Lloyds Banking Group plc (LYG) Q3 2016 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Lloyds Banking Group Q3 2016 Interim Management Statement Conference Call. At this time, all participants are in listen-only mode. There will be a presentation by Antonio Horta-Osorio and George Culmer, followed by question-and-answer session. [Operator Instructions] Please note this call is scheduled for one hour. I must advice you that this conference is also being recorded today. I will now hand the conference over to Antonio Horta-Osorio. Please go ahead.

Good morning, everyone and thank you for joining us for our 2016 third quarter results presentation. I am going to give you a short overview of the results and explain why I believe Lloyds is well positioned within the current macro environment and George will then cover the financial results in more detail. After this we will take your questions. So turning to slide one for those of you following the webcast presentation. In the first nine months of 2016 our differentiated business model has continue to deliver with a robust underlying profit of £6.1 billion and a strong improvement in statutory profit before tax to £3.3 billion, despite taking a further PPI provision following the FCAs additional consultation on the matter. The group's capital generation also remained strong with 60 basis points generated in the third quarter. Our relentless focus on cost has allowed us to respond to the current market conditions, with a significant progress made in our simplification program continuing to drive lower operating costs. These efficiency savings have more than offset a marginal reduction in income and driven positive operating jaws. Our credit quality remains strong. In the first nine months, our net AQR was just 14 basis points, and we continue to see deterioration in the underlying lending portfolios, with these trends principally reflecting our low-risk business model and the low interest rate environment. With regards to PPI, the FCAs additional consultation paper had proposed a deadline for complaints of June 2019, while the outcome is not yet finalized, we are taking a further provision of £1 billion to cover additional operating costs and redress. Despite recent headwinds from the pension schemes, our capital generation remains strong, as this was offset by gains in our group's portfolio. We have therefore maintained our balance sheet strength with the CET1 ratio of 14.1% pre-dividend or 13.4% post, and a total capital ratio of 21%. We also remain focused on delivering on our targets to support people, businesses and communities as set out in our helping Britain prosper plan. Over the last 12 months, we have continued to increase net lending in each of our targeted customer segments. For instance, our SME lending growth continues to outperform the market at 4% year-on-year and UK Consumer Finance continues to grow strongly at 9%, including growth of 23% in motor finance. Our differentiated simple low-risk business model is delivering for our customers and shareholders. And as a result, we are reaffirming our stated 2016 guidance. The hard work undertaken in the 5 years to transform and simplify the business has allowed the UK government to sell most of its stake in the Lloyds, returning £17 billion, including dividends on its original £20 billion investment. We welcome it recent decision to recommence a new trading plan with the intention of selling it’s remain 9% sake over the next 12 months. Looking at the UK economy, the outlook remains uncertain, following the outcome of the EU referendum. However, the strength of the recovery in recent year’s means that UK is well positioned faced into the situation. Both households and corporates are now in a stronger financial position, given the deleveraging that has occurred since 2009. As reflected in the reducing ratios of debt to GDP, unemployment now below 5% is also at its lowest level in over 11 years. Mortgage affordability has improved and is significantly better than the long-term average, largely due to the low interest rate environment, coupled with wage growth in recent years. House prices have increased, which combined with low mortgage growth has led to much healthier LTVs. Our customers on average now have mortgage debt which is less than half the value of their homes. Looking longer term, the UK has clear structural strength that have allowed economy to flourish in the past, and which are likely to remain in place. In terms of our business trend see the referendum, there has been no significant impact in any of our consumer markets. In the corporate sector, we have seen some impact as businesses have deferred elements of their investment and borrowing both pre-and post-referendum, given the uncertainty. However, the aggregate volume effect has been relatively limited. Overall these early trends remain insufficient for us to be able to extrapolate the likely longer term outlook. I am confident that the group is well positioned to continue delivering for our customers and shareholders, given the transformation of the group in recent years and our distinct competitive advantages. Our business model is built around being a simple, UK focused, retail and commercial bank, which benefits from a multi-brand, multi-channel distribution platform and a market leading digital proposition. With a 21% market share, we operate in UK's largest digital bank, serving 12.4 million online customers and 7.8 million mobile banking customers. As you have heard me say many times before, one of the key differentiators of our business model is our rigorous cost management process and the cost culture that is fully embedded in the organization. Our cost discipline means that we have the lowest cost to income ratio among our UK peers and this cost advantage will be of particular importance as we fight a more challenging income outlook across the sector. In addition, our low-risk approach, coupled with improvement in the UK economy in recent years have ensured that our credit quality has improved dramatically since 2010, with impaired loans now representing only 2% of lending balances. More recently we have not needed to make any material changes to our risk appetite, following the referendum and this is a testament to the low risk approach we have implemented. Finally, our capital generation has been and continues to be strong. As a result, we have seen a significant strengthening of our CET1 capital ratio, which has improved from 7.1% in 2010 to 14.1% pre-dividend or 13.4% post as of September 2016. Given this competitive advantages, we believe we are well positioned to continue delivering for both our customers and shareholders. I would now like to pass the call over to George, who will run you through the financials.

Thanks, Antonio, and morning, everyone. As you heard, underlying profit was $6.1 billion for the first nine months with a marginal reduction in income offset by 2% improvement in operating costs, given positive operating jaws and a cost income ratio of 47.7%. On credit, impairments increased to $449 million due to expected lower releases and write-backs, with a gross AQR 26 basis points, which is in line with prior year. The net AQR was 14 basis points and we continue to expect the 2016 full year AQR to be less than 20 basis points. At the end of day, the underlying return on required equity was 13.6% with reduction on prior year, primarily due to moving underlying profit and the impact of a banking surcharge tax. Looking at income, net interest income of $8.6 billion was up 1% driven by an improvement in the margin to 2.72% with lower deposit and funding costs continue to more than offset lower asset pricing. The margin in Q3 was 2.69% and impacted by the base rate cut in August, we yet to benefit from the recently announced deposit rate changes. Looking forward, we continue to expect the full-year NIM to be in line with our existing guidance around 2.70%. Our income was $4.5 billion and down 2% from prior. Third quarter totaled $1.4 billion, down on Q2 due mainly to insurance, but up 4% from Q3 of last year. We anticipate full year other income to be around £6 billion. Moving on statutory profit, statutory profit before tax is increased by more than 50% to $3.3 billion due to reduction in below the line item. Such as you know, the group took a £790 million charge in Q1 redemption to ECN or probably the Supreme Court ruling there are no further charges for this item. Market volatility and other items totaled £18 pounds, this includes a £484 million gain on sale of groups taken Visa Europe, which negatively offset the fair value unwind charge of $156 million, amortization, intangibles of 255, as well as negative insurance volatility of $157 million. On restructuring, the $390 million charge major effect the simplification program severance costs relating to the accelerated role reduction, that also includes $97 million cost for the group's non-ring-fenced bank bill. On PPI, as Antonio has already mentioned, the FCA's additional consultation paper is now proposed complaints deadline of June 2019, and we've taken a provision of $1 billion in Q3 to cover for additional operational costs and redress. Other conduct was $610 million for year-to-date with a Q3 charge of $150 million, $100 million of which relates to packaged bank accounts. Finally, our tax charge is $4.2 billion, representing effective rate of 36%. As highlighted, reflects revaluation of groups deferred tax assets for the corporation tax rate change, the banking surcharge and the deductibility of conduct provision. We continue to expect a medium-term effective rate of around 27%. Finishing on the capital, as you heard from Antonio, the business remains well capitalized and continues to be strongly capital generative, with a CET1 ratio of 14.1% pre-dividend accrual. In Q3 we've increased capital around 60 basis points, comprising 50 basis points of underlying growth, a further 60 for market movements and 10 of other items, offset by around 60 basis points from conduct. With a market movement now in an AA corporate credit spreads, moved the groups defined benefit pension schemes and deficit, some of which is capital by approximately 20 basis points. Offsetting this in the current low interest rate environment, we have decided it is no longer appropriate with holding gilt to maturity. We therefore reclassified to available-for-sale the $20 billion of gilts within the liquidity portfolio to a previously classified held-to-maturity. These actions benefit capital around 80 basis points, which reflect the impact of the market movements in the year on the value of the gilts. In terms of year-to-date capital growth, groups generated 110 basis points, which comprises a 160 of underlying growth, 10 for other items, including again, offset by 80 basis points from conduct. Market movements in the year have been posted 20 basis points with a favorable held-to-maturity impact, largely offsetting the market driven pensions and RWA movements. For the full year, reaffirming our guidance around 160 basis points of capital generation pre-dividend. Finally, TNAV of 54.9 pence per share is 45 on June with underlying profit offset by conduct, tax and the interim dividend cash payment. The impact of market movements on pension is largely offset to held-to-maturity reclassification benefit. For the year-to-date TNAV is up by 2.6 pence per share and up by 5.5 pence of excluding dividend payments, primarily driven by strong profit growth and positive reserve movements. So in summary, while UK uncertainty, the economy is well positioned given its structural strength and recovery in recent years. At Lloyds we have a clear strategy, a strong balance sheet, a sustainable competitive advantageous in our low risk and low cost business. Our differentiated business model continues to deliver with a significant improvement in profit and strong capital generation. This confidence in the future means we are reaffirming our 2016 guidance and are well positioned to continue deliver to customers and shareholders. That concludes today's presentation. We are now available to take your questions.

Thank you. [Operator Instructions] Your first question comes from the line of Chris Manners, Morgan Stanley, London. Please go ahead.

Two questions, if I may. The first one was on the net interest margin outlook. And maybe if you could talk to us a little bit about the competitive environment you're seeing, what you're doing to offset the low rate environment maybe in terms of liability of re-pricing and what the impact of this move in the guilt portfolio might be. And the second one was on capital return. Obviously, I suppose, we've got a more constructive tone from the Bank of England. I saw your Pillar 2As being cut by 10 basis points on the Common Equity Tier 1 component. And, obviously, you had a big move there on the gilt portfolio again. Are we really going to be able to pay down a special so we just finish the year at 13.0%? Is that your clear intention? Thanks very much.

Hi, Chris. So a number of things about into that question there. Let me start with the gilt and come back in NIM competitive environment. To be clear, as we said in the presentation and it was also there in the press release, the reclassification gilt in fact are revised view in terms of the low interest rate environment and as you know hold to HTM you have to give a commitment, your intention is to hold these things to maturity. And that was no longer the case, post-Brexit vote, post base rate cut, I think it’s consistent with what we'll see us doing over hedge, et cetera. And so our intention is not all these two maturity. Of course we've classified them as available-for-sale. That gives us a capital benefit. Please be in no doubt that that capital benefit is good as any other capital benefit. And that goes toward our capital base, and as they available there for distribution or deployment, as we see fit. So in terms of that as we said in my presentation, we still reaffirm the guidance of 160 basis points. You can see if we started the year where that would take us from a 13% up to 14.6%. Our view on capital requirement is not changed, as you said we've got some good news in terms of Pillar 2A coming down. We continue to see our requirement be in the 12 plus one position on dividend, base dividend has not changed. Our position on potential for special dividend has not changed and the board will consider that at the end of this year. And the impact of the guilt is part of that capital equation, this is not an inferior form of capital and it adds to our capital base. It is offset what is going on in pensions. It is offset some of the market movements we saw our WAs. So it is part of our capital calculation and will be part of our distribution deliberations that we will conduct at the end of the year. So let's stop there. In terms of it feeding back into NIM and all those sorts of again, just to be absolutely crystal clear what we've done on gilt has no impact on the future trajectory for NIMs, it’s just a reclassification from held-to-maturity to AFS, it doesn't introduce any macro volatilities or dilute name or anything like that. It terms of NIM, so again, 269, part of that compares - part of that is because we have flow through some of the pricing impacts on the base rate cut, some of our response to that won't take effect until Q4, until actually moving some - the early part of next year. We remain very robust around the NIM. The NIM that we have delivered and that we'll continue to be able to deliver. That comes from, yes there were headwinds out there in terms of base rate some potential for the base rate cut. But the actions that we're taking in terms of managing customer balances, the actions that were taken in terms of optimization in terms of cost retail or across commercial, the action we're doing on funding costs, and you would have seen, for example, on Monday this week we called in some of the crisis securities about $2.4 billion of those which had a yield of about 9% to 12%. So those will be called refinancing give us the benefit we do go into to next year. And some of that is that we were very confident around the 270 and certainly while we will give former guidance in terms of next year, when we come to come. And as we look forward now, we pretty good about the potential and I think we'll be hopeful of targeting maintaining NIM around about 270 level. So that's what we're targeting at the moment for next year.

Fantastic. So that would be probably about 10 basis points ahead of consensus, so I think that's quite encouraging, so thank you.

And to your question about what we see in terms of competitors and outlook, I mean as we thought at H1, I think the market as a whole has assumed that the risk premiums going forward will be different from the past. And if you adjust for swaps movements and margins in mortgages are up versus June this year, which we thought would likely be the case. On the other hand, as you know, in terms of NIM in general and we said at Q2, we have kept an abnormal influx of deposits following the referendum vote. And that's what you remember made our loan to deposit ratio go down from 109 to 107 in June, we said we would go back to 109 and possibly be hired given the lower level of rate. Well during Q3 we have continued additionally inflow of deposits and that's why our loan to deposit ratio is even lower at 106. That is an additional lever that we have in terms of managing the NIM which we tend to fully use as we go back to our - the 110, and that together with TFS makes us comfortable now which George just said that we will be able to hold NIM at around the current levels for 2017.

Got you. So would you want to try and draw down as much TFS as you could, so £22 million?

Truly, and that was what the Bank of England also asked us to do because as you know this was then to partly compensate for the impact of lowering base rates on banks and we tend to do it. And now, we have drawn complete plans in how to do it, and that's why George has told you what is our expectation for next year on NIM. But the deposit is quite important as well. Additionally, flux of deposits, which obviously gives us additional levers in terms of pruning the higher cost deposits, keeping the target loan to deposit ratio which we now think should be around 110, maybe slightly higher.

Okay. That’s great. Thank you.

Thank you. Your next question comes from the line of Joseph Dickerson, Jefferies. Please go ahead.

Hi. Good morning, gentlemen. Chris actually asked most of my questions but perhaps if you could quantify in Q3 any headwind that you had to the NIM from, say, the timing mismatch around deposit re-pricing. In other words, if the balance sheet was held static what would have been the drag from the lag effect of, say, liability repricing versus asset repricing? And then the second question that I had is you've obviously been associated with certainly a major potential credit card portfolio out there in the press. And so I wanted to ask without commenting on a specific deal, could you just go through what the hurdles you would require for any on portfolio or business acquisition. And also when it comes to funding, presumably and correct if I'm wrong, your funding costs would be de minimis given your liquidity position? Thanks, guys.

Hi. This is George here. First of in terms of Q2 to Q3 impact, I mean, it’s not a huge impact, when you look at the two quarter, I think the 274 in Q2, I think that’s about 4 basis points on headwinds and within that moment that would just be a small element from repricing and that sort of be one or two just basically because of the timing. So it’s a small number, there is a bit more to come. But going back partly to Chris's answer, again without specifics I would be comfortable with the actions that were taken to balance that in terms of the saving side, and in terms of the liability management, that we will be able to offset and manage the book and deliver the types of NIM which we're just talking about. So in terms of being precise, it's a small number in terms - its two basis points, bit more to come. But the reactive response is yet to come. In terms of your question M&A, obviously we're not going to comment, but look what I was going to say and may not be mother and apple pie, but shareholder value is absolutely preeminent in anything that we do and you know, we are absolutely aware all entities that are out there, and liabilities that they may or may not have, we're going to anything that would threaten the potential of shelter creation within this particular business. So please, please, please be no doubt of that. Similarly you know where we're interested in terms of strategic growth, you're seeing what we're delivering in consumer finance, which is now that we have targeted, that’s now what we believe or underweight where we believe there's still good returns that can be made and that's an area that we're focusing, we are targeted on. So that - that’s the key area.

George, can I just ask one more question on the funding side? In past quarters you've given us some of the costs of retail savings and the fixed deposits. Is that something you're able to quantify for us this quarter? And also anything - any change in the churn rate on the SVR book?

Okay. Well, SVR book is about 9% and I think that’s where we were. So the Halifax was over 399 or now down to 374 for that base rate cut, $48.9 billion and that was 50.7, so that's about 89% in terms of year-on-year attrition. In terms of savings costs, in terms of funding. So, retail savings I mean, previously talked a blended rate of about 94 basis points to Q2, I think it was 106, that’s down to 86 basis points at the end of Q3, within that fixed is still I think 197, fixed ISA [ph] 177, so that’s down from like 208, 186 respectively at Q2, you see the trajectory. I would also point out to the optimization point you know, when you look at retail savings, retail savings came into this year about $274 billion, they are now about 271 and we obviously prioritized call over a tactical brand. But in terms of optimization and in terms of some of that flight quality as well which sort around Brexit, commercial is growing from 135, up to about to 143 and the an average cost of the commercial deposit we've got to ensure healthy [indiscernible] 40 to 50 basis points. So you can see the optimization that is taking place there and to Antonio's point he made, which is an ongoing process, we literally do that line by line in terms of cost of funds and which I can now believe in that TFS and look where can retire the more expensive development, like the critical part of managing the spread, delivering the NIM and talking about the types of NIM that we've just spoken about in last question or so.

Thanks so much.

Thank you. Our next question comes from the line of Jonathan Pierce, Exane. Please proceed.

Yes, morning. Thank you. Can I just ask a couple of questions? The first one is back on the AFS reclassification. Can I ask what you've done with those bonds that have been reclassified? There clearly wasn't a hedge before, I guess, because they were being held to maturity. But have you now put a hedge in place such that there won't be any adverse movement in capital as yields potentially move back up? That would be the first question.

Okay. Jonathan, the question is about right.

Yeah. Sure. I mean it's supplementary to that one, really, before the second if that's okay. Your broad intention around these bonds, are you thinking you will just sit on them and this is purely an accounting reclassification? Or is there an intention to maybe crystallize these gains in any reasonable size? And then the second question is on the structural hedge. You told us at the interims you were reinvesting that short, as it were, as it matured. Is that still your policy? Or are you staring to take advantage of some of the small moves up in yields that we've seen in recent weeks?

That’s two questions. The second one, so the structural hedge, we continue not invest, we were about $122 billion, I think we're down to about $110 billion now Q3. So we continue to let that roll off. And part of that philosophy you also see in that action we've taken on the gilt. So just to your point, the first of it, we do hedge gilt, the bank loans they hedge balance sheet and when the gilts come in, we do hedge them. When you - without making this an accounting lecture, when you move them into HDM, I actually have a separate hedge, which I can then actually net offer against my structure as I got to pay for, , which I can net off against my effects. But they were hedge when they move to would like to exhibit remain agile, and economic basis, but from an accounting basis, I can actually separate the two. When moving back to AFS, I can basically bring that hedge back, precisely to you point they will be hedge again, again interest rate exposure, if I move into interest rates. I'm agnostic too because they are hedge what you do have and this is one reasons why you put these into HDM for the first space, is do have the second order impact, which is basically the assets swap risk, which is just a differential in movements in the gilt and the swap prices and that place in. The second order impact. That’s part of why you put them into HDM, so can actually avoid that. But it is very much second order. But they were hedged, and now they are hedged again, obviously no doubt about that. In terms of our intentions with of, it is certainly not you know, to hold to maturity in the world where we now live when you see what we did structural hedge, we can't make decision , that were been some very small disposals of the. We will see where rates go will depend on that. But as I said, it is - what you're doing and what we are do is not were doing is as a consistent done with the hedge in terms of where we see the right kind of shells money given us the flexibility to act and respond to market.

Sorry, can I just ask, I'm going to pretend I understood everything you just said on the AFS stuff, but, in very simple terms, are you saying that now they're in AFS there is a true accounting and capital hedge if rates start to move up, so there won't be any negative impact in Q4?

That is correct.

Sounds great. Thank you for that.

Thank you. Our next question comes from the line of Jason Napier, UBS, London. Please proceed.

Good morning. Jonathan's asked at least two of the questions that I had, so I'm going to add another two, I'm afraid. They're also on the gilt portfolio shift. I think I'm right in believing that if they are not sold down that the capital will attrite over time and I just wondered whether - I think from the EBA data that you've got around an eight-year residual on the portfolio. But I wonder whether that's the right way to think about the fade if you were, indeed, to hold onto them. And then a number of investors this morning have been posing the question as to what net interest income impact would be seen, if any, if the entire portfolio were churned in the market today? Thank you.

You're absolutely right, obviously that the balance in eight year term on these, so that’s about a fade of 10 basis points, which is in the theme of running of the bank is noise and you will not us see amending any capital guidance because of that, that's about a thing that I will absorb, whilst you know, sticking with previous NIM. The noise factor but it’s over edges. In terms of the note will be to sell $20 billion, what the income dilution would be, I don’t have the numbers to hand, it will be a much smaller number than the people might think simply because you got to look at the next in terms of the gilt, that’s the swap that sits against that, because in that process, I think if you sold them, you do have redundant hedge at that point. So I don’t have the number to hand but you have to look at the net yield as opposed to the to the gross yield, so it would be a much smaller number were we to hypothetically suddenly dispose $20 billion of gilt.

Okay. Thank you. And then if I may, just as a cheeky follow up, can I just ask you to repeat or clarify what I think you said earlier, that there is a hope that you might target 2.7% as the net interest margin for next year as well? Did you say 2.7%? Or did you say…

We fully have update guidance when we do our full-year results. But as we stand today as we look forward, we would certainly be hoping to hold NIM round about that 270 level as we go into next year - through the next year.

Jason, I mean, we have been telling you repeatedly that we really think we have a competitive advantage in managing NIM because we do it. As you know, that we the whole balance sheet is the difference between the assets and liabilities. We do the decisions every week on all product at the top of the bank and on top of this we have a multi-brand strategy, which I repeat would be very helpful in terms of managing deposit costs in a low rate environment. And we have been telling you repeatedly over the last 2 to 3 years that we were hoping to hold margin for longer, in spite of adverse headwinds and as we discussed before and George and I told you after consulting the TFF in its entirety and the additional deposit inflows that we got post-vote and getting you in Q3, we think that we will be able to hold it again lower, hold it base steady for longer, and this is a real - a real competitive advantage that we think we have and the base rate obviously hurts us. It’s not good retail and commercial bank, as you know, but we are now confident that we're going to be able to hold it steady for longer, and during 2017, as George just told.

Thank you. That’s very clear.

Thank you. Your next question comes from the line of Martin Leitgeb, Goldman Sachs. Please proceed.

Yes, good morning. A few questions also from my side. The first just to add on obviously on the NIM questions and NIM guidance from here. Could you just clarify or to the extent possible, obviously, what kind of assumption we should be making in terms of the progression from here in terms of average interest earning assets into 2017 because, looking at the number, the number has remained fairly stable in 2016 and also before? And the reason I'm asking is obviously we have seen, particularly on the mortgage side, some of your competitors lowering from book pricing, whereas Lloyds and the Halifax brand has remained fairly firm in terms of pricing. And I was just wondering whether we should expect here some decrease in terms of internal volumes or mortgage balances or overall average interest earning assets. The second question was just to follow on that. In terms of other income headwinds we are facing, given the expected economic slowdown into next year, how should we think about other income progression into '17 from here? Thank you.

Average interest high margin, yes, you're right, relatively stable. I always caveat this answer because it depends upon market conditions more competitors’ do you know, et cetera and those sorts of things. But for the moment, as we look forward, I relatively stable. You've seen its stability in Q3 and I could probably project the relative stability as we move forward in terms of the average interest assets.

And Martin, to give you some color between the segments which is the way we manage this, you should continue to expect SMEs to grow around current levels. So we said in H1 that our SME book which was growing in net terms by 5% the year for the last four or five years, we expect to the last 3% or 4%, given that some investors pulled out in terms of investment decisions and following as we said. It is growing at 4% now year-on-year, so you should expect that the SMEs at around the same right. We had a commitment of having £2 billion of net lending growth between SMEs and mid-markets corporate, which we believe we will meet again this year. And because you should expect again next year, mid , the market, growing 2% year-on-year which is again gaining market share because the market overall around zero and they would expect that to continue. Consumer finance should continue to grow around the same right 9% net year-on-year as of now and on mortgages your precise question, I mean, we are expecting with NIM guidance that our mortgage book will continue to evolve around the current trends. So our open mortgage book is decreasing around 1% year-on-year, you should expect that trend to continue. So these are the overall assumptions we have on the different segments to give you some more color on the total IIEAs [ph].

And another income, I think pretty tough, I think when you look at this year, we might for this year we might come in slightly ahead, but last year I think we announced that it’s going to be around about the $6 billion mark. Q3 year-to-date has done a couple of central last year. I think this is said presentation, led by insurance, large portion of that actually is simply related in terms of swap rates which we use to discount returns on share to funds and share the bank asset. And so it’s a sort of economic impact on insurance that is the primary cause of that being down. But I think the outlook will stay tough in terms of other income some of that structural and similar I think it will continue to be market infected think that's what rates on it.

Thank you very much. Very helpful.

Thank you. Your next question comes from the line of Chintan Joshi, Mediobanca Please proceed.

Hi, good morning. I have two questions as well. Continuing on the AFS portfolio, I note one of your peers has a $0 billion AFS portfolio. So I take your comments on board that capital benefit is as good as any other? But, nonetheless, can I check following up on comments made earlier what the net impact of the pension and the gilt portfolio would be if you to mark to market today. Clearly some of those yields have come back. And also are there further gilt portfolios that you can reclassify or is this it. And then the second question was on our PPI how have monthly reactive complaint trends developed in the quarter relative to the previous quarter, how much cost did you incur in the third quarter just want to get a sense of you know what that and it is currently and if I should be cleaning up that run rate for any remediation costs are the cost that I do not recover in the future?. Thank you.

Super. I would do with PPI first, and I'll come back to the TSF. The PPI cash spend in the first quarter of this year we spent about 900 million of which you have a lot of pocketbook the remediation activity. What happened I move through the are moved out of remediation out for review and I'm really just coming back to my reactive, in the first quarter this respect as part of the 900 million, second quarter we spent around about the 600 million, Q3 without is down about 4 million and I would expect that to continue to pull down. But as I said, I hope to that in terms of dealing with reactive and you come down to below the million pounds a month that's that that's a very clear trajectory that will, in terms of all those reactives either with resumed about 10,000 were running around Q3 about 8.5 times thousand and 8000 the sort of non-applicable to number. The money to put up hedges you about flat 7778 down to the end of 2019 may be slightly different of the ones that we have seen while volumes below the that things like to present - we can place to be much unexpected, which is a lower unit cost another the moment of the. So it seems without about the 7778, which is pretty close to where we are at the moment in terms of it all market movements access pensions was something so let myself pensions attention, to the for the surface to about a 740 deficit over since the half year I would in that but within that, am I did when begun a 47 billion PSI scheme that represents a pretty small relative movement and that reflects the Acetylated we've done of the last few years in terms of interest rates and inflation, which hundred 40 and out that the credit risk because you know the discount rate which is a studied index the discount essentially will my liabilities in terms of my assets, while have about 40% in credit, the reason for learning will have international credit for you get a basic mismatch that. But we do think in terms of how to manage we've been able to offset most of those macroeconomic impacts quarter and then ever spread. And is sort of spread and in terms of credit going out a few basis points. If I was 700 million deficit of public call back a few hundred million that was important that. And in terms of impact of the guilt portfolio get to the top of it. But what are the P&L to do Johnson's question earlier head, so you know, I have a small that hedges those out there in terms of a capital. I am I to be hedged from interest rate perspective. So there will be there. There may be some assets will movements since then. And for that is very much second oldest so when interest rate perspective, the overheads, there is there a capital impact.

Thank you. Can I have a cheeky follow up on the NIM? If I think about the fourth quarter, your re-pricing really hits in the fourth quarter on annualized run rate, which means NIMs should be slightly lower in 4Q versus 3Q. And then if I take your guidance of 2.7% for next year, that actually implies that NIMs will be rising through the year. Am I reading that correctly?

You really do that everywhere overly over the precise in terms of the basis point here or there, but as I said you when we get to benefit some actions on deposits and savings when they kick in and that takes time and that you know noticed there is no of things seven board and understand what you. You have to remove the assets before allows before you are able to move the savings and is sometimes meant right.

I am with you on that. Thank you very much.

Thank you. Your next question comes from the line of Andrew Coombs, Citigroup. Please proceed.

Good morning. If I could follow up on the interest margin, please, with a couple of questions. The first is could you just confirm did you say that your assumption of trying to maintain 2.7% next year was based on a stable front book mortgage pricing from here? So I just want to clarify that…

We did not say that.

So what is built into your assumption in terms of front book pricing from here? Do you envisage if…

What we said was two different things. When ask about the current environment there in the first question when we will work from Chris about how the current environment is, I told you this function today. The net impact of market margins, taking into consideration swaps movement - swap movements have been slightly up. So that's what happened until today. We are not assuming higher prices going forward. What we know and that's why we are able to tell you that you referred all of our balance sheet, which we do talk about confusing all the liabilities the full use of TSS and the additional deposit inflows that continue through quarter three, we are comfortable that will continue to be able to hold margin stable for longer, and that's why perspective, if we gave you on NIM. It’s an overall perspective, given the present believer that we have available. And obviously is market concerns but we had enough possible that we tell.

Okay. And on the instant access accounts, I think, George, the last time you gave us the average blended rate on outstanding at the end of first quarter and I think it's 0.5%. Perhaps you could update us where that is today. And then also in terms of the trajectory going forward, following on from Chintan's question, I know you've announced to a number of your savers plans to cut rates, and I think a lot of those come through on December 1. So is it a case of we should get the full benefit of that shown through in Q1 but thereafter really the ability to offset any asset margin pressure comes more from the TFS and wholesale funding as opposed to deposit rate cut?

It’s get tougher as you punch the floor, but I think still think that’s something could do in terms of the fixed account of those actually flow-through got the benefit from them, in addition that is down to write down to the other 44, but then the three, but want to get tougher. I mean, but still ability to manage this better manage the liabilities that I would be. And if you look at a multi-brand - the multi-brand strategy you look at the prices of Halifax deposits were slightly but it's for example, you see that although the difference between the cost of the deposit is still a significant difference and we continue to over time. So we have more levers again by the fact that we have a multi-brand strategy and we have higher cost Halifax deposits which we intend to us to use and the fact that we have been having access inflows as I was telling you is an additional lever that will enable us to that and have a loan to deposit ratio target method around hundred and 110%.

Okay. Very clear. A final one on this, sorry to keep pushing, the outstanding FLS money that you have, would the assumption be that that will just roll into TFS and that you potentially would then take additional TFS on top?

It is a very we will be able to use of TFS and the way we look at it to get back, the same as other business is run. We know we have a source of funding. We will then look at all our sources of funding in terms of the popular retail deposit, be a commercial deposits, be they also funding be they are better left of we look to see if you have, what is the later ages mix for the group and we put everything on the table and assess the marginal cost that's how we run rate and when we look at the Phyllis under receipt of the low-cost a source of funding should we can we pay at any moment. The flexibility we like it, and we don't have many mandatory admitted to the next year.

Okay. Thank you, guys.

Thank you. Your next question comes from the line of Chris Can't, Autonomous. Please go ahead.

Good morning, all. I just wanted to follow up on the margin guidance. Thank you for that. I'm just trying reconcile it with what you've said about not rolling the structural hedge and the fact that the volume there has shrunk GBP12 billion in the quarter, I guess, continues to come down next year, and you will have an adverse impact of the older positions, probably the more profitable positions, rolling off first. So I just wanted to understand, when you're guiding margin to be flat next year, assuming you're not recommencing hedging, which is obviously what you're suggesting as your assumption, how much of a drag is that actually creating to the top line? So how much of an offsetting benefit do you have to assume comes through from deposits, because it would appear to be reasonably meaningful? That would be the first question.

Chris, I mean, you're right and the numbers that we've given a very cognizant of rate and especially with the hedge and I'm just trying to think how clear is the number. But I mean, you know, there is a headwind that will run into a few hundreds of millions, so we have to work to offset. But what I've referenced to you is not just Antonio's previous answer on what we can do on retail deposit and we manage that, but also things like again, I think I mentioned this earlier, things like the cool [ph] that we've just done in terms of the 2.4 billion of tier 2 which had a nine - between 9% and 12% coupon, that prices funding rose, if you just do the math on that in terms of reply, you can see there is a significant pickup in terms of offset to July. So we factor that in you know, we need to work hard, [indiscernible] optimize the mix, all those sorts of things. But yes, I mean, it’s little cognizant to that and that we will continue to roll.

Thank you. If I could also ask on the outlook for other income. Obviously you guided to $6 billion for this year. If I think, looking into next year, one of the things you've had as a running sore there, I suppose, is the roll off of interchange fees. Has that now washed through entirely? And should we expect GBP6 billion to be a base to grow from? Or would you expect, on balance, the risk to be to the downside in 2017?

Similar changes is fully flow through, though I am going to be very helpful to your NIM, I think you know that’s when you see, I think as I said in response to an earlier question, it’s tough and I think we'll through stay pretty tough, how that plays out in terms of precise financials, we will wait and see as we go through some of internal places. But I think we'll say tough environment.

Okay. Thank you.

Thank you. Your next question comes from the line of Raul Sinha, JPMorgan. Please go ahead.

Morning, Antonio, morning, George. I think we've done the gilts to death, so I'm just going to ask about the capital generation in Q4. Obviously the 50 basis points that is to come in Q4 is at the top end of your 150 basis points to 200 basis points range. So I was just wondering if there's anything larger or specific that you want to call out in terms of the performance in Q4 on the capital. You usually get an insurance dividend as well. So is that why you think you'll be at the top end of the usual range? That's my first one.

In terms of top end, were 110 and were saying 260, so 50 basis point, I mean, when you look at my underlying year-to-date it’s been sort of 1.6 you know, we've done PPI, you know there's some things we would look at in terms of RWAs, insurance is out there. So I don't - there is still a voice of number moving part, feeling pretty good about 160. In terms of underlying return [indiscernible] that comes through in Q4, which is the slight seasonality, which impacts earnings, but I am feeling pretty comfortable about 150.

And then the tick up in impairment in this quarter, I know it's from very low levels and you've reiterated your guidance, which obviously is still well below normalized levels. But I was just wondering if I can get some thoughts from you guys on what you are seeing in terms of asset quality for the SME and, in particular, for the unsecured sectors, because they tend to be more sensitive to the cycle?

Again, as we said, - deterioration. The slight pickup is all to do with the recoveries and write-backs, I think we've talked about the 25, 26 basis point, growth AQR which is being pretty constant. We did write-backs and recoveries to see this good, to see they continue because there is rise in terms of what you're provided, but we knew the quantum reduce. But in terms of SME, since Brexit we actually run a whole load f early warning indicators which we take through GECs, risk committees et cetera and there is nothing that we've seen in there in terms of - they lead to believe that any deterioration in terms of the underlying trends in both the unsecured and the SME.

And I mean, you have to take into consideration as well, that we have a low risk profile. So we have been telling over the last few years that we were first worried about large corporates a few years ago, in terms of margins versus returns, in terms of low confidence and therefore we have materially decreased our large corporate portfolio a few years ago, then two years ago, we were worried about London house prices if you recall, and we were the first to reduce the loan to income value for high properties, so that we could reduce market share in London, which is not essentially lower than the rest of the book. Last year we told you about buy to let, the regulator worried. We have not increased our performing buy to let, which is the only segment which is growing in mortgages and that's - that plays into our REIT margin trade-off which we always get re-factory. We have the low risk profile which we believe is absolutely the right one to have as the economic cycle was progressing. And therefore as George was saying, we didn't have to make any risk appetite changes when we went through to this meeting in the last few months because we already have taken those actions in advance. And apart from that, looking at the different segments in the economy out there, we really do not see any sign of deterioration in our key target segments. So 19 SMEs, mid-markets on the core mortgage risk, on the on the consumer finance credit cards, we don't see any signs. So the AQR is slightly higher, not because it comes from the low base, but basically because we had less recoveries as George told in the third quarter, because the growth is very much in line with the previous ones.

Sure, thanks very much. That's really helpful. If I can just have one follow-up on all of the NIM discussion. At GBP380 billion of deposits, I think you mentioned 87 basis points or 88 basis points the last time we saw - I would have thought it's pretty difficult for you to re-price the whole book straightaway in Q4 or in Q1 even. And there would be a staggered duration profile of the re-pricing that should actually give some kind of tailwind to your margin, which is probably what's driving your confidence as you look forward. So is that a fair assessment? Or do you think it's like a step change in Q4 where a lot of this pricing is done?

The first part of your of your question is correct, the stagnant approach that you guys have now experienced in these things are coming right back. So you're correct, the first part…

You're not saying that there's going to be a step up and then again a quarterly decline every - because, effectively, you've got one of the highest deposit costs amongst all the large UK banks. And I would have thought that, given the multi-brand deposit cost, you would have quite a long tail of deposit re-pricings still ahead of you.

That exactly right, we intend to use as it as - I said before, you're absolutely right.

Fantastic. Thanks very much.

Thank you. Your next question comes from the line of Peter Toeman, HSBC. Please proceed.

Yes, morning. You very kindly gave us an exposition about the hedging of the gilts that had moved into the available-for-sale category. I wondered if you could confirm that there are no other material interest rate mismatches anywhere else in the book, fixed rate, variable rate mismatches. My other question was on the multi-brand strategy because, true, Halifax has a higher deposit cost than Lloyds but Lloyds has a higher mortgage cost or the front-end mortgage rate at Lloyds is higher than the front-end mortgage rate at Halifax. And I wondered if it's possible to get some idea of the differentiation in volume growth that might be produced by these differences in pricing structure.

I'll do the first one, and then will give something about the second one. First, within the bank we do not run material interest rate mismatches, [indiscernible] Jonathan's question, but when we buy gilt, I will buy the asset swap to hedge out the interest rate risk, that's what happens, and if [indiscernible] available for sale, from purchase it’s quite simple. Here, you know, I do that, I buy the gilt, I buy the swap, so I am hedged, then actually when I am setting this, it helps maturity from an accounting perspective, no longer you need to hedge. I still got from an economic perspective, enabled me to actually move that hedge and I connect to - off against my structural hedge, which gives me some additional capacity go through net assets, et cetera. But we don't run material interest rate risk within that bank. So it's an accounting type - that was an accounting and economical.

And all fixed rate mortgages are swapped?

That’s correct.

And relating to your question on the different brands and Lloyds and Halifax, I mean, you are right, as we discussed in the previous question, so we have higher cost deposits in Halifax and Lloyds and we have been shrinking that difference. We have been shrinking that difference over time and do continue to do it. So we'll use that difference which is an additional lever in terms of margin management. And in terms of the mortgage book, we also adapt our mortgage prices. You correctly said, to the different brands, I mean, different brands have different customers which have different preferences and that's why we have a multi-brand strategy because we believe that the different preferences enable us to fulfill customer’s needs in a better way in terms of revenue versus cost. We have some additional cost of having differences commercial approaches to customers, but we believe overall customers are more satisfied than we have better returns in terms of revenues minus cost of the strategy and I think it has been very clear. For example, in the way we have been managing NIM in the last few years.

Okay.

Thank you. Your next question comes from the line of Rohith Chandra-Rajan, Barclays. Please proceed.

Hi, morning and I appreciate time is getting on, so a very quick one from me, please. Just on the other income. If I look at GBP6 billion guidance for the year it suggests a 4% to 5% uplift in the fourth quarter. I was wondering, George, if you could quantify that discount rate impact on the insurance business in the third quarter and how much of that you expect to reverse, based on where rates currently are in the fourth quarter. And if there's anything else that we should think about going in 4Q in terms of other income. That was it, thank you.

That would come through, we've done a smooth basis, so that will come through automatically. But the thing that we would learn about sort of - I think it is around about $50 million in the nine months, so you probably - if you just extrapolate that forward in terms of a full year impact. So I think that’s probably the best answer I can give to the question. In terms of coupon [ph] there is a sort of seasonality of result, if you look at [indiscernible] I think we were $1.3 billion of that order and then I think came back more strongly. In short, with insurance tends to be more of a stronger final quarter, some of seasonality, some of that is - as you can look and update assumptions and things like that, because insurance tends to have stronger fourth quarter. And I think I would expect that again.

Okay, because I guess Q3 last year was very negatively impacted by, I guess, capital markets, in particular. And that was - and then you had a bounce back in Q4. I guess we haven't quite had the same underlying performance in Q3 this year?

Looking to capital market story last year, insurance again was a large part in terms of when you look at the difference between Q2 to Q3, it went from 1.6 to 1.3. I think again insurance was the main lumpiness and that is around bulk - and such things. $6 billion is I think the right number for the full year.

Okay. And is there any bulk annuity pipeline that's visible at the moment?

Yes, so it’s not hugely for those in pipeline.

Okay. All right. Thank you.

Thank you. The investor’s relations team will pick up with those who haven't had time to ask their question. Thank you. Ladies and gentlemen, that concludes the Lloyds Banking Group Q3 2016 Interim Management Statement Conference Call. For those of you wishing to review this conference the replay facility can be by accessed by dialing 0800-032-9687 within the UK and 1877-482-6144 within the US or alternatively you standard international on 0044-207-136-9233. The reservation number is 2156889. Thank you for your participation. You may now all disconnect.