Lloyds Regulatory News (LLOY)

Lloyds Bank plc

Q3 2022 Interim Management Statement

27 October 2022

Member of the Lloyds Banking Group

REVIEW OF PERFORMANCE

Income statement

In the nine months to 30 September 2022, the Group recorded a profit before tax of £4,480 million compared to £5,103 million in the same period in 2021, representing a reduction of £623 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 for the first nine months of 2021. Profit after tax was £3,346 million.

Total income increased by £1,047 million, or 9 per cent, to £12,119 million in the nine months to 30 September 2022 compared to £11,072 million in the first nine months of 2021; there was an increase of £1,209 million in net interest income and a decrease of £162 million in other income.

Net interest income was £9,458 million, an increase of £1,209 million compared to £8,249 million in the nine months to 30 September 2021. The increase in net interest income was driven by an improved margin, as a result of UK Bank Rate increases and continued funding and capital optimisation, partly offset by mortgage margin reductions. Increased average interest-earning assets reflecting continued growth in the open mortgage book also contributed positively.

Other income was £162 million lower at £2,661 million in the nine months to 30 September 2022 compared to £2,823 million in the same period last year. Net fee and commission income increased by £58 million to £971 million, compared to £913 million in the first nine months of 2021, due to higher credit and debit card fees, reflecting increased levels of customer activity, more than offsetting some reduction from lower levels of corporate financing activity. Net trading income was £305 million lower at £88 million in the nine months to 30 September 2022, in part reflecting the change in fair value of interest rate derivatives and foreign exchange contracts not mitigated by hedge accounting. Other operating income increased by £85 million to £1,602 million compared to £1,517 million in the nine months to 30 September 2021, in part due to improved gains on disposal of financial assets at fair value through other comprehensive income.

Total operating expenses decreased by £131 million to £6,629 million compared to £6,760 million in the first nine months of 2021. Increased staff costs reflected salary increases and the impact of a one-off £1,000 cost of living payment to staff, partly offset by headcount reductions. In addition, there was an increase in IT-related costs, as a result of the Group's strategic investment programmes. Depreciation charges were lower reflecting the continued strength in used car prices. The charge in respect of regulatory provisions was £346 million lower at £67 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 nine months to 30 September 2022 of £1,010 million, compared to a net credit of £791 million in the first nine months of 2021, largely reflecting a low charge arising from observed credit performance and a charge in the first nine months of 2022 as a result of updates to the assessment of the economic outlook and associated scenarios, compared to a significant credit in the first nine months of 2021. The updated outlook includes elevated risks from a higher inflation and interest rate environment, offset by a £400 million release of the COVID-19 central adjustment in the nine months to 30 September 2022.

The Group's loan portfolio continues to be well-positioned, reflecting a prudent through-the-cycle approach to lending with high levels of security, also reflected in strong recovery performance. Observed credit performance remains stable, with very modest evidence of deterioration and the flow of assets into arrears, defaults and write-offs at low levels and below pre-pandemic levels. Stage 3 loans and advances have been stable across the third quarter. Credit card minimum payers and overdraft and revolving credit facility (RCF) utilisation rates have remained low and in line with recent trends.

The Group's expected credit loss (ECL) allowance increased in the first nine months of the year to £4,519 million (31 December 2021: £4,000 million). This reflects the balance of risks shifting from COVID-19 to increased inflationary pressures and rising interest rates within the Group's base case and wider economic scenarios. The deterioration in the economic outlook is now reflected in variables which credit models better capture. As a result, the Group's reliance on judgemental overlays for modelling risks in relation to inflationary pressures has reduced, with these risks now captured more fully in models.

The Group recognised a tax expense of £1,134 million in the period compared to £141 million in the first nine months of 2021. During the first nine months 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.

REVIEW OF PERFORMANCE (continued)

Balance sheet

Total assets were £24,590 million, or 4 per cent, higher at £627,439 million at 30 September 2022 compared to £602,849 million at 31 December 2021. Cash and balances at central banks rose by £13,223 million to £67,502 million reflecting the placement of funds from increased available liquidity. Financial assets at amortised cost were £14,947 million higher at £505,263 million at 30 September 2022 compared to £490,316 million at 31 December 2021, as a result of a £2,456 million increase in loans and advances to banks, £4,434 million increase in loans and advances to customers, net of impairment allowances, £2,780 million in debt securities, and £5,163 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 due to attractive growth opportunities as well as foreign exchange movements, partially offset by further reductions in the closed mortgage book and hedging impacts. Other assets increased by £3,772 million mainly due to a £2,272 million increase in deferred tax assets and a £470 million increase in current tax recoverable. Financial assets at fair value through other comprehensive income were £6,787 million lower at £20,999 million as a result of asset sales during the period.

Total liabilities were £28,395 million, or 5 per cent, higher at £590,472 million compared to £562,077 million at 31 December 2021. Customer deposits increased by £5,771 million to £455,144 million compared to £449,373 million at 31 December 2021, as a result of continued inflows to Retail current and savings accounts and Commercial Banking balances. Repurchase agreements at amortised cost increased £16,255 million to £46,361 million, as the Group took advantage of favourable funding opportunities and amounts due to fellow Lloyds Banking Group undertakings were £3,654 million higher at £5,144 million, also reflecting funding arrangements. Subordinated liabilities decreased by £2,675 million following redemptions during the period.

Ordinary shareholders' equity decreased £3,794 million to £32,616 million at 30 September 2022 as retained profit for the period was more than offset by negative movements in the cash flow hedging reserve as a result of increased interest rates and adverse defined benefit post-retirement scheme remeasurements.

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 15.0 per cent at 30 September 2022. The reduction on 1 January 2022 reflected the impact of regulatory changes (as previously reported), with the subsequent increase during the first nine months of the year reflecting profits for the period and a reduction in risk-weighted assets (post 1 January 2022 regulatory changes) partly offset by pension contributions made to the Group's defined benefit pension schemes and an accrual for foreseeable ordinary dividends. The total capital ratio reduced from 23.5 per cent at 31 December 2021 to 20.4 per cent at 30 September 2022, reflecting the reduction in CET capital, increase in risk-weighted assets, the completion of the transition to end-point eligibility rules for regulatory capital on 1 January 2022 and movements in rates, partially offset by sterling depreciation and eligible provisions.

Risk-weighted assets increased from £161.6 billion at 31 December 2021 to around £178 billion on 1 January 2022, reflecting regulatory changes which include the anticipated impact of the implementation of new CRD IV models to meet revised regulatory standards for modelled outputs. Risk-weighted assets subsequently reduced by £5 billion during the first nine months of the year to £173.2 billion at 30 September 2022, largely reflecting optimisation activity and Retail model reductions linked to the resilient underlying credit performance, partly offset by the growth in balance sheet lending. The new CRD IV models remain subject to finalisation and approval by the PRA and therefore the final risk-weighted asset impact remains subject to this.

The Group's UK leverage ratio of 5.2 per cent at 30 September 2022 has reduced from 5.3 per cent at 31 December 2021, reflecting a reduction in total tier 1 capital, offset in part by a reduction in the exposure measure principally related to off-balance sheet items.

CONDENSED CONSOLIDATED INCOME STATEMENT (UNAUDITED)

CONDENSED CONSOLIDATED BALANCE SHEET (UNAUDITED)

ADDITIONAL FINANCIAL INFORMATION

1. Basis of presentation

This release covers the results of Lloyds Bank plc (the Bank) together with its subsidiaries (the Group) for the nine months ended 30 September 2022.

Changes in accounting policy

Except for the matter referred to below, the Group's accounting policies are consistent with those applied by the Group in its financial statements for the year ended 31 December 2021 and there have been no changes in the Group's methods of computation.

In April 2022, the IFRS Interpretations Committee was asked to consider whether an entity includes a demand deposit as a component of cash and cash equivalents in the statement of cash flows when the demand deposit is subject to contractual restrictions on use agreed with a third party. It concluded that such amounts should be included within cash and cash equivalents. Accordingly, the Group includes mandatory reserve deposits with central banks that are held in demand accounts within cash and cash equivalents disclosed in the cash flow statement. This change has increased the Group's cash and cash equivalents at 1 January 2020 by £1,682 million (to £40,296 million) and decreased the adjustment for the change in operating assets in 2020 by £974 million (to a reduction of £5,882 million) resulting in an increase in the Group's cash and cash equivalents at 31 December 2020 of £2,656 million (to £51,622 million); and decreased the adjustment for the change in operating assets in 2021 by £114 million (to an increase of £5,174 million) and, as a result, the Group's cash and cash equivalents at 31 December 2021 increased by £2,770 million (to £55,960 million). The change had no impact on profit after tax or total equity.

2. Capital

The Group's Q3 2022 Interim Pillar 3 Report can be found at www.lloydsbankinggroup.com/investors/financial-downloads.

3. Base case and MES economic assumptions

The Group's base case economic scenario reflects the outlook as of 30 September 2022 and was revised in light of developments in energy pricing, changes in UK fiscal policy prior to the balance sheet date and a continuing shift towards a more restrictive monetary policy stance by central banks. The Group's updated base case scenario was based upon three conditioning assumptions: first, the war in Ukraine remains 'local', without overtly involving neighbouring countries, NATO or China; second, the fiscal loosening implied by the UK Government's 'Growth Plan' of 23 September 2022 would be offset principally by Government spending cuts; and third, central bank reaction functions, including of the Bank of England, are focused on controlling inflation, motivating a more rapid tightening of UK monetary policy. The Group continues to assume that no further UK COVID-19 national lockdowns are mandated. Based on these assumptions and incorporating the macroeconomic information published in the third quarter, the Group's base case scenario comprises an economic downturn with a rise in the unemployment rate, declining residential and commercial property prices, and continuing increases in the UK Bank Rate against a backdrop of elevated inflationary pressures. Risks to the base case economic view exist in both directions and are partly captured by the generation of alternative economic scenarios. Each of the scenarios includes forecasts for key variables as of the third quarter of 2022, for which data or revisions to history may have since emerged prior to publication.

At 30 September 2022, the Group has included an adjusted severe downside scenario to incorporate high CPI inflation and UK Bank Rate profiles and has adopted this adjusted severe downside scenario in calculating its ECL allowance. This is because the historic macroeconomic and loan loss data upon which the scenario model is calibrated imply an association of downside economic outcomes with lower inflation rates, easier monetary policy, and therefore low interest rates. This adjustment is considered to better reflect the risks around the Group's base case view in a macroeconomic environment in which supply shocks are the principal concern.

ADDITIONAL FINANCIAL INFORMATION (continued)

3. Base case and MES economic assumptions (continued)

UK economic assumptions - Scenarios by year

Key annual assumptions made by the Group are shown below. Gross domestic product and Consumer Price Index (CPI) inflation are presented as an annual change, house price growth and commercial real estate price growth are presented as the growth in the respective indices within the period. Unemployment rate and UK Bank Rate are averages for the period.

ADDITIONAL FINANCIAL INFORMATION (continued)

3. Base case and MES economic assumptions (continued)

UK economic assumptions - Base case scenario by quarter

Key quarterly assumptions made by the Group in the base case scenario are shown below. Gross domestic product is presented quarter-on-quarter. House price growth, commercial real estate price growth and CPI inflation are presented year-on-year, i.e from the equivalent quarter in the previous year. Unemployment rate and UK Bank Rate are presented as at the end of each quarter.

4. 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. If the base case moves adversely it generates a new, more adverse downside and severe downside which are then incorporated into the ECL. 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 on pages 5 to 7.

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.

1 Reflects the new organisation structure, with Business Banking and Commercial Cards moving from Retail to Commercial Banking and Wealth moving from Other to Retail.

ADDITIONAL FINANCIAL INFORMATION (continued)

5. 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 £93 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 £75 million, Loans and overdrafts of £65 million, Small and Medium Businesses of £1,104 million and Corporate and Institutional Banking of £1 million.

ADDITIONAL FINANCIAL INFORMATION (continued)

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

1 Reflects the new organisation structure, with Business Banking and Commercial Cards moving from Retail to Commercial Banking and Wealth moving from Other to 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, Small and Medium Businesses of £515 million and Corporate and Institutional Banking of £3 million.

5 Other excludes the £400 million ECL central adjustment.

ADDITIONAL FINANCIAL INFORMATION (continued)

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