Business context and reporting period
Lloyds Banking Group plc filed this audited IFRS annual report on Form 20-F on 9 March 2018 for the year ended 31 December 2017. The UK-focused group provides retail and commercial banking, insurance and wealth services. It acquired MBNA’s UK credit card business on 1 June 2017; 2017 segment comparatives were restated following an internal reorganisation.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total income, net of insurance claims | £18.659bn | £17.267bn |
| Net interest income | £10.912bn | £9.274bn |
| Profit before tax, statutory | £5.625bn | £3.888bn |
| Profit for the year | £3.897bn | £2.164bn |
| Profit attributable to ordinary shareholders | £3.392bn | £1.651bn |
| Underlying profit before tax | £8.493bn | £7.867bn |
| Net interest margin | 1.86%; 2.11% excluding OEIC unitholder effects | 1.54%; 1.89% excluding OEIC effects |
| Cost:income ratio, statutory | 66.2% | 73.1% |
| Impairment charge, statutory | £688m | £752m |
| Operating cash flow | (£3.195bn) | £2.074bn |
Net income attributable to shareholders rose substantially, while the underlying pre-tax measure increased 8%. Statutory profit excludes no items; underlying profit is a non-GAAP measure that excludes conduct provisions, restructuring, market volatility and other specified items. The large gap between the two should be considered when assessing earnings quality. The effective tax rate was 31%, above the 19.25% UK corporation tax rate, principally because of the banking surcharge and limits on deducting conduct provisions.
The fall in reported total income before insurance claims largely reflects lower insurance investment gains and the associated lower insurance claims expense, which substantially offset one another. Net interest income rose 18%, including a £622m favourable change in amounts payable to OEIC investors; excluding that effect, it increased 9%. Lower funding costs and MBNA supported margins, partly offset by asset-margin pressure.
Underlying segment profit before tax: Retail £4.403bn (2016: £4.058bn); Commercial Banking £2.489bn (£2.379bn); Insurance and Wealth £939m (£973m); Other £662m (£457m).
Balance sheet, capital and liquidity
At year-end, total assets were £812.109bn (down 1% year on year), customer loans £472.498bn (up 3%), customer deposits £418.124bn (up 1%), shareholders’ equity £43.551bn, and subordinated liabilities £17.922bn (down 10%). Wholesale funding fell 9% to £101.1bn. The loan-to-deposit ratio was 110%.
The common equity tier 1 ratio was 14.1% (2016: 13.4%) and the total capital ratio 21.2% (unchanged). The UK leverage ratio was 5.3% fully loaded; the Group also reported an adjusted 5.4% ratio after specified adjustments. The liquidity coverage ratio was 127%, supported by £120.9bn of eligible liquid assets. The Group had fully used its £20bn Bank of England Term Funding Scheme capacity by year-end. Cash and cash equivalents were £60.982bn, down £1.406bn over the year; operating cash flow was negative, with movements in operating assets and liabilities materially affecting the bank’s cash-flow presentation.
Material changes versus 2016
- Statutory profit before tax increased 45%, while profit for the year rose 80%; underlying profit before tax rose 8%.
- Net interest income improved, but other income fell £7.012bn (23%), mainly because insurance policyholder investment gains were lower than in 2016. Insurance claims expense also fell £6.766bn, largely reflecting those investment movements.
- Operating expenses declined 2% to £12.346bn; conduct-related provisions within expenses were £2.165bn versus £2.374bn in 2016. Excluding provisions, expenses were slightly lower.
- Impairment losses were lower overall, but customer-loan impairment rose to £697m from £592m, including £118m related to MBNA. Management attributed the increase mainly to lower releases and recoveries and the acquisition, rather than broad deterioration in credit quality.
- Customer loans rose with MBNA and growth in consumer finance and SME lending; closed mortgage books and some corporate lending declined. CET1 strengthened despite the MBNA acquisition.
Outlook, risks and unusual items
Management described the near-term UK outlook as relatively benign, expecting 2018 growth at a pace similar to 2017, gradual interest-rate increases and marginal house-price growth, subject to no sudden confidence shock. It expected the asset-quality ratio to remain below 30 basis points in 2018 and through the plan period, versus an estimated through-cycle level of around 35 basis points. Management noted household spending pressure from inflation exceeding wage growth and uncertainty around the UK’s future EU relationship.
The next strategic plan prioritises customer experience, digitisation, targeted growth and changes to ways of working. The Group plans to invest more than £3bn in strategic initiatives. Stated goals include adding more than £50bn to Financial Planning and Retirement open-book assets and gaining over one million pension customers by 2020, and more than £6bn of net lending growth to start-ups, SMEs and mid-market businesses during the plan period.
The Board recommended a 2.05p final dividend, taking the 2017 ordinary dividend to 3.05p per share, up 20%. A buyback of up to £1bn was announced after year-end, commencing 8 March 2018 and expected to finish within 12 months. Management estimated that the buyback would reduce CET1 by about 50 basis points; the adjusted CET1 ratio after dividends and allowing for the buyback was 13.9% at year-end.
- PPI: The Group added £1.3bn of provision in 2017, bringing total provision to £18.675bn; £2.438bn remained unutilised at year-end. Assumptions include 11,000 complaints per week through the August 2019 deadline. Each additional 1,000 weekly complaints above that assumption was estimated to add £200m to costs.
- Other conduct and legal matters: £865m was charged in 2017 for other legal and regulatory matters; £1.292bn remained unutilised. Significant items include arrears handling, packaged bank accounts and compensation relating to the HBOS Reading fraud. Outcomes remain uncertain in several investigations and lawsuits.
- Tax contingency: An adverse HMRC decision on a former Irish subsidiary’s loss-relief claim could increase current tax liabilities by approximately £650m and reduce deferred tax assets by approximately £350m. The Group disputes HMRC’s position.
- Accounting change: IFRS 9 was adopted on 1 January 2018. The Group estimated an approximately £1.3bn increase in impairment provisions and a £1.2bn reduction in shareholders’ equity, net of tax, at adoption; expected-credit-loss charges may be more forward-looking and volatile.
- Other risks: EU-exit uncertainty, competition and digital disruption, cyber and operational resilience, regulatory change including ring-fencing by January 2019, consumer indebtedness, climate-related insurance exposure, and funding-market conditions. The 2017 Bank of England stress test was passed without required capital action.
PwC issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective as of 31 December 2017.
Important facts for investors to verify
- Reconcile the £5.625bn statutory pre-tax profit with £8.493bn underlying profit, focusing on conduct provisions and the treatment of insurance volatility and OEIC effects.
- Track PPI complaint volumes against the 11,000-per-week assumption, provision utilisation and the August 2019 deadline; assess sensitivity to additional complaints.
- Verify IFRS 9’s realised opening provision, equity and capital effects against the Group’s estimates, and monitor subsequent impairment trends.
- Assess the sustainability of margins, deposit funding and liquidity as Bank of England funding schemes mature and wholesale issuance needs rise.
- Monitor CET1 after dividends and the announced buyback, regulatory buffer changes, ring-fencing implementation and any material legal, tax or conduct developments.