Lloyds Regulatory News (LLOY)

Lloyds Bank plc

2023 Half-Year Results

26 July 2023

Member of the Lloyds Banking Group

CONTENTS

FINANCIAL REVIEW

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 overseas locations. 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

The Group's profit before tax for the first half of 2023 was £3,530 million, 8 per cent higher than the same period in 2022, benefiting from higher total income, partly offset by operating expense and impairment charge increases. Profit after tax was £2,590 million (half-year to 30 June 2022: £2,441 million).

Total income for the first half of 2023 was £9,040 million, an increase of 12 per cent on the same period in 2022, primarily reflecting higher net interest income in the period. Net interest income of £7,009 million was up 15 per cent on the prior year, driven by stronger margins as a result of the higher rate environment and higher average interest-earning banking assets, supported by growth in the open mortgage book, Retail unsecured and European retail business.

Other income was £68 million higher at £2,031 million in the half-year to 30 June 2023 compared to £1,963 million in the same period in 2022. Net fee and commission income was broadly stable at £646 million. Net trading income was £101 million lower at £107 million in the half-year to 30 June 2023, in part reflecting the effects of the higher rate environment on the Group's derivatives. Other operating income increased to £1,278 million compared to £1,107 million in the half-year to 30 June 2022 as a result of improved Lex performance and the acquisition of Tusker.

Total operating expenses of £4,829 million were 10 per cent higher than in the prior year, given the higher planned strategic investment, new business costs and inflationary effects, partially mitigated by continued cost efficiency. In addition there was a higher operating lease depreciation charge in the six months to June 2023 reflecting the depreciation cost of higher value vehicles, the Tusker acquisition, lower gains on disposal and recent declines in battery electric used car prices.

The Group recognised remediation costs of £62 million largely in relation to pre-existing programmes (half-year to 30 June 2022: £58 million). There have been no further charges relating to HBOS Reading and the provision held continues to reflect the Group's best estimate of its full liability, albeit uncertainties remain. Following the FCA's Motor Market review, the Group continues to receive complaints and is engaging with the Financial Ombudsman Service in respect of historical motor commission arrangements. Discussions are continuing, with the remediation and financial impact, if any, remaining uncertain.

The impairment charge was £681 million compared with a £364 million charge in the half-year to 30 June 2022. The increase reflects the expected credit loss (ECL) allowance build from Stage 1 loans rolling forward into a more adverse economic outlook, as well as increased flows to default primarily in legacy variable rate UK mortgage portfolios and higher charges on existing Stage 3 clients in Commercial Banking. This increase was partly offset by a lower charge from economic outlook revisions. The Group's ECL allowance increased to £5,028 million, compared to £4,796 million at 31 December 2022 resulting from the Stage 3 increases in UK mortgages and Commercial Banking alongside low levels of write offs in the period. Asset quality remains resilient with only modest deterioration to date from a low base, with credit performance similar, or remaining favourable, to pre-pandemic experience.

The Group recognised a tax expense of £940 million in the period compared to £842 million in the first half of 2022.

FINANCIAL REVIEW (continued)

Balance sheet

Total assets were £2,598 million lower at £614,330 million at 30 June 2023 compared to £616,928 million at 31 December 2022. Cash and balances at central banks rose by £3,724 million to £75,729 million reflecting increased liquidity holdings. Financial assets at amortised cost were £8,961 million lower at £482,435 million compared to £491,396 million at 31 December 2022 with increases in debt securities of £2,709 million and loans and advances to banks of £888 million, offset by a reduction in reverse repurchase agreements of £8,729 million and loans and advances to customers of £3,982 million to £431,645 million. The reduction in loans and advances to customers was largely as a result of the exit of £2.5 billion of legacy Retail mortgage loans (including £2.1 billion in the closed mortgage book) during the first quarter. Financial assets at fair value through other comprehensive income decreased £875 million as a result of asset sales during the period. Other assets increased £2,269 million, reflecting higher settlement balances and higher operating lease assets following the acquisition of Tusker in February 2023.

Total liabilities were £3,403 million lower at £574,466 million compared to £577,869 million at 31 December 2022. Customer deposits at £439,914 million have decreased by £6,258 million (1 per cent) since the end of 2022. This included decreases in Retail current account balances of £6.2 billion as a result of tax payments, higher spend and a more competitive market, including the Group's own savings offers where balances increased by £3.5 billion. Commercial Banking deposits were stable during the first half of 2023. In addition, there were decreases in deposits from banks of £1,289 million and repurchase agreements at amortised cost of £3,968 million. Offsetting these reductions, debt securities in issue increased by £7,387 million following issuances of commercial paper, and other liabilities increased £2,493 million as a result of higher settlement balances and lease liabilities.

Total equity increased from £39,059 million at 31 December 2022 to £39,864 million at 30 June 2023, as a result of profit for the period and issuance of other equity instruments partially offset by a £1.9 billion dividend paid in the period and market movements impacting the cash flow hedge reserve and pensions.

Capital

The Group's common equity tier 1 (CET1) capital ratio remained flat at 14.8 per cent at 30 June 2023 (31 December 2022: 14.8 per cent). This largely reflected profit for the period, offset by the accelerated full year payment of fixed pension deficit contributions made to the Group's three main defined benefit pension schemes, an increase in the deduction for goodwill and other intangible assets, including those related to the acquisition of Tusker in February 2023, the accrual for foreseeable ordinary dividends and an increase in risk-weighted assets.

Risk-weighted assets have increased by £3.6 billion during the first half of the year to £178.5 billion at 30 June 2023 (31 December 2022: £174.9 billion). This largely reflects the adjustment for the anticipated impact of CRD IV models taken in the second quarter. Excluding this, lending growth and a small uplift from model calibration were partly offset by capital efficient securitisation activity and other optimisation activity.

The CRD IV model updates reflect an updated impact assessment following a further iteration of model development. The models remain subject to further development and final approval by the PRA. On that basis final impacts remain uncertain and further increases could be required.

RISK MANAGEMENT

PRINCIPAL RISKS AND UNCERTAINTIES

The most important risks faced by the Group are detailed below. The external risks faced by the Group may impact the success of delivering against the Group's long-term strategic objectives. They include, but are not limited to macroeconomic uncertainty; high interest rates and high inflation which are contributing to the 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. The Group has experienced only modest deterioration in credit performance across its portfolio to date, most notably in UK mortgages where new to arrears and flows to default have increased on legacy variable rate loans. The Group continues to work with its customers to proactively support them through cost of living pressures, the impact from rising interest rates and any deterioration in broader economic conditions.

The Group remains committed to the effective implementation and embedding of Consumer Duty into its purpose, strategy and culture in order to deliver good outcomes for our customers throughout their journeys. This activity seeks to align and enhance the Group's approach to supporting all customers, including those who may be vulnerable and customers in financial difficulty.

CRD IV model changes reflecting the revised regulatory standards introduced in 2022 remain subject to approval by the PRA with the resultant risk-weighted asset and expected loss outcome dependent upon this. An adjustment to risk-weighted assets has been taken in the second quarter, to reflect the anticipated impact of CRD IV models, following a further iteration of model development. On that basis final impacts remain uncertain and further increases could be required.

There have been minor changes to the definition of these risks compared to those disclosed in the Group's 2022 Annual Report and Accounts, such as clarifying third party and outsourced arrangements. The Group continues to conduct a detailed review of its Enterprise Risk Management Framework, which may result in a reclassification of the principal risks.

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.

Capital risk - The risk that an insufficient quantity or quality of capital is held to meet regulatory requirements or to support business strategy, an inefficient level of capital is held or that capital is inefficiently deployed across the Group.

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

Climate risk - The risk that the Group experiences losses and/or reputational damage, either from the impacts of climate change and the transition to net zero, or as a result of the Group's responses to tackling climate change.

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. Customer harm or detriment is defined as consumer loss, distress or inconvenience to customers due to breaches of regulatory or internal requirements or our wider duty to act fairly and reasonably.

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

Data risk - The risk of the Group failing to effectively govern, manage and protect its data throughout its lifecycle, including data processed by third parties, or failure to drive value from data; leading to unethical decision making, poor customer outcomes, loss of value to the Group and mistrust.

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.

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.

PRINCIPAL RISKS AND UNCERTAINTIES (continued)

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.

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

Operational resilience risk - The risk that the Group fails to design resilience into business operations including those that are outsourced, underlying infrastructure and controls (people, property, 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 customers and stakeholder expectations and needs when the continuity of operations is compromised.

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.

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

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CAPITAL RISK

Capital resources

An analysis of the Group's capital position as at 30 June 2023 is presented in the following table. This reflects the application of the transitional arrangements for IFRS 9.

CAPITAL RISK (continued)

Movements in CET1 capital resources

The key movements are set out in the table below.

1 Reflects the reversal of the brought forward accrual for the interim ordinary dividend, net of the accrual for foreseeable 2023 ordinary dividends.

CET1 capital resources have increased by £428 million during the period, primarily reflecting profit for the period, partially offset by:

• Accelerated fixed pension deficit contributions paid during the period into the Group's three main defined benefit pension schemes

• An increase in goodwill and other intangible assets, which included the acquisition of Tusker in February 2023

• The accrual for foreseeable 2023 ordinary dividends

Movements in total capital

The Group's total capital ratio increased to 20.7 per cent (31 December 2022: 20.5 per cent) primarily reflecting the increase in CET1 capital, the issuance of a new AT1 capital instrument and an increase in eligible provisions recognised through Tier 2 capital. This was partially offset by the increase in risk-weighted assets and the impact of sterling appreciation on Tier 2 capital instruments.

CAPITAL RISK (continued)

Risk-weighted assets

1 Threshold risk-weighted assets are included within the Standardised (STA) Approach.

2 Threshold risk-weighted assets reflect the element of deferred tax assets that are permitted to be risk-weighted instead of being deducted from CET1 capital.

Risk-weighted assets have increased by £3.6 billion during the first half of the year to £178.5 billion at 30 June 2023 (31 December 2022: £174.9 billion). This largely reflects the adjustment for the anticipated impact of CRD IV models taken in the second quarter. Excluding this, lending growth and a small uplift from model calibration were partly offset by capital efficient securitisation activity and other optimisation activity.

The CRD IV model updates reflect an updated impact assessment following a further iteration of model development. The models remain subject to further development and final approval by the PRA. On that basis final impacts remain uncertain and further increases could be required.

CAPITAL RISK (continued)

Leverage ratio

The table below summarises the component parts of the Group's leverage ratio.

1 Includes deconsolidation adjustments that relate to the deconsolidation of certain Group entities that fall outside the scope of the Group's regulatory capital consolidation and adjustments to exclude lending under the UK Government's Bounce Back Loan Scheme (BBLS).

Analysis of leverage movements

The Group's UK leverage ratio increased to 5.7 per cent (31 December 2022: 5.4 per cent), reflecting the increase in the total tier 1 capital position and the £8.5 billion reduction in the leverage exposure measure, principally related to the reduction in securities financing transactions.

Stress testing

As part of the 2022 Annual Cyclical Scenario stress test run by the Bank of England, the Group's resilience to a severe economic shock where the House Price Index (HPI) falls by 31 per cent, Commercial Real Estate (CRE) falls by 45 per cent, unemployment peaks at 8.5 per cent and the Base Rate peaks at 6 per cent was assessed. The results of this exercise were published by the Bank of England on 12 July 2023, with the Group comfortably passing the relevant hurdle rates.

Pillar 3 disclosures

The Group will publish a condensed set of half-year Pillar 3 disclosures in the second half of August. A copy of the disclosures will be available to view at: www.lloydsbankinggroup.com/investors/financial-downloads.

CREDIT RISK

Overview

The Group's portfolios are well-positioned for the current macroeconomic environment. The Group retains a prudent approach to credit risk appetite and risk management, with strong credit origination criteria and robust LTVs in the secured portfolios.

Observed credit performance remains resilient, despite the continued economic uncertainty with only modest evidence of deterioration to date. New to arrears have slightly increased in UK mortgages but remain broadly stable across unsecured portfolios, with only credit cards marginally above pre-pandemic levels. Looking forward, there are risks from a higher inflation and interest rate environment as modelled in the Group's expected credit loss (ECL) allowance including the impact of the multiple economic scenarios (MES). The Group continues to monitor the impacts of the economic environment carefully through a suite of early warning indicators and governance arrangements that ensure risk mitigating action plans are in place to support customers and protect the Group's positions.

The impairment charge in the first half of 2023 was £681 million, compared to a charge of £364 million in the first half of 2022. The increase reflects the expected credit loss (ECL) allowance build from Stage 1 loans rolling forward into a more adverse economic outlook, as well as modest increases in UK mortgages new to arrears rates and additional charges on existing Commercial Banking clients in Stage 3.

The Group's ECL allowance on loans and advances to customers increased in the period to £5,014 million (31 December 2022: £4,779 million), largely due to underlying increases in UK mortgages and additional charges on existing Commercial Banking clients in Stage 3.

Group Stage 2 loans and advances to customers have increased to £61,418 million (31 December 2022: £60,103 million), and as a percentage of total lending at 14.1 per cent (31 December 2022: 13.7 per cent). Updates to the macroeconomic outlook drive offsetting movements, with Stage 2 increases in UK mortgages driven by higher UK Bank Rate projections offset by Commercial Banking reductions reflecting the modestly improved GDP outlook. Of the total Group Stage 2 loans and advances to customers, 93.4 per cent are up to date (31 December 2022 94.1 per cent). Stage 2 coverage reduced to 3.2 per cent (31 December 2022: 3.3 per cent).

Stage 3 loans and advances to customers increased to £7,855 million (31 December 2022: £7,611 million), and as a percentage of total lending to 1.8 per cent (31 December 2022: 1.7 per cent). Stage 3 coverage increased by 1.1 percentage points to 26.6 per cent (31 December 2022: 25.5 per cent) largely driven by additional charges on existing Commercial Banking clients in Stage 3.

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 the impacts from higher interest rates and from 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, embracing the standards outlined in the Mortgage Charter and including where customers are leveraging Pay As You Grow options under the UK Government Coronavirus scheme

CREDIT RISK (continued)

Impairment charge (credit) by division

1 Impairment charges for Retail, Commercial Banking and Other reflect the new organisation structure; comparatives have been presented on a consistent basis. See page 32.

Total expected credit loss allowance

Movements in total expected credit loss allowance

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

2 Includes £60 million, within write-offs and other relating to the £2.5 billion legacy portfolio exit in the first quarter of 2023.

3 Total ECL includes £14 million relating to other non customer-related assets (31 December 2022: £17 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 £116 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 £67 million, Loans and overdrafts of £48 million and Small and Medium Businesses of £610 million.

CREDIT RISK (continued)

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

1 Contains centralised fair value hedge accounting adjustments.

2 UK Motor Finance for Stages 1 and 2 include £92 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 £67 million, Loans and overdrafts of £52, million, Small and Medium Businesses of £607 million and Corporate and Institutional Banking of £1 million.

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. As of 31 December 2022, interest-only mortgage customers at risk of not meeting their final term payment are now directly classified as Stage 2 up to date 'Other', driving movement of gross lending from the category of Stage 2 up to date 'PD movement' into 'Other'.

2 Includes assets that have triggered PD movements, or other rules, given that being 1 to 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).

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. 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 in note 11 on page 47 onwards.

The table below shows the Group's ECL for the probability-weighted, upside, base case, downside and severe downside scenarios, with 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 typically held constant reflecting the basis on which they are evaluated. However, post-model adjustments in Commercial Banking have been apportioned across the scenarios to better reflect the sensitivity of these adjustments to each scenario. Judgements applied through changes to model inputs are reflected in the scenario ECL sensitivities. The probability-weighted view shows the extent to which a higher ECL allowance has been recognised to take account of multiple economic scenarios relative to the base case; the uplift being £680 million at 30 June 2023 compared to £668 million at 31 December 2022.