Lloyds Banking Group plc (LYG) Q3 2017 Earnings Report, Transcript and Summary

Thank you for standing by and welcome to the Lloyds Banking Group Q3 2017 Interim Management Statement Conference Call. At this time, all participants are in a listen-only mode. There will be a presentation by Antonio Horta-Osorio and George Culmer, followed by question-and-answer session. [Operator Instructions]. I must advise you that this conference is being recorded today. I will now hand the conference over to Antonio Horta-Osorio. Please go ahead.

Thank you and good morning everyone. I am going to give you a short overview of the results of the progress being made in delivering our strategic priorities. George will then briefly cover the financials, before we take your questions. So turning to slide 1, for those of you following the presentation. In the first nine months, our differentiated business model has continued to deliver, with a strong financial performance and improved profit and returns on both underlying and statutory basis. Underlying profit increased to £6.6 billion, driven by income growth, positive operating jaws, and a continued low AQR. We have also delivered a 38% improvement in statutory profit before tax to £4.5 billion. Performance in the third quarter was particularly strong, with income at 8%, driven in part by organic growth and in part due to the acquisition of MBNA. Statutory profit was more than double the same period in 2016, due to the better underlying performance and the absence of conduct charges. Across the Group, we continue to grow in a number of our targeted segments, including the open mortgage book, SMEs and consumer finance, and as a result, Group loans and advances at £455 billion are up £2 billion on Q2 and £5 billion on year end 2016. On capital, in the quarter, we have seen improved capital generation and some upward pressure on capital requirements, as George will explain in more detail. The Group's capital generation continues to be very strong, with 85 basis points generated in the third quarter, meaning that the Group has now generated 185 basis points in the year-to-date. This has enabled us to increase our 2017 guidance to 225 to 240 basis points. Finally, the U.K. economy remains resilient. Over the last few months, we have seen the impact of inflation on consumption through pressure on real wages. However, the economy continues to benefit from record employment levels, as well as private sector deleveraging and rising house prices in recent years. As you know, we are now approaching the conclusion of our current strategic plan, which focuses on three strategic priorities; creating the best customer experience, becoming simple and more efficient, and delivering sustainable growth. On creating the best customer experience, one of the main areas of development for us has been in digital. We operate the U.K.'s largest and top ranked digital bank, with 13.2 million customers active online, of which 9 million now use the mobile app, an increase of 15% in the last year. We have a market leading digital proposition, and will continue to invest significantly in our digital capabilities. We have invested in our customer journals [ph] and complaint resolution processes, in order to better meet our customers' needs. As a result, complaints in the first nine months are down 17% compared to the same period last year, excluding PPI, whilst the Group's net promoter scores has improved again and is up by around 60% since the end of 2010, having improved across all brands and channels. Significant progress has also been made in becoming simpler and more efficient. We remain on track to deliver our simplification program, target of £1.4 billion of run rate savings by the end of this year, having delivered £1.3 billion to date, but further opportunities remain. Our market leading cost-to-income ratio of 45.9% gives us a competitive advantage in enabling us to invest for the benefit of our customers, whilst generating superior returns for our shareholders. Our third strategic priority is delivering sustainable growth, and as you have seen, income is up 8% on the third quarter and loans and advances are ahead of prior year. This has been delivered through organic growth in target segments and our acquisition of MBNA. On MBNA, integration is ahead of schedule and is expected to complete by the end of Q1 2019, a quarter ahead of our original two year target. You will also have seen, that we recently announced the acquisition of Zurich's workplace pensions and savings business, which brings in almost £20 billion of assets under administration, and 500,000 customers, and accelerate the development of our financial planning and retirement business. Finally and in terms of value and returns for shareholders, as you have heard, capital generation remains strong. Underlying returns after tax continue to be around 15%, while we are now delivering a year-to-date statutory return of 10.5% and 15.3% for Q3, ahead of most of our peers and in line with our existing guidance for 2019. I will now hand over to George, who will run through the financials in more detail.

Thank you, Antonio and good morning everyone. As you have already heard, the Group had a strong Q3 with net interest income up 12% year-on-year and underlying profit up 9%. Given this strong performance, year-to-date total income is now up by 6% at £13.9 billion, while operating costs continue to be tightly managed, with positive operating jaws of 4%. Credit quality also remained strong, with a net asset quality ratio of 16 basis points, and a stable gross AQR year-on-year. With income, both NII and OOI grew up by 6%. The increase in net interest income to £9.1 billion was driven by an improvement in the margin to 2.85% and supported by the income from MBNA. The margin is again benefitted from lower funding and deposit costs, which continue to more than offset asset pricing pressures. With rates of increase, we have also continued to build the structural hedge, with the balance of £165 billion, we are now effectively fully hedged, with an income benefit in the first nine months of around £1.4 billion as a LIBOR. Going forward, and irrespective of any rate changes, we expect the Q4 margin to be stable on Q3 at around 2.90% and the full year margin to be around 2.85%. On other income, Q3 OOI of £1.4 billion is flat year-on-year and up 6% year-to-date of £4.8 billion. OOI benefitted from the sale of VocaLink in Q2 and better underlying business performance in Commercial Banking, which was up 6%, driven by mid-markets and global corporates and the continued growth in Lex Autolease, which offset pressure elsewhere in the Group. As we said last year, in the current environment, we do not expect to hold all gilts to maturity, and in 2017, we sold around £9 billion of gilts and other assets, with a gain on sale of around £200 million compared with around £100 million of gains in the first nine months of 2016. Turning briefly to asset quality; as you have already heard, we continue to see no deterioration in credit quality. U.K. housing market continues to be resilient, and we have seen no change in the credit performance or risk indicators in the mortgage book. Motor Finance book continues to benefit from conservative digital values and prudent provisioning. The credit card book has also continued to perform strongly, with reductions in persistent debtors and benefitting from a conservative risk appetite and modeling assumptions. The gross asset quality ratio for the first nine months, which includes MBNA is 26 basis points, on the line with previous year's and despite taking a single large corporate impairment in the third quarter. For the year-to-date, less AQR is 16 basis points and slightly up on prior year, reflecting the lower releases and write-backs, and we continue to expect a full year AQR of less than 20 basis points. The impaired low ratios improved in the quarter from 1.8% to 1.7% of closing advances, and the Group's coverage ratio has similarly increased from 43% to 45%. Finally, the Group's IFRS 9 implementation is in final stages of completion, and is currently expected, that before any transitional relief, the CET1 impact will be a reduction of between 10 and 30 basis points, after taking account of regulatory expected losses. As a consequence, initial move to IFRS 9 is not expected to have material impacts on the Group's capital position. Turning now to statutory profit, which after tax has increased by 50% to £3.1 billion due to the strong underlying business performance, and reduction in below the line items. Market volatility and other items of £13 million, much lower than prior, largely due to the £790 million UCN charge in 2016. In restructuring, the £469 million charge reflects severance costs from our Simplification program, cost of non-branch property rationalization, building a non-ring fence bank, as well as now the integration of MBNA, which has cost about £30 million today, and as you have heard, is progressing ahead of schedule. On PPI, we have taken no further charge in the quarter and have an outstanding balance sheet provision of about £2.3 billion. While net claims volumes increased as expected after FCA's recent advertising campaign, reaching around 16,000 per week of their peak, they have fallen quickly and are now running around 11,000 per week, a bit above our assumed run rate of 9,000. Finally, our cash charge is £1.4 billion, reflecting an effective rate of 31%. We continue to expect a medium term effective rate of around 27%, but remain above this currently, due to the non-deductibility of conduct provisions. Turning to the balance sheet; as you have heard, loans and advances were £455 billion at the end of September, and increased by £5 billion since 2016 year end and £2 billion since Q2, driven by growth across targeted business segments, and in particular, they have mortgage book, SME, consumer finance, and of course, the acquisition of MBNA, which bought in almost £8 billion of prime credit card balances. Risk weighted assets at £217 billion, down 2% on a year ago, even after the addition of £7 billion of RWAs of MBNA. We continue to target and optimize capital efficiency and returns, and this is clearly seen in the growth in our high returning businesses, in consumer finance and SME, offsetting reductions in the lower return in global corporates and run-off and so enhancing overrule returns and RWA efficiency. Finally, as you have heard in the quarter, we have seen both improved capital generation and some upward pressure on capital requirements. Capital generation in the quarter was a strong 85 basis points, with 60 basis points from underlying profits, 5 from movements in RWAs and 20 basis points from market and other movements. As a result, we now expect to generate between 225 and 240 basis points of CET1 this year. From acquired business, as you know the Group's current view of the appropriate level of CET1 to meet regulatory requirements and the buffer to grow the business and cover uncertainties is around 13%. During the quarter however, the PRA has increased our Pillar 2A requirement from 2.5% to 3% of CET1. As a consequence, this additional Pillar 2A capital will be held at year end, and there is upward pressure on the Group's overall current requirement of around 13%. As we are currently awaiting guidance on the PRA buffer, we will provide an update on requirements with the full year results. The Group however still expects to deliver a progressive and sustainable ordinary dividend, and the board will give due consideration at the year end to the distribution of surplus capital, through the use of special dividends or buybacks. On net assets, TNAV increased by £0.011 per share in the quarter to £0.505. Statutory profit after tax of £0.02 and favorable net reserve movements of 0.1 were partly offset by the payment of the 2017 interim dividend of £0.01 per share. Net reserve movements, included a fall in the cash flow hedge reserve from changes in interest rate expectations, offset by favorable movements in the defined benefit pension scheme. Finally, our strong capital position, stable profit and strong asset quality, have all been recognized in the recent credit rating upgrade by Moody's, in which Lloyd's Bank was upgraded to AA3. So in summary, our differentiated business model continues to deliver, with a significant improvement in financial performance, returns, and capital generation. As a result, we have enhanced our guidance for capital generation and margin, while maintaining our AQR guidance of less than 20 basis points. We are well positioned for the future. The integration of MBNA is ahead of schedule. We have acquired Zurich's workplace pensions and savings business, and we have implemented the Group's new organizational structure. These changes prepares well for the next phase in our strategy, which will be announced at our full year results next year, and with great confidence in the future of the Group. That concludes today's presentation. We are now available to take your questions.

[Operator Instructions]. And the first question comes from the line of Raul Sinha of JPMorgan. Please proceed.

Good morning Antonio. Good morning George. Can I have two please, two areas? Just the first one on OOI and the second one on capital. On OOI, if I look at your earlier guidance, that full year OOI will be up, ex-VocaLink, that implies that Q4 would be up on Q3, and I was just wondering, if you might be able to give us a little bit more detail on why that might be the case? On capital, I was just wondering to explore whether or not this rising pressure on your capital requirement actually means anything for the dividend and for the expectations? Given that you are already at 14.9% now pre-divi. If we take a new capital generation guidance, you are 15.3 to 15.5 by the end of the year, and even if we assume, you have to adjust your PPI provision for the 11,000 average claims. That still means, you have got a potential dividend, including a special of around 4.3 for the full year. So I was just wondering if any of my math is incorrect, and if I am missing something? It seems to me, that even if you held yourself to 14, you would be able to meet or even, maybe slightly exceed consensus, EPS expectations?

Hi Raul, it's George. I will answer the capital one first, and then come back to OOI. I mean, as you know on capital, we have talked for a long time around 13% of being our guidance, and you know that, within that, we are fully cognizant obviously of additional buffers that were coming in and expectations that we would offset those through reductions in some of the PRA for the 2A and for the 2B buffers, and we have seen that in reductions that we have seen in the last couple of years. Remember that -- and that around 13, it comprises of regulatory requirement and a healthy buffer that we put in for management purposes. Now it is disappointing to be able to report the Pillar 2A rather than going slightly down as you might have expected, it has gone up by 50 basis points. So I am going to have to hold that additional 50 basis points a bit at the year end, and also, that I am not able to announce, what we think the target to be, because [indiscernible] away from my Pillar 2B buffer at the end of the year. But your central theme around dividend affordability and to your sort of numbers, I am not sure -- if I just look at it in a slightly different ways, but probably come back to, which will confirm your math. I mean, we are told today, we have got strong capital generation of the 225 and the 240. Let's take the 240, the top end of that range. So if we are going to get to 240, if I say I am going to put aside 50 basis points for that Pillar 2A, I still have 190 left to spend. I think you talked about four point -- look, this isn't a prediction. My consensus is some of that 4.5P or something like that. That's 150 basis points of capital. So that would still give me 40 or 50. So look, this isn't a prediction or anything, but if I generate 240, to your point, and I am not saying this happened [ph], you could increase capital by a percent, and still meet those consensus expectations around the total distribution. So that's how I see it, and that's how I see the numbers, and I take great comfort for that.

Could you buy a couple of million of Lloyds please?

So right -- so that's how I see it. I think I am sort of confirming what you said -- I am confirming what you said, in terms of why you come back to that math. In terms of OOI, the first thing -- yeah, I think we said that ex-VocaLink, we would expect OOI to be slightly ahead of prior year, and I would still expect that. I think if you look historically, Q3, I think was flat on prior year, but Q3 was always I think about the weakest quarter, as we move through the year. So I would expect Q4 to be stronger. Why I would expect it to be stronger, there was a slight downturn, it was in commercial banking during the summer period. Insurance always has the strongest quarter in terms of Q4. We have seen true-ups on assumptions and all those sorts of things within our numbers. So I would expect Q4 to be stronger than Q3, and I would still expect OOI, ex-VocaLink to be slightly ahead of OOI to in 2016.

Thanks George. That's very helpful. Can I just have one clarification on capital? Obviously, there are a lots of moving parts here. But as I understand, there is a phasing in of the high requirements as well, because your counter cyclical buffer only goes up to 1% at some point in 2018. That assumes, that the counter cyclical buffer requirement actually only goes up by 50 basis points, and so the requirement at end 2017 is probably slightly lower as a mining constraint than it would be in 2018 anyway?

You are absolutely correct. So things like counter-cyclical or back end of 2018, things of a systemic risk which comes in, is, I think Q1 2019. So those are out there. You are absolutely correct in that statement.

Thanks. And apology, that was not me buying 2 million of Lloyds, apologies.

Thank you. And your next question comes from the line of Fahed Kunwar of Redburn. Please proceed.

Hi. Good morning. Can I just ask a couple of questions? The first one was on the increase in the hedge portfolio by about £20 billion in the quarter. Can I just ask why that has increased? My basic understanding was that the current account balance is around £100 billion, you have got around £40 billion of equity, so £140 billion hedge balance, which is what it was at Q2, it's about right. Should we infer from this as being an additional switch into current accounts from time deposits in this quarter, which has led the hedge to be increased? That was my first question. And my second question on the Pillar 2A buffer, just so I understand in 2016, I think you moved surplus to a deficit, which moved back to a surplus in 2017. So will that hopefully put downward pressure on the Pillar 2A buffer for 2017? And then the third question was on car finance, and so Pendragon recently were quite bearish on their digital values, coming through particularly on luxury cars. I was just wondering, obviously, of your £10 billion cars on the balance sheet, 4 is Lex and 6 roughly is Black Horse. Could you give an idea for the digital value they are doing on the Black Horse component, but also what they are doing on the commercial vehicles in the Lex Auto Lease component, that as well? Thank you.

So hi, it's George again. So the [indiscernible]. So the hedge, yeah, you are right. We came into this, I think they were £111 billion, and we basically put on about £66 billion [indiscernible] in the period, and we are now at about £165 billion. And obviously, as previously discussed, we don't -- we exercise discretion and how we deploy that hedge, and with the pickup in rates, we have sort to -- go back to reinvested, which is our natural state, and we -- to be slightly short though, so we are not in the wrong side, should rates pick up. So we are going to effectively be fully invested. The components are the current accounts, which has been building, which is good through the period, capital, but also there is the rate insensitive elements of variable accounts as well, which I think common with our peers, we invest that element. So it's the rate insensitive element, would be the sort of missing element of your piece. But we are up fully invested, and that gives us great stability around our name, as we go through this year and into 2018, I would say as well, in terms of the hedge and the volume that we have now got in place. The Pillar 2A, you are right -- Pillar 2A is [indiscernible], as you know. I just can tell you that the delta in that, but I am not allowed to sort of talk about the whys and wherefores. But to your point entirely, it captures those risks not captured by Pillar 1. So I have got operational risk, I have got interest rate in the banking book, within there, I got concentration. But I also have pensions, and precisely to your point, it does move around it. So the increase that we are seeing is basically derived from the balance sheet at the start of the year, whereupon, I am going to agree with everything you said. The pensions have gone from a surplus to a deficit, and to your point out, we are actually calling out that the pension scheme has actually returned to a surplus position, and I can say, that that is a good thing, in terms of Pillar 2A construction. So I would agree entirely with your central bit. Car financing; look, we continue to remain comfortable. Yeah, we have about, sort of £10 billion of residual value, of which half is Lex, then I have got about two or three JLR and two or three through PCPs within Black Horse. That sort of amortizes down to about £6 billion exposure. We monetized [ph] the hell out of this. We are still selling cars at profit. We still carry our excess provisions. We still discount new pricing to allow for dropoffs in terms of guaranteed future values, over and above where the market would place that three years out. So as I said, units still being shifted to profits. But we feel comfortable with our exposures, that's all I could say.

Perfect. Thank you very much.

Cheers. Thank you.

Thank you. And the next question comes from the line of Claire Kane of Credit Suisse. Please go ahead.

Hi, good morning. So a couple of questions; firstly on the PRA buffer, which you referenced as being one of the final components to determine what your capital target will be going forward. Given you completed the stress test, how confident are you, that you would have a binding constraint on Pillar 2B or how that might change for you going forward? You stepped away from your previous target, which was your known capital surplus to 1% buffer, and given you have had some volatility in Pillar 2A, do you expect to return to that framework of adding on a buffer, like some of your peers do? And then my second question is around the mortgage market, so just really if you could provide some commentary around the competitive landscape and what your outlook would be for volumes into Q4, if you -- is it running ahead of expectations or not? And how the pricing is coming through in the market, given yourselves and some peers have upgrades recently? Thank you.

Okay. Hi Claire. So as you know, let's just start with our previous capital guidance. As you said, back a couple of years, it used to be around 13, and within that, we used to say, that that was just sort of, roughly around about 12 plus 1. And during 2016, we were pleased to be able to announce that, within that 12, the PRA buffer or Pillar 2B buffer as well as then, had come down significantly, representing the de-risking of the business. But then we would stick to around 13, but it was now significantly less than 12 and a bigger number than one in terms of the buffer that we held. And again, we had to sort of express in that slightly clumsy way, because of what we could or couldn't say to the market. But the key thing is, it came down significantly because of derisking. We would always expect to hold a form of management buffer, what size would depend upon circumstances, that we have stuck to be around 13, despite the regulatory grounds of the Pillar 2B coming down significantly, because we obviously know that there are capital requirements to come. But with that, came down. So in terms as I look forward -- all I can say is that, it has come down significantly in the past, reflecting a derisking of the business. We continue to derisk this business, and I would make that point. Now, how that gets played out in the buffer, I don't know. As you said, stress tests are being completed, but I won't be informed until January or March time. So that is coming down, we will have to wait till then to see what actually happens in terms of the buffer itself.

Okay. And Claire, relating to your question on the mortgage markets, I would say that, overall, we don't see a significantly different picture from previous quarters, but to give you some flavor, we see some of the smaller banks increasing prices, probably because of TFS coming to a close and for LCI considerations. On the other hand, we also see some other banks investing more on intermediaries, for example. So overall, not very different. We continue to expect, as I have said previously in other calls, asset prices to continue to come slightly down, given AQRs are at extremely low levels, and in our case, we continue to expect our deposits prices to also come down, given we have higher overall deposit prices than the sectors you know very much, because of the heritage of the Halifax brands, the savings and mortgage building site, which we have progressively changed over time, being part of the Group. And of course, my answer to you is based on rates not moving. So there is an expectation in the market that rates might move in November. Of course, that will be a change. But apart from that, which I am not going to comment in this question, apart from any change in rates, I would continue to expect a similar behavior between asset prices and deposits prices in the following one, two quarters.

Thank you.

Thank you. And the next question comes from the line of Robert Noble of RBC. Please proceed.

Good morning. Well I will just pick up on that interest rate reference that you just made there Antonio. What sort of benefit would you see from a one or two interest rate hikes from the Bank of England in general? And if also, if you could just give us a breakdown as usual of the deposit prices by book, that George you normally give? Thank you.

Okay. So George will give you the breakdown. So just to give you some flavor on that Robert. We have said before, we are very positively exposed to rising interest rates. Our expectations on interest rates from the start of this second strategic plan, was to have interest rates slightly lower than 1% by 2019. It looks like now, the expectations on the markets underlines with our previous expectations, so the market expects an interest rate movement in November, as I just heard, and one more or two next year. And that's a slow rise in interest rates, is as you know, beneficial in general for retail and commercial banks, and we are significantly exposed to rising interest rates, as George has detailed before.

Yes, that's right. And then Robert, in terms of some of the savings rates and stuff. I mean, I think we talked about an aggregate savings rate of about sort of 51 basis points of Q2, that's dropped down to about 47 basis points at Q3, and within that you have probably seen main stepdown and things like the fixed book, which is sort of 132 plays at 142 at Q2, that has probably been the bigger mover. I think [indiscernible] is also down about 9 or so basis points. So we continue to show you that, and you see that in the -- if you look to the NIM walk from Q2 to Q3, I think you have got about sort of four or five up from assets, four or five back from liabilities, is what you are seeing there, and then obviously, a three month benefit from MBNA, versus you only have one month in Q2, and that's what's sort of driving that NIM forward.

Great. Thank you very much.

Cheers.

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

Hi. Good morning. Got a couple as well please. One, just a clarification actually on George's comments on capital earlier. Just to check that I heard correctly, on the potential dividend paying capacity, I think certainly [ph] to what you are saying, even if you are working to a 14% CET1 ratio at the full year, you would be able to -- there would be sufficient capital to pay the current consensus expectations around £0.045 dividend. So just wanted to check if that was right. And if that level is 13.5 rather than 14, then I guess, the dividend paying capacity would be more like £0.055 to £0.06. So that was the first one. And then the second one was just on credit quality, which I guess, all the indicators that you pointed to have been strong, there was a pickup in the quarter, which you ascribe to a single corporate exposure. Just wondering if you could talk about that a little bit, and also the reducing level of write-backs that you are seeing, I think there were 12 basis points of write-backs in the first half, falling to 7, is that a trend that we'd expect to continue? Thank you.

Hi Rohith, it's George again. So to your first point, first up, we remain -- and the Board remains committed to our progressive and sustainable dividend policy, and the Board will make its usual determination at year end, in terms of surplus capital and special buyback, etcetera. So that's a decision. But to confirm the math that I gave is the math that I gave. So that's just to show, in terms of -- if I generate the 240, if I put away the 50, just going to consensus in terms of capacity, then your math is correct. So the 4.5 is 150, and you are right. There is 40 leftover etcetera. So there is nothing with your math, and that's entirely what I said. But again, let's just say, the board will make its determination at the end of the year, in terms of what the commitment to the progressive and sustainable ordinary dividend and what we do around surplus capital. But you are absolutely right, in terms of capacity and in terms of capital generation and potential uses. So to confirm that. And then you asked a question about [indiscernible] so it's a step-up in Q3, and that reflects -- if I am looking at it again, on prior year, I have got about £40 million or so coming through from MBNA, which is a year prior, and that is entirely in line with our expectations. And then sorry, no -- on the single large corporate, it would be inappropriate to give any firm detail. The key point that we want to make, is that this is absolutely not a trend or a deterioration in terms of credit quality. We are not seeing anything in terms of credit quality coming through.

And Rohith, this is Antonio. This is not what George just said, is something that we have in repeating over the last few quarters. You have a record numbers of employment. Unemployment would be the indicator that could start rising non-performing loans, especially on the household sector. We have record employment numbers, the highest since 1975. Second, you have very low interest rates and very negative at the moment, given inflation went to 3%. We have less debt in the economy, especially in the household sector that needed it, but also in the corporate sector that is not needed. And you have, as I have mentioned before in previous calls, you have had a significant recovery of house prices throughout the country, which have put a lot of equity on the pockets -- within brackets of households. To give you an example, we have the largest mortgage lender in the country, with around £300 billion portfolio, average LTV of around 45%. So it means our retail customers have more than £300 billion of equity in their homes, and that is very important, not only in terms of equity there, but in terms of confidence. So as I said before in several calls, the fact that we have this tailwinds to the U.K. economy, in light of Brexit uncertainty, which is high and exists, that which outcome we will only know probably next year, to work in another year or two or three years, this tailwind on the economy will provoke a longer cycle, as we have been repeating, and that's what you are seeing. So we don't see in any of our portfolios, not on any sign of impairments, but any sign of increase on non-performing loans, and as George said, we still have the write-backs, which also shows how prudently we provision across the cycle as well.

You asked the question about, if I recall, the future expense of write-backs. It's a couple of [indiscernible] questions, but you know, we said we would expect to see, but at a lower level going forward. I mean, that's what we said, and we would stick to that. As we move beyond this year and into future years, we would expect to see write-backs, etcetera, but just at a lower level than that, which we are currently seeing.

Write-backs is a very good indicator of the prudency of provisioning policies of the cycle.

Okay. Thank you. So the write-backs I guess were 12 basis points in the first half of the year, that fell to 7 basis points and it sounds like, you are kind of thinking, that maybe that might be a new level or certainly trending down from the 12 anyway?

There is a sign [indiscernible] precision in your question. We would just expect a slightly lower level to that which we have seen.

Okay, thank you.

Thank you. And the next question comes from the line of Andrew Coombs of Citigroup. Please go ahead.

Good morning. Two questions please; first, is a follow-up on capital, more specifically the 50 basis point increase in the Pillar 2A. There was previously a discussion about your move from a surplus to a deficit back to a surplus again, on the pension position. But that was already named to you, and yet, you previously expected 2A to fall, rather than increase. So I was just trying to get a feel for what's driving the increase -- what can you tell us about the reason behind that hike? So that will be the first question. Second question would be on PPI; you did see initial spikes, you said 16,000 per week, that's now dropped back to 11,000 already. But even in that scenario, it's running above your 9,000 assumption. And so, why did you elect not to take extra charge provision for PPI this quarter? Is it just a case of more evidence of where that runway ends up? Thank you.

Hi Andrew, George again. So on PPI yes, as we said in the presentation; I mean, we came into this quarter, Q3, round about the sort of 9,000 level, which is what we have assumed through to the time bar. The most significant value this quarter, I will come back to your question in a moment, is actually the courts reaffirming that time bar in the quarter. I think that's a big call out, and I think in terms of the -- sort of appeals, so just your review has been turned down and has given us the certainty, which I think is the right thing for everyone, and I think that's the big call out. And as you said in the presentation, we still have something like £2.3 billion, so I have £100 million a month in that provision, which is kind of what I have been paying out over the course of Q3. But we came in round about at 9,000; and that 9,000 as you know, we have sort of gross complaints, that for the sort of total we are getting, which is round about 15,000, 16,000 a week in the undisturbed, giving us 9,000, 10,000 of net complaints. As we went through the quarter, with the FCA's appetite, and that's 16 effectively at its peak, sort of doubled up to, got to about 36,000. The net got to about 16,000, as I said in the presentation at its peak, mainly because what you were seeing was a whole load of -- whilst additional activity, a lot of that was of low quality, with not having PPIs. As said, that 16 has dropped down to -- sort of to your point, look, I am assuming I am going to get 9,000 every day of every week for the next 23 months in the provision. So that's a big number and that's a big assumption. At the moment, the monitoring of the excess that we have seen -- to give an example, the sensitivity we gave is, that if it's 1,000 more -- 10,000 of each days, each week, each month, is something like £250 million. So to me, the big event in the quarter was the reaffirmation of that deadline. Yes, there is a sensitivity around -- if volumes exceed the 9,000, 10,000 and we will continue to monitor etcetera. And if we have to act, we will act to top up. But to me it's -- I don't want to sound complacent or anything like that, but that's pretty manageable etcetera, and we will continue to monitor that, as we move forward. On the 2A, I am afraid I am going to have to frustrate you, because I am not allowed to talk about components and movements that drive it. So I appreciate the question and I appreciate why you are asking the question, but I am not allowed to give you details as to whys and wherefores of 2A increases. So I can't say more than I have said, I am afraid, and I am sorry about that.

That's understandable. Perhaps I could start to supplement you in that case about the Pillar 2B, given the PRAs or given the stress test on consumers, talking about any extra 50 basis points to the system. Lloyds, obviously, one of the banks with a larger consumer finance portfolio. Is it a case of going into the year, you are expecting offset from other parts of the stress tests declining? Or is it a case of you are embedding extra X% into your targets already?

Look, as I said previously, there is a -- we have historically seen a reduction in the Pillar 2B buffer, the PRA buffer, because it reflects the derisking of our business. Now, with the consumer finance bid that comes out, let's see how that plays through. We absolutely stand by the prime quality nature of our consumer finance and our credit card book, and we would like to think, that that would be reflected in any [indiscernible]. But we have previously come down, because we have derisked. We continue to derisk -- the other one for example, are things like conduct. That's why things like PPI are helpful, etcetera as well, in terms of derisking the system, derisking the outlook, and we would be probably more than helpful. But as I said, the quality of our credit card will be reflected, and also, how we performed in the stress tests will be reflected in terms of the PRA buffer to come. But I won't find out until January.

Understood. Thank you.

And your next question comes from the line of Jonathan Pierce of Exane. Please proceed.

Hey good morning. Two questions, I am sorry. First is back on capital. I think, talking about capital stack in terms of transitional position, is maybe not quite as helpful in some respects, thinking about where we will be at the start of 2019, and obviously, we know most of the components will stack with decent accuracy now, and I add them all up, I am getting to slightly over 13% without any PRA buffer at all and without any management buffer. So I am trying to buffer that up with -- it seems the suggestion this morning that 13.5% is going to be the new right number. Is what you are saying that you -- clearly, you can get without holding very much in the way of a management buffer at all, on top of all of these under buffers that we know about, that would be fully phased in at 14 months time. So maybe, give us a little bit of help on that start? The second question is, is just really to understand these gains that are being taken, as you sell down the AFS portfolio; presumably the bonds that you reclassified last year now are fully fungible with all of the other government bonds within that AFS portfolio. So should I think about this as, whenever you sell £1 billion worth of -- £50 billion of government bonds you now have in AFS, you are going to take sort of 2% or something of the total gain on that portfolio. Are the gains ascribed to individual bonds there? Are you able to pick and choose what you can sell to create the gains, at any one point in time? Thank you.

Okay. Right Jonathan. Okay, in terms of the gains then; I said in the presentation we said last year, in the current environment they have returned the capital I have to hold against them. Gilts are not an overly attractive asset, and so we have been selling off and we have continued to sell off, and we are at around £200 million, as I said in the presentation of gains, that was like £70 million each in the first two quarters, and so I think it was £51 million in Q3. And actually, that compares with about £45 million in Q3 of 2016. So in the in-quarter, it's not a very big distorting factor. In terms of -- do I look at gains on an individual credit basis, or do I look at gains on a sort of portfolio basis? I am not sure that really sort of matters. What I am saying is, as a class, they are not particularly attractive to us. We clearly flagged this last year, that we would step away when we did that accounting change, as we moved out of HCM into available for sale, and we have sold out and have continued to do that through this year, in terms of derisking. So I am not going to sort of tell you or project you what you should put in or expect going forward. You know, that would depend upon markets and how we view our internal positions. But we have made very substantive progress in coming out of assets, that we don't see as attractive. In terms of capital, so again, back to your very first comment. I mean, let's be clear, the position is, we currently expect to hold around 13 and we are saying, with what has come out to-date, that around 13 is under pressure. So that's what we are saying about the capital position, and we will have better information on that, at the year end, going back to sort of earlier questions, when we get the PRA and the Pillar 2 buffer. In terms of the look ahead, you are actually right, in 2019, of course, we have got the capital conservation step-up, the systemic risk comes up as well. But again, I would be hopeful within that period, as I continue to derisk, as I continue to take actions, I continue to make contributions to pension schemes, etcetera, etcetera, that the discretionary buffers would come down. Now where we end up? Well no better as we move forward. But for the immediate position, as I said, we are currently around 13, and around 13, comes under pressure, given that I was expecting to go down a bit, a few basis points, in terms of Pillar 2A, I have had to go up to 50 basis points. Let's see what they say about the Pillar 2B buffer, but going back to the earlier question, what is important, is that capital generation and the affordability of actually paying for those steps.

Okay. Thank you very much.

Thanks Jon.

Thank you. And the next question comes from the line of Joseph Dickerson of Jefferies. Please proceed.

Hi, good morning. I think we have belabored the capital thing enough, but I guess, if you could just clarify that the Pillar 2A buffer has an element of conduct risk, and presumably over time, as things like PPI roll-off and maybe there is something in there, for I don't know what happened, with HBAS. I am sure you can't comment upon that. But assuming that there is nothing major on the conduct front, that we don't know about coming up. If I was a reasonable person, I would assume that any element associated with conduct on a forward basis in the Pillar 2A buffer, should improve. If you could confirm that, that would be helpful. And then you referenced that the capital level comes under pressure, 13%. I guess, if it comes under pressure, how come you are confident enough in reiterating that 13% CET1 is the right number -- with the right CET1 level with which to operate the bank from a return standpoint? If you could comment on those two things, that would be grateful.

Okay. Hello Joseph. So yes first up, you are right, Pillar 2A, just a couple of risks, which aren't picked in Pillar 1, and so within that, you have got concentration, you have got interest rates, you have got pensions. But to your point, you also have operational risk, and within operational risk, there is a conduct element, and I would subscribe to your thesis, that as I look forward and it comes back to things like the importance of the PPI time bar, that operation -- the conduct element should diminish. And I would also then -- going back to the last point, the Pillar 2B buffer, the PRA buffer also has a conduct element of that. So there is conduct elements in both the PRA buffer and the Pillar 2A buffer, and as I look forward, I would expect conduct to come down, and I would expect that to flow through and be reflected in. Then sorry, then in terms of your cash flow position; again, just to sort of clarify; we talk about currently requiring about 13, and you know, that's our current position. It has been our position in terms of capital requirement. And again, as I said, we talk about, if I am not repeating myself, now coming under pressure, because of assumptions deviating from what we were seeing about, happens to things like the Pillar 2A, which I just talked about. The results have been, again, going back to some of the earlier questions, the current requirements of today differ from those requirements of the future. So things like the countercyclical doesn't come in full until 12 months time. Things like systemic risk doesn't come in until Q1 2019. So a number of those step-ups don't come up until subsequent periods. But look, currently around 13 is where we think is appropriate. But we do say it's under pressure, given as I said, what has happened on 2A, and as we look out. We will have more information to be able to update, but at the year end.

Thank you.

Thank you. And the next question comes from the line of Martin Leitgeb of Goldman Sachs. Please go ahead.

Yes, good morning. I have two questions, please. The first one is just the usual data on the back book, if you could just share what the current balances there are? And I was also wondering if you could tell us what the share in gross mortgage lending you had during the third quarter. And I remember, in the first half, that was around 15%, 16%, and in June, it increased or spiked at around 20%. I was just wondering what kind of number should we be looking forward there in terms of gross mortgage lending share going forward? And the second question is more broad on Brexit and impact of Brexit, and you elaborated on the risk side of things, that you don't see any signs of deterioration in any books yet, if I understood that correctly. I was just wondering, if you could shed a little bit of light on what you see in the demand side. Is there anything you notice in terms of lower demand from, say, corporate clients, investments being postponed and so forth? And similarly, is there anything you see already on the consumer side, whether that's unsecured loan demand or anything, from the report and your data, it doesn't seem like anything has appeared so far. Thank you.

I will take the first couple. So yeah, on the back book, again, it's the same old story in terms of SVR attrition. So we sort of get around to 11% in total, and within that, sort of Halifax actually was just a shade under 10, I think, with the 374 book at -- I think it was about £44.3 billion in terms of size. So again, we are not seeing any change in trends in terms of SVR attrition, let me make that point very clear. In terms of front book, in terms of volumes, yeah, we talked to the -- I think we said, we delivered about £18 billion. So in Q3, we are now at year-to-date, up to about £30 billion -- £30.1 billion in terms of new business, so that's just over 11.5 in Q3. Market share, I think we are down about sort 15% in the first half. I think in Q3, we are about 17% share of new business. So that has picked up, as we alluded to, I think at the -- as you said, the Q2 presentation.

Okay. And Martin, relating to Brexit. I mean, to give you some color; so in terms of the household sector, as I said previously, we see some impact on real wages, because inflation hitting over 3%, makes real wages growing negatively, as you know, and consumption is two thirds of GDP. So we see people saving a little bit less, borrowing a little bit more and holding some purchases, which is normal, when they have an inflation shock. And as I had said in previous calls, that behavior is normal behavior, when something changes. But it is also allowed by the fact that households have significantly deleveraged in the previous 10 years since the crisis. And in terms of corporates, we see some impact, as we had said previously, our SME net lending is growing at 2%, while previously it was growing at 4%-5%. So some impact, but not much in some companies, given the uncertainty, are holding some investment projects. But we are still growing 2% instead of the previous 4%-5%. So as a whole, not much, that's why GDP, I believe, was growing 2% and is now growing around 1.5%. So some impact, but not very much. Going forward to your second part of the question, obviously it all depends on the agreement that the U.K. will get with EU, where we export and import around 50%. So 50% of our trade is with EU. Normally, in my opinion, agreements only come close to deadlines. So we will probably only know the agreement next year. Businesses, as you know, are asking for a transition period and the government is minded to try to agree that. So if we have a two, three year transition period, we will know the agreement next year, for an implementation in three, four years down the road. And that's why, I have been saying, that for the next few quarters, which is the normal time spent, where we can reasonably see what's going to happen, we continue to expect GDP to grow around these levels.

Thank you very much.

Next question comes from the line of Chris Cant of Autonomous. Please proceed.

Hi, thanks. I just had two questions, following up on previous comment. My --

Can you speak a bit louder please?

The management buffer, you've referred back to your previous guidance of needing sort of 1% over 12 as a management buffer, and with the advent of IFRS-9, the increased volatility that it will create, I was just wondering if you could update us on your views on the right level of management buffer for the business please? So obviously that's not something a regulator can prevent you from disclosing? And then you also made a comment, George, about great stability on NIM into the fourth quarter and into 2018, just thinking about the comments around 2018, and what I can infer from that. Are you talking about rate stability year-over-year there, or rate stability on your exit run rate of 219 please? Thanks.

I think just rate stability, I think, Chris. You're right, I mean, the management buffer, but the amount you hold on the management buffer will depend upon circumstances. So at the moment, as it stands today, we hold a management buffer significantly in excess of the one. That goes back, the comments we were making earlier about the reduction in the Pillar 2B buffer, that we weren't allowed to talk about, which bought down the regulatory requirement. But we expanded out our management buffer, because we knew there were changes coming. Now as you go through those changes, you won't need to hold such a big. If you look at how you distribute capital, you might not need to hold such a big management buffer. So it will depend upon circumstances, and so, I am going to be slightly frustrated, I am not going to give you a number. But at the moment, it is significantly greater than that. But as you move through and as capital uncertainties disappear, then the management buffer could flex accordingly. And then in the NIM; look, we are not giving formal guidance today and all those sorts of things. But I think, to go back to my point, we have got a very strong contribution from the structural hedges. We have built the volumes and locked into some of the higher rates that we are seeing. I would expect that very strong contribution from the hedge to continue into 2018, which will underpin whatever we say about NIM, when we get to the year end.

If I could just push you a bit more on that management buffer point. I mean, I appreciate there are a couple of uncertainties, but there always was. Other banks were able to guide on what they think the right level of comfort buffer? I mean, this is a discretionary buffer you are holding to ensure you don't have to cover dividend or whatever. You previously framed that as being equivalent to one year's worth of ordinary dividend that you wanted to have in the tin, in case of a bad year. Is that the right way to think about -- still does IFRS-9 change your view on the necessary size of the buffer? Other banks do give numbers for this. I can understand why you can't talk about Pillar 2B yet, because you don't know your stress tests. I can understand, you can't talk about the components of Pillar 2A, because the regulator won't let you. But this is the decision for you as a management team. I don't understand why you can't give the market some guidance. And you can see from your share price reaction this morning, concerns around capital are very real. I don't think you are doing us any favors by not telling us.

All right. Well thank you Chris. We will -- I have said what I wanted to say, and I hear your reasons why you think we should. We will talk more about it, just probably at the year end, when we have got all the pieces. And so, I think that's the right time to talk about it, Chris.

Thank you. Ladies and gentlemen, we have now run out of time. So this concludes the Lloyds Banking Group Q3 2017 Interim Management Statement Conference Call. For replay information for those of you wishing to review the conference, the replay facility can be accessed by dialing 0800-032-9687 within the U.K. or just 1877-482-6144 within the U.S. Alternatively, use the standard international on 0044-071369233. The access code is 60210107. Thank you for participating in the call today.