Lloyds Regulatory News (LLOY)

Lloyds Bank plc

2022 Half-Year Results

27 July 2022

Member of the Lloyds Banking Group

CONTENTS

REVIEW OF PERFORMANCE

Principal activities

Lloyds Bank plc (the Bank) and its subsidiary undertakings (the Group) provide a wide range of banking and financial services through branches and offices in the UK and in certain locations overseas. The Group's revenue is earned through interest and fees on a broad range of financial services products including current accounts, savings, mortgages, credit cards, motor finance and unsecured loans to personal and business banking customers; and lending, transactional banking, working capital management and risk management services to commercial customers.

Income statement

In the half-year to 30 June 2022, the Group recorded a profit before tax of £3,283 million compared to £3,420 million in the same period in 2021, representing a reduction of £137 million as higher total income was more than offset by the impact of a net impairment charge for the period compared to a net credit in the first six months of 2021. Profit after tax was £2,441 million.

Total income increased by £745 million, or 10 per cent, to £8,052 million in the half-year to 30 June 2022 compared to £7,307 million in the first six months of 2021; there was an increase of £713 million in net interest income and an increase of £32 million in other income.

Net interest income was £6,089 million, an increase of £713 million compared to £5,376 million in the six months to 30 June 2021. The increased net interest income was driven by growth in average interest-earning assets and deposits as well as an improved margin; the net interest margin benefited from bank base rate increases and deposit growth, offsetting mortgage book margin impacts and competitive pressures on pricing.

Other income was £32 million higher at £1,963 million in the six months to 30 June 2022 compared to £1,931 million in the same period last year. Net fee and commission income increased by £58 million to £648 million, compared to £590 million in the first six months of 2021, due to higher credit and debit card fees, reflecting increased levels of customer activity, more than offsetting the impact of reduced levels of commercial banking fees as a result of fewer significant capital markets transactions and lower levels of corporate financing. Net trading income was £95 million lower at £208 million in the six months to 30 June 2022, in part due to the impact of movements in credit spreads on valuation adjustments. Other operating income increased by £69 million to £1,107 million compared to £1,038 million in the six months to 30 June 2021, in part due to improved gains on disposal of financial assets at fair value through other comprehensive income.

Total operating expenses decreased by £159 million to £4,405 million compared to £4,564 million in the first six months of 2021. There was an increase of £93 million in operating costs; the impact of staff salary increases and higher variable pay was only partly offset by staff number reductions and there was an increase in IT-related costs, as a result of the Group's investment programmes. Depreciation charges were £33 million lower reflecting the ongoing impact of a reduced, but stabilising, Lex fleet size as a result of industry-wide supply constraints in the new car market. The charge in respect of regulatory provisions was £252 million lower at £58 million and largely related to pre-existing programmes. There have been no further charges relating to HBOS Reading since the end of 2021 and the provision held continues to reflect the Group's best estimate of its full liability, albeit significant uncertainties remain.

There was a net impairment charge in the six months to 30 June 2022 of £364 million, compared to a net credit of £677 million in the first six months of 2021, largely reflecting a low charge arising from observed credit performance and a charge in the first six months of 2022 as a result of revisions to the Group's economic outlook, compared to a significant credit in the first half of 2021. The updated outlook includes additional risks from a higher inflation and interest rate environment of c.£0.4 billion, partially offset by reductions in COVID-19 related risks of c.£0.3 billion. The latter included a £200 million release from the Group's central adjustment which addresses downside risks outside of the base case conditioning assumptions in relation to coronavirus.

Overall the Group's loan portfolio continues to be well-positioned, reflecting a prudent through-the-cycle approach to credit risk with high levels of security. Observed credit performance remains robust and the flow of assets into arrears, defaults and write-offs remains at low levels. The Group's expected credit loss (ECL) allowance increased slightly in the first six months of the year to £4,064 million (31 December 2021: £4,000 million). This reflects the balance of risks shifting from COVID-19 and potential related restrictions to those from increased inflationary pressures on households and businesses.

REVIEW OF PERFORMANCE (continued)

The Group's operations are predominantly UK-based with no direct credit exposure to Russia or Ukraine. The Group does have credit exposure to businesses that are impacted, either directly or indirectly, by higher energy costs or commodity prices, or potential disruption within their supply chains. Such activity continues to be monitored through prudent risk management.

The Group recognised a tax expense of £842 million in the period compared to a credit of £288 million in the first six months of 2021; during the first-half of 2021 the Group had recognised a deferred tax credit in the income statement of £1,189 million following substantive enactment, in May 2021, of the UK Government's increase in the rate of corporation tax from 19 per cent to 25 per cent with effect from 1 April 2023.

Balance sheet

Total assets were £23,474 million, or 4 per cent, higher at £626,323 million at 30 June 2022 compared to £602,849 million at 31 December 2021. Cash and balances at central banks rose by £16,096 million to £70,375 million reflecting the placement of funds from increased available liquidity. Financial assets at amortised cost were £9,485 million higher at £499,801 million at 30 June 2022 compared to £490,316 million at 31 December 2021, as a result of a £4,139 million increase in loans and advances to customers, net of impairment allowances, £1,839 million in debt securities, and £2,349 million in reverse repurchase agreement balances. The increase in loans and advances to customers, net of impairment allowances, was driven by continued growth in the open mortgage book and increases in Corporate and Institutional lending, partially offset by further reductions in the closed mortgage book and hedging impacts. Other assets increased £2,488 million due to a £942 million increase in retirement benefit assets as a result of accelerated pension contributions in the period and a £381 million increase in current tax recoverable. Financial assets at fair value through other comprehensive income were £3,757 million lower at £24,029 million as a result of sales during the period.

Total liabilities were £23,531 million, or 4 per cent, higher at £585,608 million compared to £562,077 million at 31 December 2021. Customer deposits increased by £1,555 million to £450,928 million compared to £449,373 million at 31 December 2021, as a result of continued inflows to retail current and savings accounts offset by a small reduction in commercial deposits. Repurchase agreements at amortised cost increased £18,047 million to £48,153 million, as the Group took advantage of favourable funding opportunities and debt securities in issue increased by £4,499 million reflecting issuances of commercial paper and certificates of deposit. Subordinated liabilities decreased by £2,143 million following redemptions during the period.

Ordinary shareholders' equity decreased £51 million to £36,359 million at 30 June 2022 as retained profit for the period was more than offset by negative movements in the cash flow hedging reserve.

Capital

The Group's common equity tier 1 (CET1) capital ratio reduced from 16.7 per cent at 31 December 2021 to 14.1 per cent on 1 January 2022, before increasing during the period to 15.2 per cent at 30 June 2022. The reduction on 1 January 2022 reflected the impact of regulatory changes, including an increase in risk-weighted assets as well as other related modelled impacts, in addition to the reinstatement of the full deduction treatment for intangible software assets and phased unwind of IFRS 9 transitional relief. The subsequent increase in the first half of the year reflected profits for the period and a reduction in risk-weighted assets, partly offset by accelerated pension contributions made during the first quarter. The total capital ratio reduced from 23.5 per cent at 31 December 2021 to 20.7 per cent at 30 June 2022, largely reflecting the reduction in CET1 capital, increase in risk-weighted assets and completion of the transition to end-point eligibility rules for regulatory capital on 1 January 2022.

Risk-weighted assets increased from £161.6 billion at 31 December 2021 to around £178 billion on 1 January 2022, before reducing during the period to £173.8 billion at 30 June 2022. The increase on 1 January 2022 reflected the impact of regulatory changes, including the anticipated impact of the implementation of new CRD IV models to meet revised regulatory standards for modelled outputs and a new standardised approach for measuring counterparty credit risk (SA-CCR) following the UK implementation of the remainder of Capital Requirements Regulation (CRR) 2. The new CRD IV models remain subject to finalisation and approval by the PRA and therefore uncertainty over the final impact remains. The subsequent reduction in risk-weighted assets during the first half of the year was largely driven by optimisation activities and reductions from retail models reflecting the benign credit performance, partly offset by the growth in balance sheet lending.

The Group's UK leverage ratio of 5.4 per cent at 30 June 2022 has increased from 5.3 per cent at 31 December 2021, reflecting a reduction in the exposure measure, principally related to off-balance sheet items, offset in part by a reduction in the total tier 1 capital position.

RISK MANAGEMENT

PRINCIPAL RISKS AND UNCERTAINTIES

The significant risks faced by the Group are detailed below. There has been no change to the definition of these risks from those disclosed in the Group's 2021 Annual Report and Accounts.

The external risks faced by the Group may also impact the success of delivering against the Group's long-term strategic objectives. They include, but are not limited to supply chain and socio-economic pressures arising from the war between Russia and Ukraine and the coronavirus pandemic, which are contributing to cost of living increases and associated implications for UK consumers and businesses.

Heightened monitoring is in place across the Group's portfolios to identify signs of affordability stress. However, there has been no adverse performance to date and the Group's portfolios remain broadly stable.

Lloyds Banking Group participated in the Bank of England Biennial Exploratory Scenario on Climate (CBES), with industry level results published in May 2022. The exercise explored the financial risks posed by climate change, with projections of climate risks likely to create a drag on institutions' profitability. Lloyds Banking Group will continue to develop climate scenario analysis capabilities and improve its climate risk management.

The Group's principal risks and uncertainties are reviewed and reported regularly to the Board in alignment with Lloyds Banking Group's Enterprise Risk Management Framework.

Market risk - The risk that the Group's capital or earnings profile is affected by adverse market rates or prices, in particular interest rates and credit spreads in the Banking business, interest rates, and credit spreads in the Group's defined benefit pension schemes.

Credit risk - The risk that parties with whom the Group has contracted fail to meet their financial obligations (both on and off-balance sheet).

Funding and liquidity risk - Funding risk is defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient. Liquidity risk is defined as the risk that the Group has insufficient financial resources to meet its commitments as they fall due, or can only secure them at excessive cost.

Capital risk - The risk that the Group has a sub-optimal quantity or quality of capital or that capital is inefficiently deployed across the Group.

Change/execution risk - The risk that, in delivering its change agenda, the Group fails to ensure compliance with laws and regulation, maintain effective customer service and availability and/or operation within the Group's risk appetite.

Conduct risk - The risk of customer detriment across the customer lifecycle including: failures in product management, distribution and servicing activities; from other risks materialising, or other activities which could undermine the integrity of the market or distort competition, leading to unfair customer outcomes, regulatory censure, reputational damage or financial loss.

Data risk - The risk of the Group failing to effectively govern, manage and control its data (including data processed by third party suppliers), leading to unethical decisions, poor customer outcomes, loss of value to the Group and mistrust.

People risk - The risk that the Group fails to provide an appropriate colleague and customer-centric culture, supported by robust reward and wellbeing policies and processes, effective leadership to manage colleague resources, effective talent and succession management and robust control to ensure all colleague-related requirements are met.

Operational resilience risk - The risk that the Group fails to design resilience into business operations, underlying infrastructure and controls (people, process, technology) so that it is able to withstand external or internal events which could impact the continuation of operations and fails to respond in a way which meets customer and stakeholder expectations and needs when the continuity of operations is compromised.

Operational risk - The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.

Model risk - The risk of financial loss, regulatory censure, reputational damage or customer detriment, as a result of deficiencies in the development, application or ongoing operation of models and rating systems.

PRINCIPAL RISKS AND UNCERTAINTIES (continued)

Regulatory and legal risk - The risk of financial penalties, regulatory censure, criminal or civil enforcement action or customer detriment as a result of failure to identify, assess, correctly interpret, comply with, or manage regulatory and/or legal requirements.

Strategic risk - The risk which results from:

• Incorrect assumptions about internal or external operating environments

• Failure to understand the potential impact of strategic responses and business plans on existing risk types

• Failure to respond or the inappropriate strategic response to material changes in the external or internal operating environments

Climate risk - The risk that the Group experiences losses and/or reputational damage as a result of physical events, transition risk, or as a consequence of the responses to managing these changes, either directly or through the Group's customers.

CREDIT RISK

Overview

The outlook for a number of macroeconomic variables for the UK has deteriorated despite the post-COVID-19 recovery seen early in the year. The main challenges facing the economy are cost of living pressures and the impact of the war between Russia and Ukraine, which is aggravating existing inflationary pressures, higher commodity prices and supply chain issues to the UK economy.

Whilst not immune, the Group's portfolios are well-positioned, despite rising inflationary pressures and the Group retains a prudent approach to credit risk appetite and risk management, with robust LTVs in the secured portfolios. Despite the external environment, flows of assets into arrears, defaults and write-off have remained at low levels. However, the Group continues to monitor the economic environment carefully through a suite of early warning indicators.

The Group participated fully in UK Government lending schemes, including the Bounce Back Loan Scheme and the Coronavirus Business Interruption Loan Scheme, where UK Government guarantees are in place at 100 per cent and 80 per cent, respectively. These and other support measures mean that true underlying risk may potentially not be reflected in asset performance so the Group is carefully monitoring the level of arrears and will continue to review customer trends and contagion impacts to other lending.

The net impairment charge in the first half of 2022 was £364 million, compared to a release of £677 million in the first half of 2021, reflecting a low charge in relation to observed performance and a charge from economic outlook revisions. The latter includes a release from the Group's central adjustment which addresses downside risks outside of the base case conditioning assumptions in relation to COVID-19.

This reporting period also coincided with implementation of CRD IV regulatory requirements, which resulted in updates to credit risk measurement and modelling to maintain alignment between IFRS 9 and regulatory definitions of default. Most notably for UK mortgages, default was previously deemed to have occurred no later than when a payment was 180 days past due; in line with CRD IV this has now been reduced to 90 days, as well as including end-of-term payments on past due interest-only accounts and all non-performing loans.

The Group's ECL allowance on loans and advances to customers remained stable in the period at £4,059 million (31 December 2021: £3,998 million). Changes related to CRD IV have not materially impacted total ECL as management judgements were previously held in lieu of known changes, however some material movements between stages are observed.

Stage 2 loans and advances to customers increased from £34,884 million to £43,808 million, and as a percentage of total lending increased by 2.0 percentage points to 10.0 per cent (31 December 2021: 8.0 per cent), predominantly as a result of the higher proportion of mortgage accounts reaching the broader CRD IV definition of default introduced on 1 January 2022. Of the total Group Stage 2 loans and advances, 91.9 per cent are up to date (31 December 2021: 89.0 per cent) with sustained low levels of new to arrears. Stage 2 coverage reduced to 3.1 per cent (31 December 2021: 3.4 per cent).

Stage 3 loans and advances increased in the period to £8,060 million (31 December 2021: £6,406 million), and as a percentage of total lending increased to 1.8 per cent (31 December 2021: 1.5 per cent), also as a result of UK mortgages being subject to the CRD IV definition of default change. Stage 3 coverage decreased by 4.3 percentage points to 23.1 per cent (31 December 2021: 27.4 per cent) largely driven by comparatively better quality assets moving into Stage 3 through CRD IV changes.

Prudent risk appetite and risk management

• The Group continues to take a prudent and proactive approach to credit risk management and credit risk appetite, whilst working closely with customers to help them through cost of living pressures and any deterioration in broader economic conditions

• Sector, asset and product concentrations within the portfolios are closely monitored and controlled, with mitigating actions taken where appropriate. Sector and product risk appetite parameters help manage exposure to certain higher risk and cyclical sectors, segments and asset classes

• The Group's effective risk management seeks to ensure early identification and management of customers and counterparties who may be showing signs of distress

• The Group will continue to work closely with its customers to ensure that they receive the appropriate level of support, including where repayments under the UK Government scheme lending fall due

CREDIT RISK (continued)

Impairment charge (credit) by division

1 Corporate and other primarily comprises Mid Corporates and Corporate and Institutional.

Group total expected credit loss allowance

Movements in Group total expected credit loss allowance

1 Contains adjustments in respect of purchased or originated credit-impaired financial assets.

2 Total ECL includes £5 million relating to other non customer-related assets (31 December 2021: £2 million).

CREDIT RISK (continued)

Loans and advances to customers and expected credit loss allowance

1 Contains centralised fair value hedge accounting adjustments.

2 UK Motor Finance for Stages 1 and 2 include £94 million relating to provisions against residual values of vehicles subject to finance leasing agreements. These provisions are included within the calculation of coverage ratios.

3 Total and Stage 3 ECL allowances as a percentage of drawn balances exclude loans in recoveries in Credit cards of £73 million, Loans and overdrafts of £65 million, Retail other of £761 million, SME of £158 million and Commercial Banking other of £2 million. Other excludes the £200 million ECL central adjustment

CREDIT RISK (continued)

Loans and advances to customers and expected credit loss allowance (continued)

1 Restated to reflect migration of certain customers from SME business within Commercial Banking to Business Banking within Retail.

2 Contains centralised fair value hedge accounting adjustments.

3 UK Motor Finance for Stages 1 and 2 include £95 million relating to provisions against residual values of vehicles subject to finance leasing agreements. These provisions are included within the calculation of coverage ratios.

4 Total and Stage 3 ECL allowances as a percentage of drawn balances exclude loans in recoveries in Credit cards of £67 million, Loans and overdrafts of £65 million, Retail other of £379 million, SME of £135 million and Commercial Banking other of £4 million. Other excludes the £400 million ECL central adjustment.

CREDIT RISK (continued)

Stage 2 loans and advances to customers and expected credit loss allowance

1 Includes forbearance, client and product-specific indicators not reflected within quantitative PD assessments.

2 Includes assets that have triggered PD movements, or other rules, given that being 1-29 days in arrears in and of itself is not a Stage 2 trigger.

3 Expected credit loss allowance on loans and advances to customers (drawn and undrawn).

4 Restated to reflect migration of certain customers from SME business within Commercial Banking to Business Banking within Retail.

CREDIT RISK (continued)

ECL sensitivity to economic assumptions

The measurement of ECL reflects an unbiased probability-weighted range of possible future economic outcomes. The Group achieves this by generating four economic scenarios to reflect the range of outcomes; the central scenario reflects the Group's base case assumptions used for medium-term planning purposes, an upside and a downside scenario are also selected together with a severe downside scenario. The base case, upside and downside scenarios carry a 30 per cent weighting; the severe downside is weighted at 10 per cent. These assumptions can be found in note 2 on page 39 onwards.

The table below shows the Group's ECL for the probability-weighted, upside, base case, downside and severe downside scenarios, the severe downside scenario incorporating adjustments made to CPI inflation and UK Bank Rate paths. The stage allocation for an asset is based on the overall scenario probability-weighted PD and hence the staging of assets is constant across all the scenarios. In each economic scenario the ECL for individual assessments and post-model adjustments is constant reflecting the basis on which they are evaluated.

CREDIT RISK (continued)

Retail

• The Retail portfolio has remained robust and well-positioned despite pressure on consumer disposable incomes from a rising cost of living. Risk management has been enhanced since the last financial crisis, with strong affordability and indebtedness controls for both new and existing lending and a prudent risk appetite approach. The Retail lending book is concentrated towards higher income segments who have reduced their debt commitments during the pandemic and should be better able to withstand the cost of living challenge

• The Group is closely monitoring the impacts of the rising cost of living on consumers. Despite no deterioration in credit quality, proactive action has been taken to increase living cost assumptions in affordability assessments with more targeted action for those customers deemed to be most at risk

• Despite external pressures, arrears rates remain low and generally below pre-pandemic levels. New lending credit quality remains strong and performance is stable

• Contagion impact on Retail lending from the Bounce Back Loan Scheme (BBLS) is limited. However, small businesses in some cases are under significant pressure from BBLS repayments alongside external pressures and the Group continues to monitor this segment closely

• The Retail impairment charge in the first half of 2022 was £485 million, compared to a release of £89 million in the first half of 2021. Credit performance was favourable year-on-year, adversity is explained by revisions to the macroeconomic outlook. The first half of 2021 benefitted from a large release of ECL following the effectiveness of Government interventions and vaccine rollout, relative to expectations at earlier stages of the pandemic

• Additional judgements have been raised in the first half of the year to capture the increased risk of inflation and impact on the cost of living for retail customers, and additionally for segments of the Retail book that are considered less resilient to disposable income shocks

• Existing IFRS 9 staging rules and triggers have been maintained across Retail from the 2021 year end with the exception of mortgages. The change maintains alignment between IFRS 9 and new regulatory definitions of default. Default continues to be considered to have occurred when there is evidence that the customer is experiencing financial difficulty which is likely to significantly affect their ability to repay the amount due. For mortgages, this was previously deemed to have occurred no later than when a payment was 180 days past due; in line with CRD IV this has now been reduced to 90 days, as well as including end-of-term payments on past due interest-only accounts and all non-performing loans. Overall ECL is not materially impacted as management judgements were previously held in lieu of these known changes. However, material movements between stages were observed, with additional assets in Stage 3 and Stage 2 at the point of implementation, as a result of the broader definition of default

• Stage 2 loans and advances now comprise 10.2 per cent of the Retail portfolio (31 December 2021: 7.9 per cent), of which 91.3 per cent are up to date performing loans (31 December 2021: 87.3 per cent), due to the higher proportion of mortgage accounts reaching the new CRD IV definition of default. Stage 2 ECL coverage has also decreased to 2.8 per cent (31 December 2021: 3.3 per cent) as the risk of these accounts is comparatively lower. Stage 2 balances and coverage of Retail products excluding UK mortgages show a general increasing trend following updates to the macroeconomic outlook, with a lower impact of CRD IV changes (90 days past due definition already adopted)

• Stage 3 movements are directionally similar to Stage 2. Loans and advances have increased to 1.5 per cent of total loans and advances (31 December 2021: 1.0 per cent). Stage 3 ECL coverage decreased to 14.6 per cent (31 December 2021: 20.9 per cent) due to a higher proportion of mortgages triggering 90 days past due, with lower coverage on average

CREDIT RISK (continued)

Portfolios

UK mortgages

• The UK mortgages portfolio is well-positioned with low arrears and a low loan-to-value (LTV) profile. The Group has actively improved the quality of the portfolio over recent years using robust affordability and credit controls, whilst the balances of higher risk portfolios originated prior to 2008 have continued to reduce

• The housing market remains resilient despite the macroeconomic uncertainty. However, price growth and activity levels are expected to soften this year with rises in UK Bank Rate and associated mortgage rates alongside a household income squeeze weakening consumer confidence

• Total loans and advances increased to £310.5 billion (31 December 2021: £308.3 billion), with a reduction in average LTV to 40.2 per cent (31 December 2021: 42.1 per cent). The proportion of balances with an LTV greater than 90 per cent decreased to 0.4 per cent (31 December 2021: 0.5 per cent). The average LTV of new business decreased to 61.9 per cent (31 December 2021: 63.3 per cent)

• There was an impairment release of £64 million for the first half of 2022 reflecting continued resilient house prices and benign credit performance. This compares to a net release of £175 million for the first half of 2021, which included a comparatively greater benefit from house prices in relation to expectations earlier in the pandemic. Total ECL coverage remains flat at 0.3 per cent (31 December 2021: 0.3 per cent)

• Stage 2 loans and advances increased to 9.7 per cent of the portfolio (31 December 2021: 7.1 per cent), and Stage 2 ECL coverage has reduced to 1.1 per cent (31 December 2021: 1.8 per cent). This is largely as a result of the higher proportion of mortgage accounts reaching the broader CRD IV definition of default

• Stage 3 ECL coverage decreased to 7.4 per cent (31 December 2021: 9.5 per cent) again largely due to a higher proportion of mortgage accounts triggering the broader CRD IV definition of default of 90 days past due (previously 180 days)

Credit cards

• Credit card balances increased to £15.1 billion (31 December 2021: £14.5 billion) due to increased levels of customer spend but remain below pre-pandemic levels

• The credit card portfolio is a prime book which has performed well in recent years, with lower arrears rates compared to the High Street Bank peer group

• The impairment charge was £273 million for the first half of 2022 compared to a charge of £67 million for the first half of 2021, with overall ECL coverage increasing to 4.2 per cent (31 December 2021: 3.6 per cent). These increases are largely due to the updates to the UK's macroeconomic outlook in addition to precautionary judgements to account for the increased risk of inflation and impact on the cost of living for Retail customers

• Stage 2 loans and advances have increased to 15.2 per cent of the portfolio (31 December 2021: 14.3 per cent) and Stage 2 ECL coverage has increased to 15.1 per cent (31 December 2021: 12.0 per cent), both reflecting updates to the UK's macroeconomic outlook

• Stage 3 ECL coverage decreased to 53.6 per cent (31 December 2021: 56.9 per cent) due to model parameter updates to account for favourable recoveries performance

Loans and overdrafts

• Loans and advances for personal current account and the personal loans portfolios increased to £10.1 billion (31 December 2021: £9.6 billion) with continued recovery in customer spend and demand for credit

• The impairment charge was £241 million for the first half of 2022, compared to £58 million for the first half of 2021. These increases are largely due to the updates to the UK's macroeconomic outlook in addition to precautionary judgements to account for the increased risk of inflation and impact on the cost of living for Retail customers

• Stage 2 ECL coverage increased to 21.2 per cent (31 December 2021: 15.4 per cent) and overall ECL coverage increased to 5.4 per cent (31 December 2021: 4.7 per cent), both reflecting updates to the UK's macroeconomic outlook

• Stage 3 ECL coverage increased slightly to 70.7 per cent (31 December 2021: 67.5 per cent)

CREDIT RISK (continued)

UK Motor Finance

• The UK Motor Finance portfolio increased to £14.5 billion (31 December 2021: £14.3 billion) with continued new car supply constraints being offset by continued strong demand for used vehicles

• There was an impairment charge of £7 million for the first half of 2022 reflecting continued low levels of losses given continued resilient used car prices. This compares to a net release of £40 million for the first half of 2021, which benefitted from ECL releases as used car prices materially outperformed expectations set earlier in the pandemic. However, used car prices have begun to fall from recent high levels with this trend expected to continue. Overall ECL coverage has decreased to 2.0 per cent (31 December 2021: 2.1 per cent)

• Updates to Residual Value (RV) and Voluntary Termination (VT) risk held against Personal Contract Purchase (PCP) and Hire Purchase (HP) lending are included within the impairment charge. Continued resilience in used car prices and disposal experience, partially driven by global supply issues, has resulted in broadly flat RV and VT ECL of £94 million (31 December 2021: £95 million)

• Stage 2 ECL coverage increased to 4.4 per cent (31 December 2021: 4.0 per cent) and Stage 3 ECL coverage increased to 58.7 per cent (31 December 2021: 57.7 per cent)

Other

• Other loans and advances increased to £20.4 billion (31 December 2021: £19.6 billion)

• The impairment charge increased to £28 million for the first half of 2022, compared to £1 million for the first half of 2021, primarily due to updates to the UK macroeconomic forecast

Retail UK mortgages loans and advances to customers1

1 Balances include the impact of HBOS related acquisition adjustments.

CREDIT RISK (continued)

Commercial Banking

• Commercial Banking actively supported its customers throughout the pandemic, through a range of propositions, including capital repayment holidays, working capital line increases and financial covenant waivers, as well as supporting small businesses and corporates through full use of UK Government schemes

• Although the UK economy recovered during the first quarter of 2022, the macroeconomic outlook has subsequently deteriorated. The war between Russia and Ukraine has aggravated inflationary pressures and supply chain disruption, adding to the cost of living squeeze, with some sectors such as travel, transportation, retail, leisure and hospitality particularly impacted. However, as a proportion of the Group's overall lending, exposure to these sectors remains relatively limited with prudent risk appetite parameters in place to support customers and protect the Group's positions

• The Group is cognisant of a number of client risks associated with rising inflationary pressures and the weaker UK economic outlook, including weakening consumer sentiment, energy, fuel and commodities price inflation, supply chain disruption, labour markets, credit markets, interest rates and climate change

• The Group expects the longer term recovery to be slower in a few of the impacted sectors and anticipates structural changes over time in these, and a number of other sectors. Sector and credit risk appetite continue to be proactively managed to ensure the Group is protected and clients are supported in the right way

• Observed credit quality has been strong and broadly stable in the first half of 2022, noting that this could still be influenced by increased liquidity as a result of the significant temporary support provided by the UK Government in light of the pandemic, which has the potential to distort the underlying credit risk profile, particularly in the predominantly secured SME portfolio. Repayments under these schemes commenced in the second half of 2021, with low arrears to date. The level of arrears continues to be carefully monitored, with early risk mitigating activities taken as appropriate

• Although significant uncertainties remain, with a number of headwinds and the withdrawal of the Government COVID-19 support measures yet to impact portfolio performance to date, the Group continues to provide early support to its more vulnerable customers through focussed risk management via its Watchlist and Business Support framework. The Group will continue to balance prudent risk appetite with ensuring support for financially viable clients on their road to recovery

Impairment

• There was a net impairment charge of £77 million in the first half of 2022, compared to a release of £585 million in the first half of 2021. The charge was driven by economic outlook revisions offset by an observed performance release

• ECL allowances increased by £64 million to £1,379 million at 30 June 2022 (31 December 2021: £1,315 million). The ECL provision at 30 June 2022 captures the impact of inflationary pressures and supply chain constraints and assumes additional losses will emerge as a result of these and as structural changes emerge in some sectors

• Stage 2 loans and advances decreased marginally by £34 million to £6,001 million (31 December 2021: £6,035 million), of which 95.8 per cent are current and up to date. Stage 2 loans as a proportion of total loans and advances to customers reduced to 8.7 per cent (31 December 2021: 8.9 per cent). Stage 2 ECL coverage was higher at 4.8 per cent (31 December 2021: 4.0 per cent) with the increase in coverage a direct result of the forward look multiple economic scenarios

• Stage 3 loans and advances reduced to £2,586 million (31 December 2021: £2,862 million) and as a proportion of total loans and advances to customers, reduced to 3.7 per cent (31 December 2021: 4.2 per cent). Stage 3 ECL coverage increased to 39.2 per cent (31 December 2021: 34.8 per cent) predominantly driven by net repayments on Stage 3 loans and advances

CREDIT RISK (continued)

Commercial Banking UK Direct Real Estate

• Commercial Banking UK Direct Real Estate gross lending stood at £10.6 billion at 30 June 2022 (net of exposures subject to protection through Significant Risk Transfer (SRT) securitisations). The Group has a further £0.7 billion of UK Direct Real Estate exposure in Business Banking within the Retail division

• The Group classifies Direct Real Estate as exposure which is directly supported by cash flows from property activities (as opposed to trading activities, such as hotels, care homes and housebuilders). Exposures of £5.0 billion to social housing providers are also excluded

• Recognising this is a cyclical sector, caps are in place to control origination and exposure, including a number of asset type categories. Focus remains on the UK market and new business has been written in line with a prudent risk appetite with conservative LTVs, strong quality of income and proven management teams

• Overall performance has remained resilient and although the Group saw some increase in cases on its closer monitoring Watchlist category, levels of this remain significantly below that seen during the pandemic. Transfers to the Group's Business Support Unit have been limited

• Rent collection has largely recovered and stabilised following the coronavirus pandemic, although challenges remain in some sectors. Despite some material headwinds, including the inflationary environment and the impact of rising interest rates, the portfolio is well-positioned and proactively managed, with appropriate risk mitigants in place:

- CRE exposures continue to be heavily weighted towards investment real estate (c.90 per cent) over development. Of these investment exposures, c.90 per cent have an LTV of less than 60 per cent, with an average LTV of 39 per cent

- c.93 per cent of CRE investment exposures have an interest cover ratio of greater than 2.0 times and in SME, LTV at origination has been typically limited to c.55 per cent, given prudent repayment cover criteria (including a notional base rate stress)

- Approximately 48 per cent of CRE exposures relate to commercial real estate (with no speculative development lending) with the remainder related to residential real estate. The underlying sub-sector split is diversified with c.15 per cent of exposures secured by Retail assets and appetite tightened since 2018

- The Office portfolio is focused on prime locations with strong sponsors and low LTVs, as well as no speculative commercial development

- Use of SRT securitisations also acts as a risk mitigant in this portfolio, with run off of these carefully managed and sequenced

- Both investment and development lending is subject to specific credit risk appetite criteria. Development lending criteria include maximum loan to gross development value and maximum loan to cost, with funding typically only released against completed work, as confirmed by the Group's monitoring quantity surveyor

FUNDING AND LIQUIDITY RISK

The Group has maintained its robust funding and liquidity position with a loan to deposit ratio of 96 per cent as at 30 June 2022 (96 per cent as at 31 December 2021). Customer deposits remain elevated despite the uncertainties that persist around the macroeconomic environment.

The Group's liquid assets continue to exceed the regulatory minimum and internal risk appetite, with a liquidity coverage ratio (LCR) of 134 per cent (based on a monthly rolling average over the previous 12 months) as at 30 June 2022.

The Net Stable Funding Ratio (NSFR) was implemented on 1 January 2022. The Group monitors this metric monthly and is in excess of the regulatory requirement of 100 per cent.

The Group's credit ratings continue to reflect the strength of the Group's business model and balance sheet. Over the course of the year, Fitch and S&P affirmed the Group's ratings. In July, Moody's downgraded the subordinated ratings for Lloyds Bank plc by one notch based on their Loss Given Failure methodology. This was a technical and methodological change that puts us in line with peer issuers. The agencies continue to monitor the impact of cost of living increases and rising rates for the UK banking sector. The Group's strong management, franchise and financial performance along with robust capital and funding position are reflected in the Group's strong ratings.

Lloyds Bank Group funding requirements and sources