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[Audio Gap] Lloyds Banking Group 2021 Q3 Interim Management Statement Call. [Operator Instructions] There will be an introduction from Charlie Nunn and a presentation by William Chalmers followed by a question-and-answer session. [Operator Instructions] Please note that this call is scheduled for 1 hour. I'm emphasizing that this call is being recorded today.I will now hand over to Charlie Nunn. Please go ahead.
Thank you, operator, and good morning, everyone. Thank you very much for joining our third quarter results presentation. I'd like to start by saying how pleased I am to be speaking to you today. It feels to me personally like to see a long time coming, so it's great to be here with you.As you know, we would usually present a quarterly update. But I wanted to introduce myself to you. I'm going to talk briefly about our initial thoughts since joining the Group, before handing over to William for the usual run-through of the financials. So this is my 11th week with the Group. And since joining Lloyds in August, I've being impressed by the power of the Group's purpose of helping Britain's prospects. This purpose runs through everything the organization does and the Group is clearly playing its part during the pandemic. I've also seen firsthand the strength of the Group's colleagues, our customer franchise and the breadth of our digital banking proposition. These are significant competitive advances and it can give us a great base upon which to build.The Group has a strong stewardship mindset and a proven track record of managing risk, alongside our balance sheet and capital strength. This will provide a springboard to the Group in the future. The Group has strong foundations, and we're now working on the detail of the next evolution of our strategy. I'm not going to talk today about our plan, as clearly, they are still under development. So I want to let you know about some of the areas we will be thinking about.Firstly, we have exciting opportunities to grow and deepen customer relationships across all of our businesses. Wealth and Insurance, we've talked about as I've started to land with the organization, I can see opportunities across all of our businesses.Secondly, the pandemic is driving a shift in how customers turn back. Given my digital experience, I'm now very focused on how we can support this transition and leverage the increasing adoption of technology by both our customers and based on the incredibly strong starting position Lloyds Banking Group has around its digital capabilities and services.Thirdly, our commitment to efficiency will remain unchanged. And finally, I'm also very focused on enhancing the Group's investment proposition and delivering sustainable long-term returns and distributions whilst investing in the business.I would like to give a quick sense of my initial views and some of the exciting opportunities we have. I will talk more about this in February, when we will provide a strategic update alongside the full year results.And with that, I'm going to hand it to William. William?
Thank you, Charlie. Good morning, everyone. Before covering the Q3 financials, I'll turn first to the continued progress on the strategic review 2021, as outlined on Slide 3. We've made strong progress on Strategic Review 2021, ensuring the Group maintains momentum at the time of change, both for the organization and of course, in the external environment. We're pleased with our progress and we're delivering on our commitments.And depending on our strategy, our focus of 2021 is on helping Britain recover. In respect of this, we've so far delivered GBP 12.8 billion of lending to first-time buyers, exceeding our full year target of GBP 10 billion. We're also expanding the availability of affordable and quality homes by increasing our funding to the Housing Growth partnership.Within Scottish Widows, we have introduced a fossil fuel-free fund, allowing pension savers to invest with a positive environmental impact. We continue to make progress against our customer-focused ambitions in becoming the preferred financial partner for personal customers. We have delivered our strongest open book mortgage growth in over a decade, generated GBP 5 billion of net new assets under administration in Insurance and Wealth and announced the acquisition of Embark Group, which will complete our wealth capabilities.Customers continue to improve our service rankings. We are exceeding our targets for both our all channel net promoter score as well as our mobile app NPS.In our ambition to be the best bank for business, we have seen over 50% growth in SME products originated digitally. Meanwhile, we continue to improve our core market offering, improving our position in the league tables.Enhancing our capabilities is an important part of our Strategic Review 2021 commitments. As example, we continue to build our infrastructure, including further investment in data-driven business, and we've delivered an improved merchant services proposition in the payments area, the latter resulting in a 12% growth in new clients so far this year. And finally, we're rolling out hybrid ways of working for our colleagues, allowing us to remain on track for an 8% reduction in office space in 2021.I'll now turn to financial update beginning on Slide 4. We saw a solid financial performance in the first 9 months of the year, built upon continued business momentum. Net income of GBP 11.6 billion is recovering, up 8% from prior year with Q3, up 5% on Q2. Net interest income of $2.9 billion in the quarter is benefiting from higher average interest earning assets of GBP 447 billion on a Q3 margin of 255 basis points, which is up slightly on the second quarter. Other income of GBP 1.3 billion in the quarter is up 4% from Q2. Net income of GBP 11.6 billion includes GBP 111 million operating lease depreciation charge in the quarter. This remains below our typical run rate given the ongoing strength of used car prices.As you heard from Charlie, we remain committed to efficiency. Our cost income ratio in the quarter was 48.3%. The slower increase in costs versus prior year reflects the accelerated rebuild of variable pay, which I mentioned at the half year. And this, in turn, reflects our stronger-than-expected financial performance.Underlying asset quality remained strong and combined with the improved macroeconomic outlook supports a net impairment credit of GBP 84 million in the quarter, now totaling GBP 740 million in the year-to-date.Based on all of these inputs, statutory profit before tax of GBP 5.9 billion for the 9 months is significantly up against prior year and represents a solid recovery. Alongside, we have delivered continued balance sheet growth and streamed strong capital build. The CET1 ratio now stands at 17.2%, up from 16.2% at 2020 year-end.Now let me turn to Slide 5 and cover the continued franchise growth seen in the third quarter. As you can see, continued mortgage growth was the main driver of our balance sheet momentum. Growth in the open mortgage book slowed in the quarter versus Q2. Nonetheless, it was still up at GBP 2.7 billion and is now GBP 15.3 billion higher than at the end of 2020.We're also just starting to see growth in credit card balances, which are up GBP 0.2 billion in the quarter, partly driven by a recovery in travel spend, and we expect this gradual growth to continue over the coming quarters.Commercial banking balances are up GBP 1.5 billion in the quarter as we've seen higher corporate and institutional drawing more than offset repayments of lending from government support schemes. On the other side of the balance sheet, we've seen continued inflows through our trusted brands. Deposit balances in retail are up GBP 4 billion in the quarter. Total Group deposits are now up more than GBP 28 billion so far in 2021 and over GBP 67 billion since the end of taking before about how the significant deposit growth will give us opportunities to diversify our customer relationships and indeed to increase our formal hedgeable balances.In the context of the balance sheet purchase touched upon, average-interest earning assets saw growth of GBP 5 billion in Q3. AIEAs now stand at GBP 443 billion for the year-to-date. And we continue to expect low single-digit percentage AIEA growth for 2021.We expect mortgage growth to continue into next year, alongside the gradual recovery in unsecured balances in retail. In commercial balances, we expect AIEAs to be impacted by our government guaranteed loans being repaid and our ongoing optimization of our portfolio.I'll now turn to Slide 6, income performance a little bit detail. Net interest income of GBP 8.3 billion is up 2% from the first 9 months of last year, with Q3 up 4% from Q2. This is on the back of increasing average interest earning assets and a strengthening net interest margin of 255 basis points in Q3, up 4 basis points in the quarter. Within the net interest margin, mortgage completion margins were around 160 basis points in Q3. Application margins were below this level. However, we continue to see mortgage lendings attractive even at these lower rates for both returns and an economic value perspective.Overall, the impact of this competitive mortgage pricing margin has been more than offset by improved income from the structural hedge, higher deposit balances and improved funding costs. So taking together, we expect the margin to continue to be solid in Q4 and for 2021 to be modestly above 250 basis points. This represents a slight improvement versus our expectations at the half year.We remain positively exposed to regulators. We provided some new disclosure on this in the appendix. You can see that we expect each 25 basis point parallel shift in the yield curve and associated base rate rise to benefit interest income by around GBP 225 million in year 1. The assumptions on this are as stated in our appendix, including an illustrative of 50% pass-through assumption on deposits. It's worth noting that changes in competitive pricing behavior, pass-throughs and other assumption changes in fact, had a significant impact on the actual outcome emerging rates.Now turning to other income. Performance has improved to GBP 3.8 billion for the year-to-date and GBP 1.3 billion in the quarter. The year has benefited from gradually rebuilding from customer activity as well as a strong contribution from the Group's equity investment businesses.Within that grouping, Lloyd's Development Capital income was particularly strong in Q3 based upon a couple of very attractive exits. If you were to strip out the circa $100 million outperformance in the quarter from these particular exits, you'll then get to a more reasonable run rate for other income in the current operating environment.At this point, it's also worth noting that we included a further appendix on IFRS 17, which will take effect in 2023. IFRS 17, as you know, is an accounting change, which will have some impact on the time of income recognition from 2023, primarily from the switch to contractual service margin accounting instead of embedded value accounting. This will also reduce the volatility earnings going forward.For a growing business such as ours, income from insurance new business initially full and gradually have added back in future years. Further explanation and illustrative effects are contained in the appendix.In discussing IFRS 17, it's important to stress that there will be no change to the economic value of the insurance business. No change to the cash flows or the capital position of the insurance business, including its ability to fair dividend and no change to the capital position of the group.Moving on to the cost on Slide 7. Efficiency remains fundamental to our business model and continue to provide competitive advantage, even in the context of the inflationary cost pressures we are all experiencing. Our marketing cost income ratio of 52.6% for the year-to-date is evident to this.Operating costs, which is excluding remediation charges were GBP 5.6 billion for the first 9 months of the year. This is up 1% on the prior year given the rebuild of variable pay that we discussed at the interim. We remain on track to deliver our operating cost guidance of circa GBP 7.6 billion for the year, while continuing to invest circa GBP 900 million in strategic initiatives in 2021.Remediation costs meanwhile were GBP 100 million in the quarter and now totaled GBP 525 million year-to-date. There were operating panel outcomes in Q3 so we continue to expect -- further charges in the coming quarters. And although uncertainty remains, especially into run rate from is likely to pick up in the fourth quarter.Restructuring costs, which we report below the line were GBP 386 million for 9 months. As mentioned previously, higher technology R&D and severance costs are likely to drive an increase in restructuring costs for the full year as compared to 2020. So again, I would expect the run rate in this area to pick up in the fourth quarter.Now turning to Slide 8, total impairments. Asset quality remains strong evinced by the sustained low levels of new to arrears and underlying charges below the pre-COVID levels. The net impairment credit of GBP 84 million in the quarter and GBP 740 million in the year-to-date is also significantly based by our improved macroeconomic outlook. Our outlook improved slightly in Q3 versus Q2. And in particular, our base case now achieved 2021 E&P growth of 6.3% and had price inflation of 4.8% with an unemployment rate peaking at 5.8% in Q4 2021.These base cases resumption remain So in this context, our ECL remained GBP [1 million] (sic) [circa 1 billion] higher than the year end 2019. And within this, we have retained our circa GBP 1.2 billion of additional management judgments reflecting pandemic and macroeconomic related uncertainties ahead. And with these underlying forecast changes, we now expect impairment for 2021 as a whole to be a net credit.Let me now turn to capital on Slide 9. Our CET1 ratio increased to 17.2% in Q3 with 159 basis points of capital build year-to-date, supported by lower RWAs, if we exclude the impact of both the software intangibles and all the the IFRS 9 transitional relief, our CET1 ratio would still be 16.1%.Capital remained significantly above our operating target of circa 12.5% plus the management buffer of circa 1% as well as our regulatory capital requirements of circa 11%. Looking forward, we expect the Embark acquisition to consume around 30 basis points on completion, so likely to be in Q4 are subject to regulatory approvals.I have mentioned previously, we expect 2021 closing RWAs to be below GBP 200 billion, and 2022 to be closed around GBP 210 billion after absorbing GBP 15 billion to GBP 20 billion of regulatory inflation on the 1st of January '22.We have a strong capital position and the Board remained committed to capital returns. We reintroduced the progressive and sustainable dividend policy at the half year. And as usual, any further decisions on circa's capital distributions will be taken by the Board for the full year.And now finally moving to Slide 10. To summarize, we continue to support our customers through uncertain times, and we're committed to Helping Britain Recover. We're delivering strong progress against the priorities of Strategic Review 2021, alongside the solid financial performance built on continued business momentum.We have a strong capital position for a CET1 ratio of 17.2%, underpinned by capital build 159 basis points in the first 9 months of the year. Together, the group's financial performance and the improved macroeconomic outlook enable us to enhance the 2021 guidance, as you can see on slide. To go through that, the net interest margin is now expected to be modestly above 250 basis points. Operating costs were expected to be circa GBP 7.6 billion. Impairment is now expected to be a net credit for the year. Return on tangible equity is now expected to be over 10%, excluding the circa 2.5 percentage point benefit from tax rate changes. Risk weighed assets in 2021 are expected to be below GBP 200 billion.And in the medium term, we continue to target a return on tangible equity in excess of our cost of equity. Next time we report, and as Charlie mentioned earlier, we will provide a strategy update alongside the 2021 results. But for now, that concludes our prepared remarks for today. So thank you for listening.Charlie and I are now available to take your questions. It's probably worth reemphasizing at this point that in the context of our ongoing strategic work, we're obviously not planning to answer questions on the outcome of that work. But nonetheless, we will do our best to answer all the other questions that you may have. So with that, thank you very much for listening, and operator, over to you.
[Operator Instructions] Our first question comes from Joseph Dickerson from Jefferies.
Just a quick question on the margin and the hedge. I think you flagged at the half year results that you have GBP 30 billion of hedge maturities in H2. I'm just wondering we stand on that now? And do you expect that actually continued to be a benefit to the margins? I know that it was about 1 basis point of the 4-basis-point quarter-on-quarter uplift in the margin. And I think at the half year, it was kind of around a 2 basis-point headwind in the first half of the year. So do you expect that to continue to be the tailwind?
Yes. Thanks very much for the -- Thank you, Joe. A couple of questions asked, just to take them in turn. The hedge maturities in H2, as we said in the half year, further GBP 30 billion to be hedged. Most of that work has been done, as we sit here in now, I guess, now end of October '21, there's not much further hedging to be done for this year.In terms of the maturities next year, we're looking at around GBP 30 billion or so of maturities over the quarter of '22, and then it picks up from that level during the course of '23. In terms of the impact on the margins before that, Joe, your second question. As you point now, we have seen some benefit from the -- further reshaping of the [indiscernible] in course of 3Q. It's certainly one of the tailwinds amongst 1 or 2 others in achieving the year-to-date margin of [ 252 ] and the Q3 performance of 255. We do expect that to repeat itself and the hedge to continue to be a tailwind during the course of Q4. We're looking, as I said in my comments, a solid margin in Q4. And the hedge alongside probably some growth in unsecured balances, probably some benefits from funding further tailwinds to margin performance in Q4. There will be some headwinds in the form of volume from net mortgages, which while good for net interest income is slightly diluted to the margin. But overall, as I say, the hedge will be part of the tailwinds that we expect to experience.
Can I just follow up on that, this interesting commentary given the yield curve you started to keeping right at the end of the quarter. But some -- aside from the -- when I look at your retail tactical deposits, is there any -- on a forward basis any flex on the retail tactical deposits? Because I know they grew another 2% in the quarter and were up about 34% year-on-year. I know it's not a large contributor to the deposit base anymore, but is there any flex there over time that as the -- The better question is what's the strategy with the retail tactical deposits?
Yes. Yes. Well, just you made come point there, Joe. One point in terms of the way in which we manage the hedge, we manage the hedge in an appropriate risk management way. And so we don't necessarily wait for the end of the course to take actions. We're taking actions through the course of the year and through the quarter of any given quarter. At times, you'll see a shaping of the curve, which makes it better attractive in some segments than others, but we will take a balanced and measured approach to managing hedge over the course of the year.In terms of your second point, retail -- tactical deposits, overall, there isn't terribly much left in the retail liability margin anymore. I think we've given you numbers on this before, so I'd be happy to do so again. But customer rates are averaging are about around 8 to 10 basis points of retail liabilities. And that gives you a sense as to there will be internal pressure on the retail margin with current interest rates.
Our next question now comes from Rohith Chandra-Rajan from Bank of America.
I had a couple of questions, please. First one was on IFRS 17, and thank you very much for the disclosure there. I appreciate it's still uncertain. But I was wondering in terms of Slide 14, just -- firstly, just to clarify what is showing the bottom right there is the year 1 impact of the implementation impacts in terms of IFRS 17 on income. And there's obviously a wide range of impacts over the last 3 years from GBP 0.8 billion down to what looks like GBP 0.2 billion potentially for this year. Can you detail some of the differences, I guess, are some of the reasons for that in the footnotes. But I was just wondering if you could help us understand what you think that 2023 year-1 impact is? When you see the tipping point? Because obviously, it's just a deferral of earnings, as you've highlighted, it's not that disappears. So what would be the tipping point where IFRS 17 becomes neutral? That will be the first question.
Yes, sure. So I think I can take it as it goes along, Rohith, recognize, you may have a further question thereafter. Why don't I deal with that first. IFRS 17, you can see what we put forward on Page 14 of the presentation is an illustrative impact of the effect of IFRS 17 replacing IFRS 4 in our earnings for any given year, and we've given you 3 historical periods to look at that. So that's on the chart.In terms of the factors behind the chart, the 2, 3 factors that significantly improved that switch from IFRS 4 to IFRS 17 are: one new business; and two, a net effect of assumption changes in the period. And if you look at 2019 and 2021, in particular, you will see that more or less works out in terms of the transition between 4 and 17, that's a new business and net assumption changes during the period. You don't see that so much in 2020. And the reason for that is because we had interest rate fall in 2020. And that, in turn, expect to impact the experience varies differently to the way which impact the contractual service margin. And that's why you see a slight discrepancy within the 2020 year, which is above and beyond or other differences above and beyond the new business and the assumption changes. So that's what's going on in terms of the factors there. We won't give you a precise number for 2023 as we look forward. It will be driven, however, by very much the same thing to say new business, net assumption changes and if there is a significant interest rate change, then, of course, that will have an effect at that point. But I don't think that will predict one. In terms of the time that it takes for IFRS 17 to effectively catch up with IFRS 4, that's an important point. It's somewhat mitigated by the fact that we've retrospectively applied IFRS 17 back about 5 years in 2016. And so some of the CSM will be built into the performance over the course of the coming years. What that means is that while the average contract life is around 15 years in insurance, the catch-up period is going to be slightly less than that. The catch-up period for IFRS 17 to IFRS 4, we think it's going to be about 5 years, prospectively, from the year of introduction. Now, these are all industry numbers at this point. As you will comment highlighted just a second ago, there's further work being done on IFRS 17, but hopefully that gives you a bit of a picture.
That's very helpful. And then the second question was, again, sorry, just coming back to the structural hedge. So you've got GBP 15 billion of unutilized capacity at the end of the quarter. Just wondering if you put any of that to work given the move in rates in October? And in terms of how that then ties into the rate sensitivity? Is it right to think that sort of every GBP 20 billion increase in the structural hedge effectively reduces the sensitivity to a 25 basis point rate move by about GBP 25 billion -- GBP 25 million, sorry, assuming the 50% pass-through that you put in, which could obviously be different?
Yes. I'll answer the first part of that question. I probably won't give you a specific answer on the second part, Rohith, for fear of, if you are working the numbers out, which I prefer leave you to do. But in terms of the GBP 15 billion outstanding, I said to Joe, a second ago, we've done most of our work in respect of the hedges we found here at the end of October. So we will have been deploying the hedge over the course of this year, including in October. But as we said now, when we look at the capacity of the hedge, most of the work has been done for the year of 2021. We then obviously look towards the GBP 30 billion of maturities during quarter '22, which is work that we'll undertake when we get to 2022. In terms of the rate sensitivity of the hedge, again, I probably won't go there specifically, Rohith, but the component of the rate sensitivity of GBP 225 billion that we put forward in the presentation in the appendix, I think just as a number of commentators have expressed over the course of this results season, in the first year, the relatively modest part of that is the head role effectively. A bigger part of that is the pass on for the deposits of the base rate.
Sorry, just on the hedge capacity. I thought your response to Joe's question was that you -- last year, you've done the GBP 30 billion of maturities that were penciling for the second half. Have you all seen some of the capacity?
Yes. Rohith, to be clear, we have used most of the -- as we stand here at the end of October, we have done most of our hedging work for the year, and that includes up to the GBP 240 billion.
Our next question now comes from Chris Cant from Autonomous.
If I just ask about IFRS 17 debt, please. So if I read between the lines correctly on Slide 14, it looks like you're talking about something like GBP 400 million of insurance revenues going away in terms of new business recognition in 2023. So when we think about other income at a group level, is it fair to say 2023, we should be thinking about something in mid- to high GBP 4 billion territory rather than slightly off to the GBP 5 billion, which is where in terms is currently existing? And then as a follow-up to that, your commentary about the assumption change on certainty, I guess, around how this actually comes in. Am I correct in interpreting if rates rise in 2023 then the year 1 impact would actually be more severe than that?
Yes. Thanks for the question. On the first question, as I said, the effect of the switch from IFRS 4 to IFRS 17, that is, as I said, a function of new business, a function of the net assumption changes in terms of real function of any variances that get beyond those 2. But those 2 are the primary ones. I think you very roughly put a number of circa 400 on it. I think historically, if you look at our typical new business performance, probably not about proxy for where we end up. That, in turn, as you know, is probably around 1/3 of the insurance income for any given period. And if you look at it in terms of the group ROI, it's roughly 7% to 8% of the group ROI just to give you some intense proportion.Having said that, I will make a couple of related points which are important to bear in mind, which is number one, this catch-up period of the CSM. And so you get these earnings added back over a period of time, as I mentioned in my earlier comments that period of time looks like it's around 5 years, but that gives you attention to the fact that this may be a hit on day 1 of the earnings when IFRS 17 is introduced, but equally a faster run rate in the earnings growth thereafter as that CSM gets back into the numbers.The second point which I'll add on which -- you'll hear me say a number of times in connection with IFRS 17, it has nothing to do with cash flows. And therefore, the performance of the business and therefore, the ability of the insurance business to dividend and therefore, either the insurance capital or the word capital position. So it's an important point to bear in mind.Your question about IFRS 17 and then into a question around ROI and a proportion of IFRS insurance earnings to ROI, I would say that the ROI, I won't comment on your precise numbers for ROI in 2023. Safe to say that ROI, you've seen our performance in this quarter, which is about GBP 1.34 billion. We believe that once you strip out the LDC GBP 100 million that we pointed out, you'll get into a pretty solid underlying run rate of earnings there. That is likely to build by -- as a result of economic activity, number one; as a result of our organic initiatives, number two. And as a result of things like Embark and Citra will contribute to ROI over time and hopefully build the pattern going forward.The third of your point, if something changes uncertainty. I mean, in essence, what happened in 2020 was that you had a sharp rundown in rates. That rundown in rates contributed more to impact experience variance that impact contractual service margin, which is why a slight discrepancy in the 2021 difference -- 2019 and 2021. So 2020 stands out a little bit in that respect. If in 2023, you see the reverse of that effect then I guess as your question implies, you'll see the reverse in terms of the impact or difference between IFRS 4 and IFRS 17.
Okay. That's helpful. If I could ask just one more follow-up on IFRS 17. I completely understand your point around -- it doesn't change the cash flows from the insurance business. I'm just trying to understand the impact on the numbers we're going to see what we get out to 2023. Is there anything in terms of an offset within the cost line of the insurance business? So do some of the costs get reshuffled into revenues and -- How big an effect will that be in terms of any benefit to the OpEx line 2023? How should we think about that?
Yes. It's a good question, Chris. And yes, there is an impact on the cost line. The impact on the cost line is roughly speaking in the GBP 100 million As we look at the numbers today, that's a number that is conceptually equivalent to GBP 400 million you quoted earlier on in your comments. So there's a benefit from the cost line from essentially similar spreading of acquisition costs. And therefore, you do see that come through as IFRS 17 is implemented in 2023 of the order of magnitude that I just mentioned.
Our next question now comes from Raul Sinha from JPM.
If I can maybe start just with a general question and got a detailed one as well. It was interesting to hear the comments on talking about growth actually being point number one that you addressed. One of the pushbacks Lloyds' shares from the market, whether Lloyd's Bank is in the lack of tangible book value growth and growth in general. So I was wondering what you think about tangible book value growth for a bank? Should that be your priority in your opinion?[Technical Difficulty]
Sorry, we can't hear that yes.
I guess the question really I was asking is about growth and tangible book value per share growth. I think one of the related impacts that you're talking about IFRS 17 is mid-single-digit hits the TNAV as well. And obviously, that will mean again, pro forma base of this and grow for quite from Lloyds. So alongside the focus on growth that Charlie outlined, I was interested in his [indiscernible] that a tangible book value per share growth should also be a metric that the market should be looking at as we would measure.The second one is in social around the return in terms of your disclosures that are quite helpful. Obviously, it's look like you made the same cost redemptions or you have the cost redemptions starting for year. So is it fair to assume that if the cost was a little different in year 1, then that rate sensitivity that you outlined might understate the actual rate sensitivity that you would see being very, very soft?
It's Charlie. Thank you for the question. We got that. Obviously, my view on TNAV and we will build on this is it partly depends on the strategy of bank, firstly, they know the second, but also, you just have to be capital around what is included in TNAV. And to your point around IFRS 17, I think is important and we'll will probably expand on that a bit. And the point around TNAV is if the organization you're looking at is obviously optimizing its balance sheet and focused on distributing income TNAV work progress material, whereas if the organization is focused on organic growth and building asset value, it will progress. Both of those strategies at a very simple level can give different outcomes to TNAV, but still strong shareholder returns. And I don't know if I make sense to your -- but certainly the way we think about it. In terms of how we're looking at the group going forward, as I said, we'll talk about that in February. But one of the things I did upfront was the priorities for us is to look at how we provide and deliver on sustainable long-term returns in distributions, whilst investing in the business. So as we think about that, we will be clear around how we think that might impact TNAV. William, do you want to do that?
Yes. Thank you. Thanks, Charlie. I think the 2 comments that I would make, just to add that. What is we are interested in TNAV, of course, we are. It's an important ingredient to the financial metrics of the bank. There are a number of factors that affect that. The number of them have been going in the right direction over the course of this year, profit being obviously the primary one. At the same time, as you pointed out, IFRS 17 will have an impact on TNAV in his introduction in 2023. But I think it's very important to bear in mind that just as that gets built back into the earnings, it also gets built back into TNAV over a period of time. So this is a temporary effect that will have on TNAV. And while we take a hit on day 1, it contributes also to a faster growth rate on day 1, day 2 and beyond. So bear that in mind as you look at the TNAV impact of IFRS 17.The second point that I'd make is, we look at TNAV for sure, we also look at returns on TNAV. And that is clearly incredibly important metric for the bank. Now as it happens, actually, the impact of IFRS 17 and the returns on tangible equity is marginally accretive. So you might hit TNAV, but you also see a marginal benefit to tangible equity. And the business, as we look to it as we invest in it and as we will discuss with you over the course of next year, it's very much about building sustainable returns.On your sensitivity point, I think the best way to answer that is, is the sensitivity linear, roughly speaking, to changes in pass-through assumptions? Yes, it is. That is to say, if we do not pass through any of the benefits of the interest rate rise, then in turn, the sensitivity will be roughly doubled what we stated as at the [ 50%] mark. So in that sense, it is pretty linear. But the second point that I would also add, Raul, to this, which I think is important, which is the environment within which those interest rate rises are taking place. In that is to say, interest rate rises happen because you are seeing an increase, a rising level of economic activity. With that rising level of economic activity, we would expect to see customer activity and keep borrowing, including things like unsecured go hand-in-hand with that. Likewise, we'd expect to see market activity tick up. Likewise, if the interest rate turn, if you like, where it is, that build the performance on indeed the capital petition of the insurance business. So all of these are factors that are not built into our interest rate sensitivity that are likely to accompany a rising rate environment, which in turn will clearly drive earnings and ultimately, capital institution.
Thank you. Jonathan Pierce from Numis has our next question today.
Two questions, please. The first, I'm really sorry to come back to IFRS 17 again. The net profit hit by the sounds of it is something in the order of GBP 300 million, taking into account GBP 100 million cost offset you just mentioned. I think the run rate of the insurance and wealth profits in the first half, the remediation was only about GBP 400 million per annum. So at least initially, there's going to be a big dip in profits. Now as you say, the capital generation of Scottish Widows is not affected by this, but I think it does bring much greater focus now on to the given streaming potential of Scottish Widows because for a period at least that could be significantly larger than the accounting profits. So I guess what I'm inviting you to give us more detail on is, what do you think the normal run rate is for upstream dividends from Scottish Widows? It's been about GBP 800 million a year on average over the last 10 years, but there was all sorts of things going on within that. What do you think a normal dividend run rate is from Scottish Widows up to the Group? That now will be the first question. The second question is just a bit of detail on the hedge. Obviously, the maturities next year will be a combination of maturities out of the hedge that existed pre-pandemic, but also, I guess, a reasonable chunk of maturities from the hedge that we've built post March of last year. Can you give us a scale of the split of that as the yield differential on those 2 parts of the maturities that are very, very different?
Yes. Yes. Thanks, Jonathan. On the first question around IFRS 17, you don't worry, you don't have to apologize coming back to it. We thought it showed a level of interest during the course of today's call. The net profit hit, you're about right. Yes. I mean GBP 400 million minus about GBP 100 million in costs. It's about right. But again, it does depend upon the volume of new business. So it will be 2 category, and pretty a precise number on it, but your numbers ballpark makes sense. That, as you say, will ensure a level of attention to essentially cash generation from the insurance business. I don't think, for us, that's a new point actually, Jonathan. We've always looked at the cash generation of the business. We look at the Solvency II capital that the business unit. And we also look at the Solvency II cash generation of the business units. And those measures have been a long-standing part of our internal KPIs to the insurance business, and they will be going forward. The Solvency II position of the Scottish Widows business today at the end of September is just a fraction below 160%. So it looks pretty healthy as of the end of September. It is, as you know, significantly influenced by rates in particular long-term rates as well as the underlying business performance. But that capital level does suggest a healthy level of capital. And we'll see whether that persists over the course of the remainder of this year. But if it does, we would have a discussion with the Scottish Widows Board at the appropriate time about what level of dividend might therefore come out of the Scottish Widows business.Looking forward, as you say, we wanted to Solvency II cash flow generation metrics, and those are very much part of our business planning. We would hope that the dividend builds over time in conjunction with not just rates, clearly, but the success of activity and the introduction of new business. I don't want to put a number on it too much, but I think as your question highlights, if you look back at those numbers of 800, for example, those numbers were significantly influenced by management actions that took place within the Scottish Widows business certainly in the year proceeding my arrival. And so I wouldn't use that GBP 800 million as a guide mark, if you like, for future ongoing sustainable dividends from Scottish Widows. We will look to ensure that business is successful. We will look to ensure that there is a continued consistent rather and reliable dividend from that Scottish Widows business. I think 800 frankly is a little bit too high, but it is -- that dividend is certainly part of our -- the way inventory manager.I would also say the final point on that, Jonathan, that as you know, the Scottish Widows business is deconsolidated from the bank as a whole, that is indeed the reason -- or part of the reason, I guess, why IFRS 17 doesn't make any difference to the group capital position. When we look at the management of that overall capital, it is, therefore, the dividend that we are most interested as a group management team. So we do pay a lot of attention to it.On the hedge, second of your 2 questions, pre-pandemic, post-pandemic. We won't give a split for that next year. As I said, the overall maturity next year is around GBP 30 billion. It then ticks up from that quite significantly in '23. I will say, though, which hopefully is helpful, Jonathan, the hedge is an overall tailwind next year. We expect it to be a tailwind based upon where we are with the hedge today, and that is a contributor, therefore, to no interest income over the next year.
Okay. That's really helpful. Just one quick follow-up on the insurance point. I think that the dividend that got you there always been, the only relevant aspect of what the insurance company is doing in the context of the Group. But clearly, if we are going to have a period where Group profits amount will certainly insurance profits are on an IFRS 17 basis in the low hundreds or millions. We can't any longer ignore this difference in the intriguing of profits versus capitals of upstream. So can I just question a little bit on this? Are we going to get insurance dividends as Scottish Widows is starting again at the end of this year or February next year, which is only normally. And where we can split out ordinary dividends from everything else that's been going on in recent years, it does feel like a number of such as GBP 400 million, GBP 500 million. That's been more in the order of a normal dividend. Would that be about right?
Thanks, Jonathan. Yes, happy to comment a little further. A couple of points, I'll make. One is, as I said, we do focus on dividends from the company, insurance company not on Group, number one. Number two, having said that, we know it is also strategically and financially, a very important part of our overall Group. So we also focus on the contribution that the insurance company makes alongside of our other divisions. And in that sense, achieve strategic and operational synergies within the Group, which is also a source of value to it. So I do want to make sure that we've portrayed a picture of the insurance company as it is, which is an integrated part of our overall Group and a very strong part of our strategic future.In terms of the start of dividends, as I said, our Solvency II ratio at the end of September is just a shade below 160%. That's a pretty solid number. We would look if rates stay where they are and Solvency ratio stays where they are or potentially improves, then we would look to have a discussion with the insurance board at the right time as to the dividend at the end of this year. As to the run rate even beyond that, again, I won't comment with any greater specificity than I have done so far, safe to say that we will look to build the insurance dividend over the course of time in conjunction with the investments that we've been making in that area.
We now have a question from Andrew Coombs from Citi.
Two questions. One on capital return, one on cost. If we look at your capital ratio, you've had a very strong build year-to-date, even if we adjust the software amortization and IFRS 9 transition, Embark, the RWA growth you're guiding in 2022. You're still looking at 15% pro forma ratio. So your question is can access capital intrigued as to your plans for that? Now I don't want to prejudge the strategy update, but any thoughts you can share on how you're thinking about buybacks versus dividends, versus maintaining a buffer for M&A, given that you've just acquired Embark? Whether there is anything else from the horizon? Is there anything you can comment on that would be welcome.Secondly, on costs, the restructuring costs have ticked up year-to-date, and you're guiding to more in Q4. Just would like an idea of what the payoff is on that? So what do you think of in terms of the savings attached to those, the time frame to recognize those savings and so forth?
Yes. Yes. Thanks, Andrew. First, in terms of capital return, there are a couple of points to make there. One is we obviously have a very strong capital position. And as you say, even if you take account of, I guess, software amortization and transitionals and RWA headwinds coming up in 1st of January '22, it remains a very strong capital position.Second point is that we entirely recognize the importance of capital return. The interest of stakeholders, shareholders and capital return is entirely acknowledged. And that's why we committed to pay a progressive and sustainable dividend at the half year. And then as usual, we will look towards any further distribution of capital above and beyond the dividend as at the end of the year.And that's nothing different to what we ordinarily do. So the fact that we're not engaged in a buyback right now means nothing other than just we're operating on a BAU basis, and we'll look towards further distributions as appropriate at the end of the year, and there will be a Board discussion at the time. In terms of form, again, any excess capital distribution question is raised for the Board at the end of the year. In terms of form, that's really also a matter for the Board. But obviously, they'll do so in consideration of investor preferences in consideration of where the share price is trading and so forth. So all of those deliberations will be taken into account at the time when that discussion is had. In terms of things like M&A and other uses. From our perspective, the strategic story has been and will continue to be primarily an organic story, where an opportunity to invest in capability or potentially at a margin scale comes up, typically through all opportunities. And then obviously, we'll look at that. But only if it is consistent with our shareholder return objectives. And so you've seen over the last couple of years, Tesco acquisition, which is an example of just building scale at limited -- very low marginal cost. You've seen this year the Embark acquisition, which is an example of building capabilities. Both small acquisitions, but both important acquisitions in terms of building either scale or capabilities. And importantly, both acquisitions that satisfy our current requirements. But again, I want to leave you with a comment that M&A is -- it's a tool towards strategic objectives, no more than that. And our strategy remains very organic.Your second question on restructuring costs. We do look for return on restructuring costs, just like we look for returns on any investments that we make. If you look at the types of restructuring costs that we have seen recently, severance, for example, is one, property reformation is another. We analyze those investments just like we analyze any other deployment of cash within the business and look at that on ROI basis, on an IRR basis and NPV basis. And our return requirements are generally relatively high for those investments. The other element of restructuring costs that we are working on right now is technology R&D. That is also subject to return requirements, but we are conscious of the need to invest over the course of time for future benefits, whether that is in terms of addressing our legacy platform, whether that's in terms of improving our customer proposition. Depends upon the particular technology investment that we're looking at. That is, as I said, subject to a return requirement, but the so Andrew, I hope that's helpful.
_Our next question now comes from Guy Stebbings from Exane BNP Paribas.
William, I had one interesting assets one back on IFRS 17. So interesting assets because it was a pretty strong third quarter, another GBP 5 billion that you referenced, how commercial might be a little bit tougher from here, but then mortgage trends remain fairly healthy. The mortgage has been a bit lackluster, presumably given some of the issues around availability of new cars. So hopefully, a rebound there starting to see growth in other unsecured lines. So is there any commentary on the outlook there around what you're expecting of interest in asset growth and consensus of GBP 451 million next year doesn't look or distraction given the starting point, but any color there would be very useful? And then on IFRS 17, I can circle back on some of the prior comments. I guess beyond just the impact of net assumption changes, the normal new business impact you referenced back in 2017 to '19, income was also distorted by the auto enrollment rate changes, which were very favorable under IFRS 4 versus IFRS 17 within the workplace planning time line. So I'm just trying to gauge if that GBP 400 million revenue number that you referenced is relative to some past years rather than the current run rate? So I will make sure we're applying to the right sort of base because we've been tracking a little bit below '17 to '19 levels in workplace [time] income already?
Yes. Thanks, Guy. On AIEAs, we won't give guidance looking forward. Maybe just a comment 1 or 2 historic trends. As you say, Q3 GBP 447 billion versus Q2 of GBP 442 billion, up GBP 5 billion in the quarter. The reason why there's a significant change during that quarter is because a lot of the mortgage growth got back ended into the end of Q2, which is, I think, consistent with the comments that we made then. And so as a result, you saw a relatively sharp uptick going into Q3 because there was a late in-quarter balances added in Q2.As I said, our overall profile for AIEAs during quarter 2021 is a low single-digit percentage growth in those AIEAs. And the drivers behind that are the ones that we've been talking about before. To your point about while we won't give any guidance for 2022, what is it looking like in terms of the underlying balances, I guess a couple of comments that I would make. One is, in mortgages, as you know, in mortgages, we're seeing both structural factors driving growth, and we're seeing cyclical factors driving growth. Cyclical ones, EG stamp duty, somewhat died away at the half year. The structural ones, low rates, low unemployment, people moving to bigger spaces and so forth. Those remain in place and therefore, leads us to think that we'll continue to see mortgage growth over the course of the coming period. And that obviously will include next year and potentially beyond. In terms of Motor, we have seen headwinds to Motor over the course of this year and that's had a lot to do with, as your question pointed out, with the supply side and the market there. It's also, to a degree, at least has some impact from the business in terms of corporate appetite for overall fleet volumes and so forth, which in turn feeds through into operating lease depreciation. But the Motor balances as the Motor market comes back to life a little bit as some of the supply-constraint start to get sorted out, I would expect they would start to have an effect both upon new cars and on used cars. And therefore, drive balances a little bit more strongly potentially going forward than we've seen in recent periods. We'll have to see. It's very activity dependent, but those are the things that are going on kind of underneath the title, underneath the headline. And then finally, unsecured -- the unsecured balances in particular, cars. As you know, we saw GBP 0.2 billion increase in balances over the third quarter. We think that is the beginning of growth, but it is relatively early days to make that call, but we think it is the beginning of growth. And therefore, we would expect that to continue in the coming quarters. Pleasingly, that growth is happening at the high end of the customer base as a relatively high quality credit that is building that growth, which is a good factor to see. We'll see how that develops over the course of the coming periods. Again, very macro and activity dependent. But we think what we've seen in Q3, at least, is the beginning of the term. IFRS 17, as you say, there was -- on your second question, couple of points there. The factors, again, driving the change between IFRS 4 to IFRS 17, we've talked about new business. We've talked about net assumption changes. I talked earlier on about a sharp change in interest rate, which changes the discount rate unwind versus the CSM contribution. So that's a further driver of difference between 4 and 17. And as you say, in the early -- well, let's say, '16-'17 or '17-'18, we did indeed see auto enrollment get added on, and that is favorable from an IFRS 4 perspective. I think as you look at the GBP 400 million that we discussed in the earlier part of the conversation, I would use that as a very rough proxy. And I would use it as a very rough proxy for the development of the insurance earnings in the period that we're showing on Slide 14 and the years thereafter. So Guy, I will give you a precise answer to your question. And again, I would give the GBP 400 million income, net GBP 300 million once to take account of costs as just a rough proxy, including for the period that were shown in '14 and beyond.
We have a question now from Martin Leitgeb from Goldman Sachs.
Just for the sake of time, I keep it short. I just wanted to ask on the outlook for mortgage pricing and the impact as we head into next year. I was just wondering if you could comment on what you have seen in the third quarter? How you see competitors acting, is pricing at current levels still rational? And the number of peers has pointed out that the mortgage churn, as we had in the next year is expected to have a negative impact in the P&L. Is that essentially the flip side of higher swap rates, which is a benefit now on the hedge, but obviously, could be a negative on the mortgage going forward? And could you help us size what the potential impact of such a churn could be following next year?
Yes. Thanks for the question, Martin. Mortgage pricing -- I'll actually start that off with just a comment -- brief comment around volumes, which have continued to be strong during the third quarter. As you saw, we had about GBP 2.7 billion open book growth during the third quarter. That's about GBP 15.3 billion year-to-date. So pretty strong volumes. That is a share of around 18% versus what we saw in Q2, which was 19%. So we're saying there or thereabouts in terms of share. To answer your question, during the third quarter, Martin, we've seen completion margins of around 160 basis points. I think I mentioned that in my comments. We've seen application margins in the quarter of around 140 -- 1.4%. With the trend in overall mortgage pricing, that has been coming down since the end of the quarter, but the average for the third quarter is 1.4%, as I said, in the context of mortgage pricing coming down a little thereafter. We're not being precise in terms of when the front book margin falls below the back book margin. But I think I've mentioned in the past that the back book margin is around 133 basis points. So you can see from the numbers that I've given you that we're not far off now, and it might be reasonable to expect that turn to happen sometime during the course of the fourth quarter based on what we're seeing. But then on the final part of your question, Martin, in terms of the mortgage sensitivity, which is essentially what you're asking, we haven't given mortgage sensitivities in the past. I don't think that we're going to start now. I do think that the impact of any mortgage price change, if you like, very much depends upon the timing of that price change. And that's obviously because the back book roll off goes up and down over a period of time. I also think it's relevant to say that at the same time as you see mortgage price changes, you see many other product moves at the same time. And so any pure mortgage analysis is questionable as to how meaningful it is in isolation. It needs to be viewed as a part of a much bigger picture, which envelops our whole P&L and balance sheet.
We have a question now from Aman Rakkar from Barclays.
A couple of questions. Can I start with costs? I guess inflation is a source of upward pressure on interest rates and positive for the top line. But I wonder, is it getting harder to manage the cost base in this inflationary backdrop? Are you having to kind of run harder to stand still? And again, we don't necessarily want to prejudge the strategy announcement in February, but no consensus is probably looking for a slight reduction in operating costs year-on-year. I'd be interested for your thoughts on that if you're able to. Second would be around capital. I know your rates have come down 20 basis points in the quarter. I also note the comments in the last couple of quarters around the reduced impact of stress tests and what that might mean for the target CET1 ratio. Are we -- is it right to think -- are we 1 step closer perhaps now towards revising that target CET1 ratio down to 13%, again, at the risk of prejudging the announcement in February. Is that the kind of thing that could happen in February that, that number comes down? And then sorry, just 1 final point of clarification. Basically, on rate sensitivity, Slide 18, the GBP 225 million, I think when I sit down with the spreadsheet, that number still looks quite low to me. I wouldn't ask you to audit my spreadsheet. But if I was to take something out for the structural hedge benefit in New Alan, the 50% pass-through that you're modeling, it does seem to imply quite a low amount of rate-sensitive deposits that sits behind that number. I guess is there any color or anything you could help explain what's going on there? And I guess as part of that, is that a 50% pass-through on total deposits, including current accounts? Or is that just the rate sensitive for this?
Yes. Thanks, Aman. Three questions there. So I'll take them in turn, Aman. I think, first of all, on the longer-term cost outlook, first point to start is in this year, clearly. As you know, costs are and will remain an incredibly important part of our story going forward. We are committed as Charlie said in his comment, I had in mind to ensure and focus on efficiency throughout the business. What that means for this year is circa GBP 7.6 billion, as we have highlighted, and we continue to stick by that commitment to 2021. As we look forward into 2022, today isn't the time obviously to give guidance, that's really for next year. But as I said, costs will remain a source of competitive advantage for the group. We have a very rigorous framework for looking at that BAU strategic initiatives, and that framework will remain in place and continue to be a source of focus. Now having said that, just like everybody else, we are subject to general inflationary pressures. Those will be in terms of people, those will be in terms of OpEx. We also are investing in new business lines, new income streams, so, for example, Embark at the half year, also Citra, the housing project, as well as our ordinary BAU initiatives across the retail insurance and commercial area. And obviously, those income generation activities sometimes come with costs that will reflect that. Now having said that, we will continue to focus on efficiency throughout the business. And so when we get to the strategic announcement as of February, we'll obviously outline what the implications of all of that are at that point in time. But Aman, I think the takeaway from this is obviously, we experienced some inflation pressures, but we remain very committed to cost discipline throughout the business and the efficiency of the business.Your second question, Aman, capital. As I said, and reiterate the capital position of the bank remains very, very strong. Are we getting closer to looking at the targets again? A couple of points to make in that respect. What is -- what we think about what we set targets? What we think about essentially is a combination of the current regulatory requirements as well as the evolving regulatory requirements, which obviously in today's terminology means RWAs are coming up means countercyclical buffer, for example. But we also think about the requirements for the business, including BAU, including stress and obviously, including the growth objectives of the business.What does that mean in practice? For now, we're at 12.5% plus 1%, which is the capital requirement that we continue to adhere to. It is apparent to us that as RWA intensity ticks up as it will in the 1st of January next year. If there is no change to economic risk, then there is no -- there is no need to increase the absolute buffer as a result of that. That is the line to your Pillar 2A point. Pillar 2A has been coming down. Pillar 2A is an absolute number rather than a percentage, as you know. You need to be a bit careful about how we express that. But essentially, we have an increased RWA intensity, which should not necessarily lead to an increase in the absolute quantum of the buffer. You have a reduction in Pillar 2A rate. And therefore, these are factors that we take into account alongside the difference between the regulatory requirements versus our targets. These are factors I think, Aman, that we'll take into account as of the end of the year to figure out what the best capital target for the business is at the time. And then finally, your question on the rate sensitivity. The rate sensitivity is really as expressed, it's a combination of the effects of parallel shift in the yield curve plus the base rate change associated with that. And the sensitivity is the effect of that on the hedge, the effect of that upon the margin widening, if any, through pass-through assumptions. And it's effect on the leads and lags within the business. I don't think it's anything much more complicated than that. The one comment that I would make is that we want to avoid double counting between those balances that are already taken account of in the hedge versus those balances that benefit from a base rate change parcel. So as you think about the balances, which this is applied, one needs to bear in mind that an element of the balances within the balance sheet right now are already hedged against. And therefore, the incremental benefit from a base rate change is for those balances that are not currently hedged against. Otherwise, you'll end up double counting between the benefit of the hedge role on the one hand and the benefit from the base rate change on the other hand.
That's really helpful. So that 50% pass-through then applies just to the rate-sensitive portion, the unhedged balances basically?
That's right. And then, Aman, perhaps just to add to that from taking your partial clarity is that effectively, what we're saying therefore, is that for those hedge balances through the deployment of the hedge over the course of this year, we have locked in earnings for those hedge balances, which will then unfold over the course of '22, '23 and beyond as that hedge change maturity.
Thank you. This concludes the Lloyds Banking Group 2021 Q3 Interim Management Statement Call. For those of you wishing to review this event, information for the replay is available on the Lloyds Banking Group website. Thank you for participating.