Earnings Call Transcript - LYG Q2 2025

Operator, Operator

Thank you for joining us, and welcome to the Lloyds Banking Group 2025 Half Year Results Call. There will be presentations from Charlie Nunn and William Chalmers, followed by a question-and-answer session. Please note that this call is scheduled for 90 minutes and is being recorded. I will now hand over to Charlie Nunn. Please go ahead.

Charlie Nunn, CEO

Thank you, operator, and good morning, everyone, and thank you for joining our 2025 half-year results presentation. I'll begin today with an overview of our financial and strategic performance, where we've continued to make strong progress, having moved into the second phase of our transformation at the beginning of the year. I'll then hand over to William, who will run through the financials in detail before we take your questions. Let me begin on Slide 3. I'd like to start by highlighting the following key messages. Firstly, we're continuing to deliver strong outcomes for all stakeholders. Our strategy is providing our customers with leading propositions and supporting the real economy, creating attractive growth opportunities and improved operating leverage across the group. We're on track to meet our 2026 targeted strategic outcomes. Secondly, we continue to demonstrate broad-based and sustained strength in financial performance. This has enabled continued improvement in shareholder distributions with the ordinary dividend up 15% at the interim stage. And finally, we remain confident of delivering higher, more sustainable returns. We are reaffirming our guidance for 2025 and remain confident in our 2026 commitments. On Slide 4, I'll provide a few examples of how we're successfully delivering for all stakeholders. We continue to build a highly differentiated franchise. Our purpose is embedded throughout our business and is driving sustainable and profitable growth. For example, we continue to take a leading role in supporting the critically important housing sector, lending more than GBP 8 billion to first-time buyers and supporting over GBP 1 billion of funding to the social housing sector in the first half. At the same time, we're delivering growth through our strategic initiatives in a number of areas. This includes significantly increasing our penetration of protection products for mortgage customers and gaining share in sterling interest rate swaps. This business momentum is underpinning our sustained strength in financial performance. We delivered growth across both sides of the balance sheet and a 6% increase in net income, including ongoing OOI strength, up 9% in the first half. This supports a return on tangible equity of 14.1% for the half and 86 basis points of capital generation. Our highly capital-generative business model is a key enabler to increasing shareholder distributions. Before covering our strategic progress in the first half in more detail, I'll briefly highlight on Slide 5, why we believe the external environment provides a supportive backdrop to our plans over the coming years. Our current forecast for the U.K. remains one of a resilient but slower growth economy. William will provide more detail on our latest estimates shortly. The economic environment and uncertainty remain difficult for some of our customers. However, the underlying fundamentals continue to strengthen. And alongside new policy measures, we see the opportunity for the economy to move to a higher growth trajectory that is forecast today over the medium term. To elaborate on this, I'd highlight the following key points. Firstly, the underlying health of the economy remains robust. Households and businesses' finances have further strengthened in the first half and business confidence remains above the long-term average. There is scope for increased activity as confidence further improves and rates fall. Secondly, the government has placed a clear focus on growth. The recently launched industrial strategy will provide significant investment into faster-growing and high potential sectors, and we welcome the ambition of the announced financial services reforms. We are well positioned to be an important partner to both sets of plans. And finally, despite significant geopolitical uncertainty in recent months, the U.K. is well placed to navigate any headwinds relative to other economies and remains an attractive destination for foreign direct investment. Taken together, we are constructive on the outlook for the U.K. economy with our strategy focused on faster-growing areas, such as housing, transition finance, infrastructure, and pensions. As such, we see the potential for the group to continue to grow faster than the wider economy over the coming years. Let me now cover some examples of the growth we are driving through our strategic initiatives on Slide 6. In February, we provided more details on how we're accelerating our transformation in the second phase over 2025 and '26. We've delivered strong progress in the first half of the year and are on track to achieve our '26 targeted strategic outcomes. We're delivering on our growth priorities with meaningful contributions from all divisions and increasing synergies between them. In Retail, we're winning market share in lending, deepening relationships and growing high-value areas such as through our new Lloyds Premier offering following a successful launch in May. In Commercial Banking, we are digitizing and driving OOI accretive diversification, gaining share in priority areas. And in IP&I, we are transforming engagement and increasing group connectivity. We now have more than 0.5 million users of our Scottish Widows app and are expanding our product set for retail customers, proving our bancassurance model. We continue to expect to deliver more than GBP 1.5 billion of additional revenues from strategic initiatives by 2026, with over GBP 1 billion delivered to date on an annualized basis. Now turning to cost and capital efficiency on Slide 7. Alongside growing revenues, our commitment to efficiency is paramount to driving sustained operating leverage. We continue to focus on increasing productivity as our customers shift to mobile first as well as decreasing costs associated with our reducing legacy technology estate. Having surpassed our original target in the first phase, we realized another GBP 300 million of gross cost savings in the first half, taking the total to circa GBP 1.5 billion since 2021. At the same time, we're continuing to improve capital efficiency through growth in fee-generating capital-lite areas and further scaling of SRTs and new origination capabilities. This supported more than GBP 2 billion of additional RWA optimization in the first half, taking the total to circa GBP 20 billion since 2021. Our continued strong progress in these areas underpins our confidence in delivering a cost-to-income ratio of below 50% and more than 200 basis points of capital generation in 2026.

William Leon Chalmers, CFO

Thank you, Charlie. Good morning, everyone, and thanks again for joining. As usual, let me start with an overview of the financials on Slide 11. Lloyds Banking Group demonstrated sustained strength in financial performance during the first 6 months of the year. Statutory profit after tax in the first half was GBP 2.5 billion with a return on tangible equity of 14.1%. Net income of GBP 8.9 billion was 6% higher than the prior year. This was driven by continued momentum in net interest income alongside 9% year-on-year growth in other operating income. We remain committed to efficiency. H1 operating costs of GBP 4.9 billion were up 4% year-on-year, in line with our expectations for this stage. Asset quality meanwhile remains robust. The H1 impairment charge of GBP 442 million equates to an asset quality ratio of 19 basis points. Our performance resulted in strong capital generation of 86 basis points in the first half. This supports our 15% increase in the interim dividend alongside our closing pro forma CET1 ratio of 13.8%. I'll now turn to Slide 12 to look at developments in our customer franchise. Our customer balances showed good growth in the first 6 months across both the lending and the deposit franchise. Focusing on Q2, group lending balances of GBP 471 billion were up GBP 4.8 billion or 1% versus Q1. We saw broad-based growth across all of our lending activities. Within Retail, loans and advances were up GBP 3.1 billion. The mortgage book is up GBP 0.8 billion since March, reflecting accelerated growth in the first quarter, driven by stamp duty changes. In this context, it's good to see volumes picking up again in June. Elsewhere in retail business, we saw continued and broad-based growth across each of our cards, loans, and motor businesses as well as European retail. Commercial lending balances were also up in Q2 by GBP 0.9 billion. Within this, we saw growth in CIB, particularly infrastructure and SPG lending. In BCB, net repayments were driven by government-backed lending balances. Excluding these, it's good to see the private lending business growing in the first 6 months, including in Q2. Turning to liability franchise. Again, we saw a good performance in deposits, up GBP 6.2 billion or 1% in Q2, now standing at GBP 494 billion. Retail increased by GBP 1 billion, notably savings accounts were up GBP 2.9 billion, following significant inflows to ISA products in what was a very strong season, offset by current accounts down GBP 1.9 billion, largely reflecting the same flows. Post tax year-end, ISA-driven migration is, of course, slowing. Commercial deposits were up in Q2 by GBP 5.3 billion. This was driven by growth in targeted sectors across both CIB and BCB. Alongside deposit developments in banking, we continue to see steady AUM growth in Insurance, Pensions and Investments, with circa GBP 2 billion of net new money in Q2. Turning to interest income on Slide 13. Net interest income grew 5% in the first half to GBP 6.7 billion. This included GBP 3.4 billion in Q2, growth of 2% versus the prior quarter. Income growth continues to be supported by positive momentum in the net interest margin with the Q2 margin of 304 basis points, up slightly on Q1. The mortgage refinancing and deposit churn headwinds continue to be more than offset by a growing structural hedge contribution. NII was further supported by AIEAs of GBP 460 billion in Q2, up GBP 4.5 billion versus Q1. The increase was driven by the impact of strong mortgage growth towards the end of the first quarter. The Q2 nonbanking NII charge was GBP 124 million, slightly up quarter-on-quarter, in line with our expectations for an upward trajectory across the year. As usual, this is driven by business growth in OOI and associated funding repricing. Looking ahead, we continue to expect net interest income for 2025 to be circa GBP 13.5 billion. H2 growth will be driven by gradual margin improvements in AIEA growth from franchise expansion. Let's turn to the mortgage portfolio on Slide 14. The mortgage book now stands at GBP 318 billion. This is up GBP 5.6 billion in H1 and GBP 0.8 billion in Q2. Increased mortgage balances are a result of healthy underlying market demand as well as our strategic initiatives in this area, helping to support a 19% market share of net new lending in the first half. In Q2, completion margins averaged around 70 basis points, slightly tighter than the prior quarter. Maturities in the book meanwhile remained higher at just over 90 basis points. Based on current applications, we expect the market to remain competitive and completion margins to be at or around Q2 levels in the second half. Needless to say, this will depend on swap rate volatility, competitive dynamics, and no doubt, product margins elsewhere. As Charlie mentioned, we continue to enhance our depth of customer relationships in mortgages, including across business areas. 20% of new mortgage customers now take up protection insurance, an increase of 7 percentage points versus last year. We also recently launched a new digital remortgage journey, delivering increased share of direct-to-bank applications, up 4 percentage points to 25% in H1. Together, these initiatives help offset margin pressure. Now looking at the other lending books on Slide 15. Consumer lending balances are performing well. Within both cards and loans, our strategic investment in tools such as Your Credit Score, used by 4.8 million customers in the last 3 months alone, is enabling us to drive growth by leveraging data to enhance decision-making and personalization. Accompanied by an improved risk scorecard, this is supporting growth in our personal loans business, with balances up GBP 0.8 billion since year-end. Alongside, cards balances were up GBP 0.7 billion and motor finance lending by the same. In the Commercial book, lending balances increased by GBP 1.2 billion in the first half. This was driven by growth of GBP 1.8 billion in the CIB business, particularly institutional balances alongside securitized products. In BCB, balances were down GBP 0.6 billion, but as I said earlier, up GBP 0.2 billion when adding back government-backed lending repayments. Delivery of the initiatives highlighted in Charlie's section earlier, such as mobile onboarding for SME clients, is clearly having an impact here. Moving on to deposits on Slide 16. Our deposit franchise grew strongly in the first half of the year. Total deposits are up by GBP 11.2 billion or 2% to GBP 494 billion. Within this, retail deposits increased by GBP 3.7 billion. Continued growth in savings balances more than offset current account reductions. Retail savings were up GBP 4.9 billion, supported by net new money inflows and strong retention activity. This included a strong performance throughout what was a busy ISA season, up 30% on last year. Notably, our existing and new ISA customers are valuable to us with average product holdings of almost 2x the group average. Current account balances, meanwhile, fell slightly in the first half by GBP 0.7 billion. Flows were driven by switches to savings, including ISAs, whilst wage growth and spending remained broadly stable. Pleasingly, commercial deposits increased in H1 by GBP 7.6 billion, driven by growth in targeted sectors, both BCB and CIB. As you're aware, our deposit franchise supports the structural hedge, which I'll now update on. Our structural hedge continues to provide a significant and growing tailwind to income. The hedge notional currently stands at GBP 244 billion, up GBP 2 billion in Q2. This follows strong deposit performance in the first half. In H1, we saw gross hedge income of GBP 2.6 billion, around GBP 0.7 billion higher than last year. The average earnings rate on the hedge was circa 2.2% in Q2. The reinvestment rate for maturities meanwhile continues to be significantly higher than this. So at around 3.5 years, the weighted average life of the hedge provides strong support for income going forward. Looking ahead, we continue to expect 2025 hedge income to be around GBP 1.2 billion higher versus 2024. We also continue to expect 2026 hedge income to be around GBP 1.5 billion higher than 2025. Moving on to other income on Slide 18. We continue to build momentum in other income across the franchise. Other income of GBP 3 billion in the first half was up 9% on H1 last year. This included GBP 1.5 billion in the second quarter, also 9% higher year-on-year. Pleasingly, this growth is driven by broad-based momentum across the business linked to our strategic initiatives as well as BAU growth. Within Retail, 11% growth versus the prior year was supported by higher income from personal current accounts and continued strength in our motor leasing business. In Commercial, year-on-year strength in transaction banking income was offset by lower loan markets activity. Having said that, more recently, we've seen a healthy rebound in client activity levels. Insurance, Pensions, and Investments delivered a strong performance in the first half, up 6% year-on-year. General insurance did particularly well with income net of claims up 35%. Member contributions in workplace pensions meanwhile, also saw good momentum. In Equity Investments, Lloyds Living is developing well with income up 19% year-on-year alongside LDC growth. Looking forward, we continue to expect strategic investment and BAU activity to drive ongoing growth in other income. Turning to operating lease depreciation. The first half charge of GBP 710 million included GBP 355 million in Q2, flat on Q1. This is a good result in the context of further adverse movements in used car prices, particularly electric vehicles over the second quarter. As mentioned at Q1, we implemented a number of significant strategic actions, which have improved business performance and helped offset the impact of both asset growth and car price movements. These include enhanced used car leasing, remarketing agreements, and risk-sharing with OEMs. Together, these should meaningfully reduce volatility in operating lease depreciation going forward. Moving to costs on Slide 19. The group continues to maintain strong cost discipline. H1 operating costs were GBP 4.9 billion, up 4% on the prior year or 2% excluding the previously disclosed front-loaded severance charges in Q1. Second quarter costs of GBP 2.3 billion are down quarter-on-quarter, partly helped by investment timing, including lower severance charges. Overall, operating costs are tracking in line with full year expectations with business growth and inflationary impacts, including national insurance, partially mitigated by savings driven by our strategic investment. The continued pace of these investment-driven savings, including reduced cost of change, as Charlie highlighted, alongside in growth, gives us confidence in operational leverage and our medium-term cost-to-income ambitions. Looking ahead, we continue to expect operating costs of circa GBP 9.7 billion for the full year. Remediation remains low at GBP 37 million in the quarter. There was no further charge for Motor Finance. Let me move to asset quality on Slide 20. Asset quality remains robust. Credit quality was stable in the period with either stable or improving new to arrears seen across our portfolios. Similarly, early warning indicators remain low and stable. For example, minimum repayment levels in cards remain modest as do RCF utilization levels in Commercial. First half impairment charge was GBP 442 million, equating to an asset quality ratio of 19 basis points. Indeed, the second quarter continued the benign trends of the first for the pre-MES asset quality ratio of 15 basis points. In Q2, there was an MES release of GBP 44 million. This consisted of the removal and integration of the Q1 GBP 100 million charge to cover tariff risks into our base case assumptions. Alongside, we saw a benefit from improvements to the HPI outlook in Retail. Together, the observed performance and MES outcome resulted in a low Q2 impairment charge of GBP 133 million or an asset quarter ratio of 11 basis points. Our stock of ECLs on the balance sheet is now GBP 3.5 billion, remaining circa GBP 400 million above our base case. We are very confident in the balance sheet, given our prime customer base and a prudent approach to risk. We continue to expect the asset quality ratio to be circa 25 basis points for the full year. Let me briefly update on our latest economic assumptions. We have made minor changes to our macroeconomic forecast since Q1. We now expect 1% growth in GDP in 2025 and a similar level in 2026, slightly lower than previously forecasted. We now expect unemployment to rise a little further, peaking at 5% in 2026. Given this context, we now assume 2 further rate cuts in 2025 and 1 in 26 to a terminal rate of 3.5%. Our assumptions for house prices meanwhile have improved, largely reflecting FCA affordability changes. Let me now address returns on TNAV on Slide 22. The return on tangible equity of 14.1% in the first half is a strong performance, including 15.5% in Q2. Within the H1 performance, the volatility and other items charge of GBP 48 million was driven by negative insurance volatility and the usual fair value unwind, partly offset by gains on the sale of our bulk annuities business, which completed in the second quarter. Tangible net assets per share at 54.5p are up 2.1p since year-end. The increase was driven by profit build and the unwind of the cash flow hedge reserve offset by shareholder distributions, including the full year ordinary dividend payment in April. As usual, at this time, TNAV is also temporarily suppressed by an accrual for the share buyback over the H1 close period with no corresponding share count reduction. This is worth 1p per share and will mechanically reverse in Q3. Looking ahead, we continue to expect further material TNAV per share growth this year and indeed over the medium term. Alongside, we continue to expect the return on tangible equity for 2025 to be around 13.5%. Turning now to capital generation on Slide 23. Capital generation was strong in the first half of the year, including in the second quarter. Within this, total RWAs ended the first half at GBP 231 million, up GBP 6.8 billion in H1 and up GBP 1.3 billion in Q2. The increase was driven by lending growth, partly offset by optimization activities and credit calibrations. Q2 also saw a partial reversal of the GBP 2.5 billion temporary RWAs that we mentioned in Q1. The remaining balance of around GBP 1.2 billion will reverse in the third quarter. Just to note that no new additions for CRD IV secured risk ratings were taken in the first half. We will revisit the position later this year. Given the healthy banking profitability and the interim insurance dividend, capital generation of 86 basis points in the first half was, as said, a strong result. Looking ahead, we continue to expect full year 2025 capital generation to be circa 175 basis points. Capital ratios are strong. Closing pro forma CET1 ratio after 50 basis points of ordinary dividend accrual is 13.8%. I'll now move on to capital distributions on Slide 24. The group's strong capital generation continues to support sustained growth in shareholder distributions. Today, the Board announces an increased interim dividend of 1.22p per share, 15% growth on last year. As usual, we will consider further capital distributions at the year-end. Dividends per share have grown consistently over our strategic plan, now up more than 80% versus 2021. Alongside this, we have undertaken consecutive and significant share buyback programs. These have reduced the group share count by circa 16% since the end of 2021, supporting growth in value for our shareholders. By executing on our strategy for the benefit of all stakeholders, we expect this growth in distributions to continue returning material excess capital to our shareholders. As before, we remain committed to paying down to a circa 13% CET1 ratio in 2026, with the end of 2025 being a staging post towards that target. Let me now wrap up the financials on Slide 25. To summarize, the group is showing sustained strength and delivering in line with expectations. In the first 6 months of the year, we saw continued growth in net income, cost discipline, and robust asset quality, driving strong capital generation and an increased interim dividend. Looking forward and based on this sustained strength, we feel very comfortable with our 2025 guidance and remain confident in our 2026 commitments, both as you can see, are set out in full on the slide. Finally, and as you may have seen in the RNS, building on our transformation and consistent with our ambition to move at pace into next year, we intend to move to preliminary reporting at this year-end. Accordingly, we'll announce our full year 2025 results on 29th of January 2026, with our full annual report and accounts following on the 18th of February. That concludes my comments for this morning. Thank you for listening. Let me now hand back to Charlie for closing remarks.

Charlie Nunn, CEO

Thank you, William. So to briefly summarize, I'm very pleased by our strong progress in the first half of the year. We're delivering significant strategic change in the second phase of our transformation and remain on track to meet our 2026 targeted outcomes. This underpins broad-based and sustained strength in financial performance with our highly capital-generative business model supporting increasing shareholder distributions. The group remains on a clear path to delivering higher, more sustainable returns. We're reaffirming our 2025 guidance and remain confident in our 2026 commitments. Thank you for listening this morning. That concludes our presentation, and we're now very happy to take your questions.

Operator, Operator

Our first caller is Guy Stebbings from BNP.

Guy Stebbings, Analyst

Two questions. The first one was on mortgage spreads. You talked to 70 basis points completion spreads in Q2, which is coming a little bit, but very much consistent with wider industry data. If we stay at that sort of level you suggested, I mean, how should we be thinking about back to front book mortgage spread churn from here? Perhaps you could frame it against that 3 basis points Q-on-Q headwind in terms of how that could moderate into future periods? Or perhaps you could give us the average back book spread now. I presume that's coming much closer to the front book now than was the case a few quarters ago. So even with the slightly tighter front book spreads, the sort of back to front book churn should be easing from here. And then the second question was just on deposits, some negative mix effects in the quarter as you talked before. And again, we've seen that in interest data, given the sort of new tax season impact clearly played a role on ISA flows. Are you able to confirm that those PCA outflows landed largely in April or maybe the start of May and perhaps eased as we got to the end of the quarter? Or were you still seeing some PCA outflows in the month of June, for instance?

William Leon Chalmers, CFO

Thank you for your questions, Guy. I’ll address them one at a time. Regarding mortgage spreads, in the second quarter, we observed mortgage spreads at approximately 70 basis points, which is slightly tighter than what we experienced in the first quarter. Looking at the current applications, which will result in completions in the third quarter, we anticipate spreads to remain fairly consistent. Therefore, we expect the trends from quarter two to continue into quarter three, and we'll monitor how this unfolds for the rest of the year. As for the maturity margins on the book, during the second quarter, they were in the range of 90 to 95 basis points. We expect these to gradually decrease in the latter half of this year, but it’s important to note that both the second half of this year and next year will not follow a completely linear trajectory. This means the mortgage headwind in any given period may fluctuate with that nonlinearity. While we anticipate the mortgage headwind we discussed previously to manifest throughout 2026, we’re still approximately aligned with that timeframe. A slight downturn in mortgage margins could extend this by a month or two, but overall, the outlook remains consistent with what we’ve communicated before. Regarding deposits, the situation has been quite positive over the half year. We’ve seen an increase of GBP 11.3 billion in deposits during the first half, with GBP 6.3 billion added in the second quarter alone. This strong performance is well-distributed, with GBP 3.7 billion from the retail sector and GBP 7.6 billion from the commercial sector, reflecting an overall increase of 2%. While there have been some fluctuations in the second quarter, particularly with a decrease in PCA movements of about 1.9, it's important to consider this in the broader context of the half year, where we saw an overall drop of GBP 0.7 billion. We also experienced a successful ISA season, with a 30% year-on-year increase and our market share at roughly 20%. This is significant as these customers tend to be valuable and often affluent, enhancing our customer base. Furthermore, ISA customers generally hold more products with us, with approximately double the average. Concerning the timing of the flows, ISAs are linked to the tax year-end, leading to significant activity in March and continuing into April. However, flows in April were significantly reduced by May, and those in June were about a third lower than in May, indicating a normalization of deposit flows over the quarter. Despite being in a declining base rate environment, we expect customers to migrate in that context, particularly those seeking fixed-term deposits. We are pleased to participate in this trend, as it aligns with our expectations and the forecast for this year, and this customer demographic remains profitable and appealing. I hope this provides useful insights into the dynamics of our deposit base.

Benjamin Toms, Analyst

The first topic is the structural hedge. By reiterating your guidance, the implied contribution from the half 2 structural hedge is a certain amount in GBP. I understand that rounding can cause some variance, but that figure is lower than I anticipated if I assume that the notional continues to increase slightly. Could you share your current thoughts on where you expect the notional to go this year and next? Secondly, you mentioned in one of the slides that the FCA's affordability changes significantly affected your house price expectations. Does this also significantly alter your mortgage volume expectations for the medium term? I thought it would only have a slight impact. Additionally, how does the mortgage pipeline look for half 2?

William Leon Chalmers, CFO

I'll take the first. I'll start on the second, and Charlie will add on the second, too, Ben. First of all, in terms of the structural hedge, the structural hedge is developing pretty much exactly as we had expected it to over the course of the first half, and we expect to continue to do so over the course of the second. If anything, rates have maybe been a touch stronger than we had expected. So maybe there's a little bit of upside building into that. But I wouldn't want to overstate that. It's pretty much according to plan. Now interestingly, what is going on there is, as I said, the expectation for earnings from the structural hedge is going to be GBP 1.2 billion higher in '25 than it was in '24, exactly as we said to you at the beginning of the year. Our expectation for '26, again, GBP 1.5 billion higher in '26 than it was in '25. And we are getting increasingly confident of that. As said, potentially a little bit of rates upside, but let's see how the rest of the rate cycle fares over the next 18 months or so. Specifically, what I mean by the confidence? I'm obviously referring to the amount of the hedge that we have locked in. So we now have '25 done, essentially, 97%, 98% in that zone. We have more than 4/5 of '26 locked in as well. And of course, as the days go by, that number is creeping up. And so as a result, the confidence in the hedge is increasing off the back of increasingly locked in volumes both in respect to '25 and in respect to '26. In any given period, having said that, Ben, you're going to see the structural hedge contribution ebb and flow a little bit. You saw a strong contribution to the margin from the structural hedge in quarter 1. I think it was about 10 basis points. You saw a slightly weaker but still strong contribution from the structural hedge in quarter 2, I think it's about 7 basis points. Looking at quarter 3, because of maturity dynamics, it's going to ebb away a little bit from that, but that's fine. That's pretty much exactly as we planned. And then it will strengthen significantly going into the fourth quarter. I realize I'm giving you probably more detail than maybe even you want, Ben, but nonetheless, hopefully, it's helpful in terms of giving you the picture as to how we expect the structural hedge to mature. As said, very much consistent with our expectations. One further point to make before I leave that topic. By the time we get to the end of '26, as I think came up at our year-end results, we are still seeing a yield on the structural hedge that is below the yield that we currently see in the swap market for term offerings. That means that the structural hedge will continue to give us support into the years thereafter, consistent with the weighted average life of the hedge of around 3.5 years. So we're seeing, therefore, the structural hedge play out in, as I said, pretty much exactly the way we expected. I'll add one further point, having what I said a second ago, the confidence in the hedge is good to see, manifested in the context of the notional balances, which we put up by a couple of billion during the course of this year. And just referring back to Guy's second question a second ago, the fact that we have put the hedge up by a couple of billion over the course of this year shows you the belief that we have and the stability of the deposits behavior that we've seen over H1 as a whole. So that's an insight, I suppose, on the structural hedge, but hopefully also gives a bit of insight into what we've seen in the deposit book as a whole. I'll kick off on the second of your questions, Ben, on FCA, HPI improvements and the like and then hand over to Charlie. It is fair to say that we see the FCA affordability changes as helpful to the overall prospects for the housing market. We think it's going to inspire more first-time buyers, we think it's going to inspire more movement and therefore, strength in HPI. And that's what's behind 3%, it's actually 2.6% up this year and about 3% up next year as expected. Mortgage volumes. If you take quarter 1 and quarter 2 together, you've got GBP 5.6 billion up on mortgages over the course of the first half of this year. That's a good performance. Looking forward, with our HPI strength in mind, we do expect continued mortgage growth over the course of the second half. I'm not going to put a number on it. It may be a touch lower than GBP 5.6 billion. Again, that's a pretty pacey performance in the first half, but we certainly expect healthy mortgage performance. And indeed, we do expect it to be boosted at the margin by that FCA, HPI contribution, Ben.

Charlie Nunn, CEO

Yes. I would add that your characterization is accurate. It enables us to compete and gives us the opportunity to do so on the margin. Last week, we announced that the latest Mansion House changes would allow us to support an additional GBP 4 billion in lending on a like-for-like basis. So far, we have completed GBP 8 billion in first-time buyer lending in the first half, reaching 34,000 customers compared to 64,000 last year. This represents a strong source of profitable growth for us and enhances our competitive stance. It is also important to note some points William made about the mortgage business; it is highly competitive and varies significantly depending on the market segment. We continue to gain and maintain market share, which is invigorating for me in my role, especially with the innovations we are implementing in our mortgage hub and our customer engagement strategies in the broker market. We are increasing our share in the direct channel, allowing us to add value for our core customers while cross-selling our protection products. We are making many innovative changes, and our focus on affordability and customer support journeys will help us remain competitive. Overall, we believe it will bolster our efforts, although it mostly aligns with what we are already doing.

Amit Goel, Analyst

So 2 questions for me. One was just on the nonbanking NII headwind. I think previously you might have commented to expect an uptick this year in the GBP 100 million order of magnitude, which seems to be well above the current run rate. I just wanted to check whether you still kind of see an uptick there? And if not, also just curious, does that have any implications for the growth in other operating income? And then secondly, just on the commercial deposit growth. I think in the slides, it comments about growth in targeted sectors. But in the report, it talks about some growth related to just corporate uncertainty about the broader environment. Just want to get a sense of do you expect some of that to reverse in the coming periods? Or is that sticky?

William Leon Chalmers, CFO

Thank you for your questions, Amit. I’ll start with your first two points. Regarding nonbanking net interest income, in Q2, it was GBP 124 million, following GBP 112 million in Q1, totaling GBP 236 million. We don't provide specific guidance on nonbanking net interest income, but we do estimate total net interest income at around GBP 13.5 billion. At the start of the year, we offered some insights into its expected development. There are two main points to consider. First, nonbanking net interest income will be influenced by both volume-related factors, which will support other operating income growth, and interest rate trends. Therefore, we do not anticipate any negative impact on other income growth, even if current rates fluctuate from our earlier expectations and support higher nonbanking net interest income performance. Additionally, this will not be a linear progression throughout the year; it will accelerate and decelerate due to refinancing obligations for specific segments, such as motor finance. Finally, nonbanking net interest income will be closely tied to the performance of Commercial Banking income, especially CIB income. Growth in certain CIB areas could influence nonbanking net interest income trends as it dictates our financing needs for those activities. Consequently, we're not seeing any concerning trends in nonbanking net interest income; in fact, other operating income is up 9% year-on-year for the first half and Q2. This reflects robust performance driven by various income sources. Looking ahead, we are maintaining our expectations for nonbanking net interest income, with the understanding that some of the momentum not realized in the first half may be captured in the second half. It will fluctuate, considering the factors I mentioned. As for your second question regarding deposits within the Commercial Banking division, we have observed certain targeted sectors within our franchise, both in CIB and BCB, experiencing changes. One observation is that some wealth managers have been parking their cash amidst volatile market conditions, especially notable in April. Whether this behavior will persist or shift is uncertain; we've anticipated some deposits might exit for a few quarters, yet they have remained quite stable, which is beneficial for both our franchise and earnings. If market conditions improve and wealth managers become more active in taking market risks, it could slightly affect those CB deposits, but we don’t expect a significant change. Additionally, it's encouraging to note that we’ve seen stability and even some growth in noninterest-bearing balances within BCB specifically. The improvement in business current accounts and similar offerings within the BCB franchise during the second quarter is a positive indicator of our client relationships and business performance.

Charles Nunn, CEO

Yes, I would like to add that with large commercial deposits and some wealth deposits, the margin is generally lower. This makes any switching in or out less significant, and we operate on that understanding. A key point made by William regarding SMEs, or BCB as we refer to it, is that we have continued to grow our market share over the last three years. This is very important to us, as the SME segment significantly contributes to the economy and is a very profitable area for Lloyds Banking Group. It primarily operates on a liability-driven basis, typically with a loan-to-deposit ratio of about 30%. Therefore, gaining market share in this area is critical, and we are consistently either winning or maintaining our position, which holds great importance.

Jason Napier, Analyst

First one, please, for William. I appreciate what Charlie mentioned earlier about the investment in OLD. Considering the revaluation of the fleet in the second quarter and the potential costs tied to that, I wonder, William, can you provide us with an idea of what the clean number for the quarter might have been and your thoughts on growth moving forward? It's encouraging to see that the hedging and risk mitigation are effective. I’d like to understand how we should view the progression in the last two quarters of the year. And then I have a question for Charlie afterwards.

William Leon Chalmers, CFO

Certainly. Regarding operating lease depreciation, it was GBP 355 million in Q2, which is the same as Q1. This stability was intentional and the result of significant management initiatives. Within that figure, there are a couple of factors to consider. Firstly, the business is experiencing growth due to an increased fleet size, which positively impacts other operating income. Additionally, higher value vehicles are contributing to this growth, particularly in the retail sector. However, we did see some weakness in rental vehicle prices, especially for electric vehicles, which was more than we anticipated in Q2. Another key factor is a series of management initiatives we introduced in Q1, such as lease extensions and remarketing, which provide significant value to customers and enhance our auction sales process, leading to better secondhand car prices. These initiatives have positively impacted operating lease depreciation, not only for Q2 but are expected to continue doing so in the future. While we may still feel some effects from any ongoing weakness in electric vehicle prices, we are now less exposed to these challenges compared to a year or six months ago due to these measures. Moving forward, we anticipate a more stable operating lease depreciation line, closely tied to underlying business growth. Although I can’t provide a specific forecast for operating lease depreciation as it is not one of our guided lines, we do expect it to be less volatile and more predictable this year, in line with the growth of our fleet and higher value vehicles. This should help in your modeling, Jason.

Charlie Nunn, CEO

And Jason, you had a second question?

Jason Napier, Analyst

Yes. The second question relates to your comments on investment in the business. I noticed from the disclosure on Page 8 that tech run and change costs have decreased by 20% since 2021, even though you've added 8,000 employees and are investing billions in technology. The first part of my question is what does that disclosure mean? How is the composition of spending different now compared to then, given that overall costs have increased by nearly 20% during the same period? Secondly, looking ahead to next year, it seems that Lloyds is projected to achieve about 8% jaws, as consensus predicts for 2026, primarily based on anticipated limited cost increases and continued strong top-line growth. Charlie, considering how you break down the costs of the group, we would appreciate your perspective on technology expenses versus branch costs versus risk. How do you view the evolution of costs into next year, and how are these segments changing differently compared to the past year?

Charlie Nunn, CEO

Thank you, Jason, for your important question. I'll address the outlook for 2026 as you asked. While we're not providing specific guidance beyond that timeframe, it's exciting to consider what's achievable in the future, which we'll elaborate on later. William laid out our overall cost trajectory and our hard cost target for this year. When thinking about achieving a 50% cost-to-income ratio next year, we anticipate strong top-line revenue growth and a stabilization, rather than a reduction, in costs. That's how we aim for a 50% or lower cost-to-income ratio. From a macro perspective, that's the right way to assess us. Different parts of our business manage costs differently. For instance, in technology, we need to drive significant productivity and cost savings while also investing more in innovation. We're reinvesting some of those savings back into the business. As we become more reliant on technology to run the bank and increase productivity, we’re also experiencing a rise in operational costs. We’ve achieved efficiencies by improving legacy systems, optimizing third-party relationships, and automating daily processes. However, we're also investing in cloud and AI technologies, which introduce additional variable costs. On the change side, we’ve seen a significant rise in productivity since we began this strategic phase, moving away from heavy reliance on third parties for engineering talent to attracting critical talent that fosters our capabilities today and in the future. This 20% to 30% productivity improvement allows us to refresh talent and keep investing in change. Later this year, our COO Ron will share how we approach productivity in this area, as we aim to enhance speed and quality in our operations. In other parts of the bank, our retail sector is making significant strides toward digital transformation, improving the productivity of physical channels, which is a major cost lever for us. As we digitize services, we see opportunities to automate back-office processes and improve productivity further. Our efficiency in decision-making, especially in areas like credit assessment, has also seen considerable gains. While we're boosting productivity for relationship managers in our SME business, we're also investing in coverage and capabilities in our Corporate and Investment Banking sector, albeit at a pace slower than revenue growth, resulting in some net growth costs. In summary, over the next 18 months, we have aggressive cost savings and productivity improvements planned, alongside reinvestments in areas that promote growth. Overall, we anticipate delivering £9.7 billion in costs this year, flattening into next year. Looking ahead, we will continue to seek opportunities for efficiency and productivity, particularly through the use of AI and generative AI, which we believe will significantly enhance our capabilities in the future. We expect to achieve the 8% jaws you mentioned.

Christopher Cant, Analyst

I would like to invite you, Charlie, to share your thoughts on the Schroders joint venture regarding the retail investment opportunity you mentioned earlier. It's obviously something you've inherited. Are you satisfied with its performance? Additionally, as we consider the future retail opportunity with the changes in advice, do you plan to capture that through the joint venture, or will you focus more on Lloyds' standalone products like the Ready-Made Investments suite you referred to? In relation to your targets for next year, while I understand you don't want to provide guidance beyond that, your reiterated guidance suggests over 15% RoTE consensus. This seems to be quite far from the cost-to-income target of below 50%. Even accounting for a bit of Motor Finance in next year's consensus, it would still be around 51%. So, is there something the consensus is missing regarding how the targets align, or is it that you're concentrating more on RoTE rather than the cost-to-income ratio? In light of this, I wonder if consensus is correct in anticipating a 9.8% figure for next year's cost number?

Charlie Nunn, CEO

Thanks, Chris. I'll take the first question and discuss the second one briefly, but William will provide his perspective on that. Regarding the wealth segment, we're pleased with SPW as it is performing well compared to the market. Although it's not a significant part of our overall revenue, it holds great importance for customers seeking full-service advice. We've been enhancing the transition for customers along with the support from our retail and BCB businesses, and we plan to keep improving that. You raised an excellent question, Chris. When we consider the targeted advice and expanding wealth advice to a broader retail audience in the U.K., we believe it will primarily focus on digital-first journeys. Due to the regulations, it won't be a complete advice journey because charging full fees wouldn't align with serving customers who are investing smaller amounts, like GBP 5,000 to GBP 20,000. As you know, advice in the industry typically costs around GBP 1,000 to GBP 2,000, depending on its complexity. We see our Ready-Made Investments journey and broader digital initiatives as vital in this area, along with our efforts with the FCA on regulatory frameworks to support this new form of guidance and advice. Looking ahead, our advancements in generative AI should be very beneficial in providing personalized, relevant advice tailored to individuals' financial situations for safe investments. This is where we anticipate growth. William, feel free to add your thoughts on what I mentioned with Jason.

William Leon Chalmers, CFO

Thank you, Charlie, and thank you for the question, Chris. To start, we anticipate achieving all our guidance for next year. This includes our return on tangible equity guidance, capital guidance, and cost-to-income ratio guidance. I want to emphasize that we expect to meet these targets, albeit with the cost-to-income ratio being a close call. We will ensure we achieve this. Regarding the factors at play, I don't believe the market is overlooking anything, but I would like to share a few insights from our perspective. Referring back to our year-end results from last year, we provided graphics that illustrated our expectations for income growth and cost stabilization. To expand on this, we forecast a stable macro environment, consistent with the figures we've released today, which is a crucial foundation. Accordingly, we expect interest income to grow, particularly due to the strength of our structural hedge. We also anticipate specific headwinds, notably from mortgages, which are predictable in their progression through '26. The deposit churn is expected to persist, but we believe it will moderate as base rates decline. These structural elements will impact our net interest income. Additionally, through a combination of business-as-usual activities and the advantages of strategic investments, we foresee volume increases. We've discussed AIEAs during this call, but there are also volume increases driven by liability management and capital-light initiatives across our related businesses, including OOI within CIB and various efforts in investments and workplace pensions within insurance. Many of these initiatives are currently maturing, as noted by Charlie, with general insurance income increasing by 35% year-to-date net of claims. This is part of several initiatives in the insurance sector that are continuing to grow into '25 and '26. Moreover, we will benefit from operational leverage gained through a flatter cost base, though I won't confirm or deny the specific figure you mentioned, Chris. However, it should give you an idea of the flatter cost expectations we are incorporating. Finally, our improved returns will come from a higher tangible net asset value. We expect TNAV to increase as part of this overall strategy. It’s important to clarify that this is not about generating higher returns from a flat TNAV; rather, it’s about achieving stronger returns from a significantly higher TNAV. This supports our confidence in achieving greater than 15% return on tangible equity, and reinforces our commitment to meeting our cost-to-income ratio target, which we will ensure we deliver on.

Operator, Operator

As you know, this call is scheduled for 90 minutes, and we have now reached the end of the allotted time. So this is the last question we have time for this morning. If you have any further questions, please contact the Lloyds Investor Relations team. Our final caller is Sheel Shah from JPMorgan.

Sheel Shah, Analyst

It's actually a follow-up to the first question that was asked on the deposit outlook. We've seen some recent policy announcements focusing on the savings gap in the U.K., which I think presents a bit of a risk to deposit flows on the front book going forward, but possibly on the back book as well. I know you've previously said that you expect the LDR to rise from current levels of around 95% to above 100%. But I'm just wondering how you're thinking about the outlook for liabilities and funding going forward. Does this change the outlook for deposit growth that you previously had in your forecast?

William Leon Chalmers, CFO

Thank you for your question, Sheel. I will start with some insights before passing it to Charlie, as your question touches on both financial and strategic aspects. You inquired about the recent encouragement toward investments mentioned in the Mansion House speech and its potential impact on our funding and deposit flows moving forward. As noted, we have experienced robust deposit growth in the first half of this year, and we anticipate this trend to continue in the second half. Our loan-to-deposit ratio currently stands at 95%, providing ample room for ongoing asset growth and supporting our expectations for the second half of 2025 and into 2026. The strength of our deposit franchise spans personal current accounts, instant access accounts, and fixed-term savings. I believe that any encouragement to invest will not undermine our overall deposit base, which is likely to remain strong due to the solidity of our franchise, brands, product offerings, branch network, and customer base. However, it's worth noting that if individuals are prompted to diversify their investments, it may primarily affect those who would have opted for cash fixed-term savings, which tend to have lower margins within our deposit base. If these individuals do move into investments, we could see a potential margin improvement from this shift. As a bancassurer with a combined cash and investment offering, we would be pleased to accommodate this transition. Now, I will turn it over to Charlie for further strategic insights.

Charlie Nunn, CEO

Thank you, William. You've highlighted some key points. There are several markets globally that have matured in this area, and from them, we can draw two important insights. Firstly, it’s crucial to be the provider for customers whether their funds are in cash or equities, and whether they're in tax wrappers, pension solutions, or self-directed platforms. Being there for customers and meeting their needs is vital for building sustainable profitability at Lloyds Banking Group. What excites us is our unique position in the U.K. to offer these services. The second point William made is also critical: if we succeed, we will likely be taking lower value deposits and directing them into investments or equities. While this may vary by the customer and the economic cycle, it’s a logical starting point. It’s important to note that I hope these changes happen quickly, but based on my experience in other markets, it may take a few years. I hope we can foster broader confidence in the U.K. for investing in risk-based assets, which would benefit everyone, including those on this call. This process won’t happen overnight; it requires time to build confidence and for people to make informed decisions. Typically, customers begin by investing a smaller portion of their wealth before committing more. Therefore, it's essential to promote good savings habits and provide solutions to support them. This ties back to our earlier discussions about enhancing digital engagement, building a strong brand, and creating straightforward ways for customers to access and adjust their portfolios. It’s a significant development, but I don’t expect it to have an immediate impact. We are well-positioned to take advantage of these opportunities.

William Leon Chalmers, CFO

I think that may be the last question. So just to say thank you to everybody for participating and for your questions this morning. I hope you found it a useful session and have an enjoyable summer.

Charlie Nunn, CEO

Thanks, everyone.

Operator, Operator

This concludes today's call. There will be a replay of the call and webcast available on the Lloyds Banking Group website. Thank you for participating. You may now disconnect your lines.