk. We are growing very much because the Jaguar Land Rover representation, which we'll consider prime business, until this year, all gross business is new business because there is no redemptions in the first four years. So I would expect the net interest income to increase in 2017.

George Culmer

Okay. And then the second one, I mean the sort of the comparison between the sort of the underlying returns that we're currently posting versus the target we've got. I mean I suppose there's two things to that one is again, the delta between the underlying and the statutory and I think if you look out hopefully, PPI will be, but a memory by then.

Other conduct, it's disappointing this year that other conduct has gone up. We expect it to trend down. It will trend down. I do think other conduct will continue to be a feature, but at a much diminished rate, but it will come down. There will also continue to be a number of small items below the line. I'm not preempting any big below the line charge or anything that people don't know about is just the amortization stuff. So there'll be a few things that go through.

In terms of the underlying result, though I mean I think it's also worth bearing in mind, yes, we've assumed a very modest amount of base rate increases we flow through. But also I think it's fair to say and again that the AQRs that we're seeing, I think, when we did our last stretch update, we talked about a through the cycle of a sort of 40 basis points. Now we would be inside that now, but I think our sort of long-term run rate certainly wouldn't be 15. So yes, there'll be a slight pickup in terms of income, but I am factoring in a higher AQR when I put that number out as well.

Fahed Kunwar

And just to be clear: So is that a 1% base rate in 2019 in that ROTE guidance?

George Culmer

It was just below 1% I think. I mean, we assume nothing happens until about 2018...

Antonio Horta-Osorio

So it's within a much more prudent interest rate environment.

Fahed Kunwar

Yes.

Antonio Horta-Osorio

Please, on the second row and then go behind you.

Andrew Hollingworth

Good morning, Andrew Hollingworth from Holland Advisors. Just one quick one on this whole return on tangible target, so I get different interest rate guidance and that's where you saw that you've given that and maybe it makes the situation more realistic from where we start today.

But sort of squaring the fact that your capital generation points, it does feel like the return on tangible target is an underlying number, not a reported number. And I know that's not what you said in the past, but the basis that you've – is it realistic to have a situation that it's a clean bank in three or four years time with no restructuring charges, with no write-down charges on sort of miss selling?

And therefore, do you not end up with a return on tangible target that will never be at reported level and actually the reason why your capital generation is lower than people are expecting in this room is because of the fact that your return on tangible is actually at the underlying level?

George Culmer

No. I mean it is definitely at that reported level. To your point and sort of going back to some elements to the earlier question, I would have thought there will be a feature of some element of conduct. I mean conduct is just when we treat our customers, we do things wrong and we make them whole, I mean it's part and parcel to this to be able to minimize those occasions. We're going to make sure that we address them as quickly as possible.

But it isn't preempted, ongoing restructuring charges, all those sorts of things. It is a generally at the reported level. Now I'm never going to see – you're never going to see a 100% flow through of underlying down to statutory. There'll be a small element of dilution, but compared with what we've shown on the charts, you've seen in prior periods, I would expect a much, much – much more reduced element in terms of that dilution.

Andrew Hollingworth

I suppose that basically then the other way to look at it is in that target you have long-term. There is some ongoing the type of restructuring that a bank such as your nature requires on an ongoing basis, that is in the target?

George Culmer

That's correct. That's correct.

Antonio Horta-Osorio

Yes. Not restructuring, in terms of ratifications to customers, right, which you were calling me selling. It is not me selling, I mean. In the same way that we lend money to people, expecting to get it back, but sometimes they don't buy and you have impairments. We try to do the right thing every time, but sometimes, clients have not been exactly the commission has not been right or something. And you have to do ratifications to customers, which are part of normal business. So as George was saying, we are assuming there will be some ratification, some customer redressing permanently, like there is some impairments. Impairment is part of business.

Andrew Hollingworth

But surely restructuring is part of normal business as well in a bank?

Antonio Horta-Osorio

Yes, but restructuring, we are not assuming anything in particular because if we did then we would assume additional cost cutting measures as a consequence, so the two go together.

Andrew Hollingworth

Thank you.

Antonio Horta-Osorio

Okay. We have two questions behind you, yes. Sorry and if you could...?

Rohith Chandra-Rajan

It's Rohith Chandra-Rajan from Barclays.

Antonio Horta-Osorio

Yes.

Rohith Chandra-Rajan

Two quick ones, please. One, just on the AQR guidance, I appreciate the 25 basis points is gross 28, stable on this year. So sort of suggesting a fairly stable economic outlook, just curious into the medium term about the sensitivities of that AQR number to unemployment, property prices, GDP, et cetera, if you can give any guidance around what you see as the key sensitivities? And then the second one was just on the margin, where you're a little bit more confident now when – than you were back in December when you reiterated the around the 2.70%. You're now saying above 2.70%. Just curious about what's changed there, please?

Juan Colombas

Second one?

Antonio Horta-Osorio

Juan, can you take the first one?

Juan Colombas

Yes. So in the [rate of] portfolio, the main sensitivities were to unemployment as you say and HPA in the mortgage book. Unsecured is basically unemployment, I would say the main driver of future impairments. And in the corporate book, what we have seen today is related to unemployment as well. What we have seen in the corporate book, which is a special feature is the low level of the corporate doing. So the interest rates are very low, so the capability of repaying debt is very strong and we see corporate in the UK also with big levels of cash and so this is a very sound position and very different, the best in the last 30 years. So that's special feature we see today.

Antonio Horta-Osorio

And just to complement what Juan said and George alluded to that. I mean, we have in our opinion, now a much lower AQR through the cycle than what this bank had six years ago because it is a very different bank. So to start with the £200 billion of toxic assets, which now are reduced practically to zero, the low risk approach that we took for six years in terms of new cohorts et cetera. We think, the AQR through the cycle – to your point as well – to your question as well is much lower than what it used to be six years ago.

And on your second question, about our confidence on margin, our confidence on margin this year, you are correct, we are forecasting now higher margin than what we said in Q3. We had said around 2.70%. We finished slightly better in the upper side of 2.71%. And we now think that the margin will be higher than 2.70% in the year.

This is mainly due to two factors: first, because we have a very good quarter in terms of as I was answering before, in terms of managing the liabilities of the bank as a whole. And through mix and great management in several divisions, we were able to go back, as I said to the target loan to deposit ratio with a lower cost of deposits. We look at margin as the difference of the two. So that has enabled us to be more optimistic about margin this year. And at the same time to invest more and keeping the open book of mortgages flat as we discussed before. So that is the first one. It's not a market-driven point, but it is a bank specific point.

And the second one to be very frank, is that time has gone by and those good results allow us to do other things. And therefore as time goes by and we keep improving the performance of the bank. We obviously feel more comfortable to do additional things and be able to continue improving performance.

So we are closer to the year. We are now more comfortable that the good work done in the second half is producing sustainable results, and that's why we are giving you a better guidance. But this is all based on this great work done at total balance sheet level from various divisions in terms of mix and deposit acquisition. Shall we take – Tom? Okay.

Thomas Rayner

Thank you, Antonio. It's Tom Rayner from Exane. Can I just come back to your mortgage strategy please, because you mentioned it a few times and given your appetite for unsecured growth and it's just you're not overly concerned by the macro environment in the UK, yet the sort of the strategy, I mean I would have looked at the new business rates in the market and on required equity, would have thought they'd still been quite attractive returns on capital. Just trying to get a better...?

Antonio Horta-Osorio

On which segment?

Thomas Rayner

Well, I mean maybe on buy-to-let as well, but if you...?

Antonio Horta-Osorio

You mean mortgages?

Thomas Rayner

Sorry, mortgages. Yes, mortgage market. The new business rates, obviously a lot lower than the back book, but still possibly giving you good returns on required equity, so just trying to get a sense for your fairly prudent approach, is it that you really don't like buy-to-let and you don't really see the mainstream market sort of recovering? Or is there an element of protecting that back book so you don't want that 9% attrition rate to start moving higher perhaps if you start pricing more aggressively? Is there any competition angles? You're actually quite glad in bringing down your market share...?

Antonio Horta-Osorio

That's a lot of questions, Thomas.

Thomas Rayner

Well, it's all the same question. I'm giving you potential answers. I'm just trying to understand your thought process?

Antonio Horta-Osorio

There is no big mystery about this. I mean, I think I have been quite open and quite constant and I would say, quite firm on this belief. I think the mortgage market, as I told Jonathan, sitting next to you also from Exane that the mortgage market is much more complicated than people might think versus other segments because it is not a direct equation between new business margin and volumes.

You have to take into consideration internal transfers, SVR attrition and the impact of price movements in any of those on the others because they are correlated. And therefore, taking that point into consideration, plus my prudent macroeconomic assumption where I think we should be prudent given uncertainty out there, and thirdly, the fact that the market grows very little and the main sector that grows is buy-to-let, where we are even more prudent, everything points to privileging risk, capital, and margin instead of volume. We don't have any doubts about that for us.

On the unsecured market, although rates have been coming down, as we previously answered, we think that it is still the highest return on risk weighted assets adjusted for the over the cycle AQR. We think where we are growing, primarily in the Jaguar Land Rover representation business is prime consumer finance. We don't do subprime anywhere between particularly like the Jaguar Land Rover brand, which we consider the prime-prime, if you want. And we are growing there at appropriate returns. We are underrepresented. And that's why we have a different strategy than in the mortgage market.

The final comment I would make is that, when you consider margins, you have to consider in my opinion, the difference of the two margins and not just versus a base rate or whatever. You have to consider every asset you give. Every loan you give, you have to fund it. So that's why we'd like to see the difference of the two and not just the margins individually.

Thomas Rayner

Can I have one more?

Antonio Horta-Osorio

You've already asked five or six questions. So can we go to the other row, please? It's the other row behind you. We have to start doing questions by house, so please.

Christopher Cant

Yes, maybe you need a ticketing strategy for the Q&A. It's Chris Cant from Autonomous. I just wanted to ask two, please. One on non-banking NII, it's been running around negative £100 million per quarter during the course of this year. I'm just wondering what guidance you can give us for next year in terms of understanding how to interpret your NIM guidance, whatever may end up negative and should we just put in 400 again? And to follow-up something you said in response to a previous question related to that, you said NII would be up in absolute terms next year. Is that a pre-MBNA comment or a post-MBNA comment, because it makes a difference?

And then secondly, you've made some comments about your capital position, the PRA buffer reducing, but sticking with the 13% because you view that as a buffer against future potential regulatory action. I'm just wondering if the thing that squares the circle between your guidance there and your capital generation guidance is actually you're expecting significant RWA increases. So when you're looking out to that 2018, 2019 point and you're talking about this 170 to 200, do you have an assumption you can share with us about the quantum of RWA inflation you're assuming? Thanks.

George Culmer

Okay, yes.

Antonio Horta-Osorio

So okay, so shall we take the first one?

George Culmer

Yes, okay, so the non-banking NII, which you're right; it has been bouncing around and I think we want to stop that. So we're going to take a longer look at that. And I would expect it to be a smaller number in 2017.

Antonio Horta-Osorio

Okay. And to your second question, I mean, I did not say I was expecting NII to go up this year, I mean and I'm not saying the opposite here. What I said is I expect NII to the question, NII to go up on the Consumer Finance area, which was the question...

Christopher Cant

Sorry. I misheard.

Antonio Horta-Osorio

Okay. And I did not say nothing about the total NII. We were discussing the Consumer Finance NII, which I related to the German deposits, which we partly used to fund. That was the conversation and on the capital, 13%...

George Culmer

No. Right, a number of things, I know we said this is in the presentation, but it's worth repeating. Yes, I mean its good news. I think it was reflective of the de-risking that we have undertaken that we've had this reduction in the PRA buffer. And again as we've said, we're going to stick at 13%. And this is about regulatory developments, Chris. This isn't about any foresight we have about RWA inflation, whatever happens to Basel IV et cetera who knows at the moment? This is about things like the position of systemic risk buffer overlays in sort of 2019. So it's not about RWAs. It's about changing capital rules.

Antonio Horta-Osorio

Yes. And what's happened on the PRA buffer is not a surprise to us. We were expecting that. As like George has said, we also know there are some known headwinds out there, like the systemic risk buffer domestically, which is taking everything into consideration. We have told you before we expect our capital to be around 13%. Now the buffer has been reduced, as expected. We know the others will come in the future. We continue to expect the 13%. Sorry. You have been trying to answer a question for some time as well. And we will go to everyone since we still have some time.

Robert Noble

Thanks. It's Rob Noble, RBC. I'm just wondering on the margin drivers in the Consumer Finance book, but split by the different products. So what's the difference in the margin between the cars, the cards and the personal finance? And what are the drivers between the three of them? And then on TFS, how much TFS funding did you take and your average interest earning asset growth, do you expect to fund that with more TFS funds over the year? Thanks.

George Culmer

So, on the TFS I think we've taken about 4.5. And I think total pass through would be expected to be around about 20 and I expect us to be drawers of the TFS. So it's an appreciated development, and we will make full use of that. I mean in terms of the first two, we'll come back to you on the sort of specifics in terms of the relatives, attractiveness in terms of card, car financing and et cetera.

So apologies to sort of push you off, but as Antonio said, this is an attractive part of the business. And when you look at the returns we're making when we look at the economic buffer that it generates. We are big supporters of the sector and so the capital we're deploying. So we will come back to you with some of the specifics in terms of the individual...

Antonio Horta-Osorio

And we manage it together because we think from the client point of view they are resource substitutes of each other. That's why we manage them together, but we can come back to you with specific points if you want.

So going to this side of the room, second row and then fourth row. So can we have a microphone there? You have it already. Thank you.

Diarmaid Sheridan

Good morning. It's Diarmaid Sheridan from Davy. Just a question around AQR, please, interested in your thoughts around IFRS 9; and maybe on day one impact, firstly, but also then through the cycle, how you think that could impact you? Thank you.

George Culmer

Okay, IFRS 9, what is it, 1/1/18 impact. We're not going to say anything now. We're obviously working on it and all those sorts of things in terms of what numbers might be a part of that is obviously because you've got to determine your view of the future when you arrive at that particular point.

So we will probably give some more update as we move through the year. As you know, from inverted myself capital perspective, there is the proposal out there to apply a transitional basis to smooth over three to five years, which they would be welcome and will make it much more sort of able to deal with.

I think I heard, I saw comments by HSBC on this. I mean it will – I'm not a big fan of IFRS 9. I mean it's going to produce more volatility. I think it's going to make it quite impenetrable for users and accounts to understand what's going on in the variables in terms of views of one's book and views of the future and how they too interact with each other. You'll get greater volatility, nothing obviously will change over the life cycle of an asset, but you'll get something that's harder to understand. It's more volatile, but so be it...

Antonio Horta-Osorio

So shall we go to the fourth row? Do you have the microphone with you?

John Cronin

Hi, John Cronin from Goodbody. Just to come back to Consumer Finance, please and I appreciate that you're going to come back with more granularity on that but just ask the question in a more broad side perhaps. You've called out that there has been some assets yield compression in that book – asset yield compression over the course of 2016 owing to the surge in motor finance lending. You talk very positively about growth in that book. So I suppose how in broader terms should we be thinking about the asset yield progression with respect to that specific book?

And my second question is to just come back to the capital guidance again. And I appreciate your point around the systemic risk buffer being the key driver of the – in terms of the retention of that guidance, but just to put it to you, if we were to find out later today, for example that all of the Basel IV so-called regulatory proposals were dropped. Would you think 13% is the optimal or appropriate target for your investors?

Antonio Horta-Osorio

So George will take the second question on why he thinks, I'll listen first one. Look, you are right about that asset compression, but it is not really an asset compression, as it has a big impact of the mix because where we are growing the most is in Jaguar Land Rover. And as I told you, Jaguar Land Rover is what we consider prime-prime car finance. And as prime-prime, it has lower margins than the rest of the segments.

So it's the significant where we are growing the most. It's true that margins in general are going slightly down, as I previously answered. But through mix, given we are growing more in Jaguar Land Rover than the rest, it looks to you a bigger compression. It's a mix effect. It has much lower AQRs and as I said, it is our highest return on risk weighted assets of all the portfolios.

George Culmer

And in terms of the capital, I mean if Basel IV does gets cut be sure to let me know. But even it does – it’s going to be replaced by something. So I mean from us as a business, we think 13% is about the right number. Now we will – as Antonio said, the movement on the PRA isn't unexpected because we have been derisking the portfolio and we would expect to see that to come through. And you've seen that in our stress test results et cetera. So, perhaps as we move forward and Basel IV did hypothetically disappear. We might come up with a slight cuter number, but it's all hypothetically. And look, you can overcomplicate these things. We manage the 13%, assume 13%.

Antonio Horta-Osorio

Okay, so we are coming to 11:00, so we'll take one or two final questions. So there is one out there and another one there, so we'll take those two final questions, please.

Ian Gordon

Ian Gordon from Investec. Two quick ones, firstly, apologies if I've missed it, but if you haven't disclosed it. Can you just spoon feed me on the planned phasing of your TFS drawings? And then secondly, probably a statement of the obvious, but in the old days, someone always used to ask the dull question, are you happy with consensus? And the answer was always sort of, yes.

Listening to your comments, in your usual understated way, you've already told us that, relative to your own consensus compilation, NII is wrong, volumes are probably wrong, the cost to income ratio is wrong, and impairments are plain nuts. So I assume that you are very unhappy with consensus.

Antonio Horta-Osorio

That was a very British and elegant way of putting the question. Those easy questions always go to my CFO.

George Culmer

No. I'll do one. The [TSF], look, we haven't said. I mean we assume sort of relatively equal drawings through the year. So I mean that's – I think that's how we will actually draw on this. So in terms of the undrawn element, assume that, that is drawn equally through the quarters of 2017.

Ian Gordon

So off of 20-ish?

George Culmer

Sorry...

Ian Gordon

Off of 20-ish?

George Culmer

Roughly, yes, of that order. And as I said, we've already done about 4.5 or so of that. And do you know I've never commented on consensus before?

Antonio Horta-Osorio

Me neither. It's quite confidential.

George Culmer

Yes, so I'd rather not start now actually. I'm sorry. Yes.

Antonio Horta-Osorio

Thanks, Ian. Shall we take the last question?

David Lock

It's David Lock from Deutsche. Just a couple of quick ones, please. The first one is on the restructuring charges. I just wanted to check. I think there's three outstanding programs you've got. You've got the simplification, the ring-fencing and then the MBNA. And it's about £750 million to run, I think, on those. If you could just confirm that figure.

George Culmer

Yes. So we had about £600 million, we've seen in the year-to-date. And there are three actually that runs with this. We've basically got the simplification, which is about £400 million of that number. We've got the non-branch property portfolio, which I think is about £50 million of that number. Then I've got my ring-fencing, which is about £150 million of that number.

And in terms of sums to come, I think the ring-fencing, we said around £300 million. It could be slightly north of that, but as I said, there's another £150 million and a bit to come on that one. On the non-branch, I think it was £300 million, so there's about another £250 million between now and, I think, 2019. And I'm not supposed to be confused by this, but on the simplification one, on the restructuring and redundancy costs essentially, I think it's – we said at the half year there would be around about £350 million to £400 million, of that order. And I think, since that point, we've taken about £150 million of that, I think.

David Lock

And then there's the MBNA, £200 million, to come...

George Culmer

MBNA will be in excess of that. That's correct, yes.

David Lock

And then the other quick question was just on the fair value unwind line. I know it's been ticking up a little bit. Just should we expect this to continue to tick up in the coming years? Or should this really start to tail off next year?

George Culmer

It drops away. It drops away. Now whether it is – I think it drops around about 2018. It drops away quite markedly.

End of Q&A

Antonio Horta-Osorio

Okay, well, thank you very much. Thanks for coming. And we'll put to close the conference call now.

George Culmer

Thank you very much.

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