I think let's get started. It's a great pleasure to introduce our next speaker, William Chalmers, Chief Financial Officer of Lloyds, a role he has held since 2019. Prior to this, William held various roles across financial services, including Co-Head of the Global Financial Institutions Group at Morgan Stanley. William, thank you for joining us.
Thank you for having me. Pleasure to be here.
Brilliant. Let's dive right in with the macro.
Sure.
How are you finding the backdrop for the U.K. currently in terms of how it's evolving, and if there have been any changes in client behavior over the past few months?
Yeah, yeah. Thanks for the question, Ben. We'll put forward our numbers as usual at Q2 in terms of the macroeconomic backdrop and the update on our forecasts. I suspect the picture will be one of more or less of stability versus Q1. What do I mean by that? When we look at our Q1 base case, we expected GDP to play out at about 0.8% over the course of this year, HPI about 1.7% positive, about 4.7% unemployment, and one further bank base rate change down to 4%. When we look at that now, there was obviously some slightly weak GDP news out this morning, but nonetheless, before that at least, GDP was probably tracking up a little bit ahead of our expectations. Unemployment payroll reports, probably a little bit of weakness, HPI perhaps a little bit stronger.
Bank base rate seems to be kind of going up and down depending upon the news as to GDP or payrolls, for example. We will see where that goes. These are kind of changes around the margin, I suppose, around the edge, and therefore the picture will be more or less one of stability is my expectation. The client behaviors overall, I think, have been very benign, really. You know, that is to say, when we look at it from the asset quality point of view, retail has been stable, even improving over the course of the second quarter. Commercial banking has been very benign. As per quarter one, there is one or two idiosyncratic risks. We talked about fiber, for example, at quarter one, but those are idiosyncratic.
They're not, if you like, forebearers of a broader deterioration at all, at least nothing that we're seeing at all. You know, overall, from an asset quality point of view, that looks very supportive. We had a GBP 100 million tariff overlay at the first quarter, as people will have seen. I think that's probably come out of the better end of our expectations. We will look to kind of integrate stroke release that in quarter two. As said, it's coming out probably slightly better than we'd expected. I think looking at that there for information, asset quality, it all looks very benign. I think where the volatility may be having an effect, Ben, is in levels of activity.
If you look at levels of activity amongst the retail client base, likewise levels of activity amongst the commercial client base, it's perhaps not quite as strong as it might be in a more fertile, more productive macroeconomic climate. That's where I think you may see some impact of volatility rather than anything more significant than that.
Okay. If we pivot to Lloyds and the strategy there, 2024 marks the completion of the first chapter of your strategic plan with further profitability and efficiency improvements targeted to 2026. As you look back and reflect on how the group strategy is currently progressing, what would you sort of call out?
Yeah, yeah. Yeah, thanks, Ben. It's the strategy that we launched in 2022 hit its first major milestone in respect of the close of 2024, as you know. That is chapter one. It's all in pursuit of higher, more sustainable returns for our shareholders as we look forward. Within that, we've got revenue growth and diversification ambitions. That's the growth part of the strategy. We've got cost and capital efficiency ambitions. That's the focus part of the strategy. And then we've got enhancing our enablers, which is basically people, data, technology. That's the change part of the strategy. So that's what's delivering it ultimately, our higher and more sustainable return expectations. Overall, I think the account that we gave of ourselves up until 2024 was, you know, hopefully pretty good.
That is to say, we delivered on about 80% of our 25 external metrics or KPIs from a strategic point of view. Likewise, financially, we delivered on the around GBP 8.8 billion in terms of strategic initiative incremental revenues that we expect to see. So strategically and financially, I think we did pretty much most of what we expected to do for that first chapter of the strategy. Now, looking forward for 2024 through 2026, we expect to accelerate our ambitions, which is a combination of effectively finishing off that which we did not complete up until 2024 and then extending thereafter. So what do we mean by that? We're looking at things in retail, for example, within depth of relationship. Likewise, the mass affluent, we recently launched a premier proposition. Within BCB, it's about transaction banking and working capital. Within CIB, it's about OOI.
We got to close of 2024, and OOI was circa 30% in excess of what it was in 2021. We've now set the target for 2026 being in excess of 45% greater than it was in 2021. This is about, if you like, completion and about extension. Alongside of that, when we get to 2026, that GBP 0.8 billion that I mentioned for incremental strategic initiative revenues, that should have grown to in excess of GBP 1.5 billion strategic initiative revenues. That is the ambition. You are familiar with our kind of higher level, if you like, ambitions around sub 50% cost income ratio, around greater than 15% ROT ambition, around greater than 200 basis points capital generation ambition, all of which we absolutely stand by and have a lot of confidence in achieving. That is the 2026 record. Overall, I think it has been good progress.
We have a lot of confidence in what we can do going forward, but there's obviously a lot of work to do.
Brilliant. Let's dive into the businesses a bit more specifically. You mentioned retail. You have, you know, roughly 20% market share in mortgages there. You posted pretty broad growth across both deposits and loans in Q1. What are the key points you're focusing on looking ahead from here for retail?
Yeah, good question. I mean, the retail business is obviously tremendously important to us. It is the bulk of our activity within the group and a very attractive proposition from a customer point of view and also from a shareholder point of view. The retail performance, as you say, Ben, has been strong. I mean, if you look at the quarter one numbers, we showed about GBP 7.1 billion lending growth. We showed about GBP 5 billion deposit growth during that quarter. Now, to be clear, it is our expectation that some of that was pulled forward, particularly on the mortgage front. There was some evidence of people looking to get mortgages completed, for example, before stamp duty changes came in.
Therefore, you should expect to see continued growth in quarter two for sure, but it will not necessarily be at the pace in the mortgage product, for example, that we saw at quarter one simply because of that pull forward factor taking place. Strategically in the retail business, we're looking to deliver on three things, I suppose. One is taking advantage of our scale so that we deliver competitive customer propositions. You'll see that evidenced in a variety of areas, but I mentioned depth of relationship a little bit ago. That's one manifestation of that. You'll also see it evidenced in terms of things like increased proportion of direct from bank mortgages. You'll see it evidenced in linking up of PCAs and mortgages in the same way.
This is about basically building off the back of our scale franchise and delivering the benefits of that to customers and ultimately, of course, to shareholders. The second area of focus is about growing in high value areas. I mentioned the launch of the premier proposition just a second ago. That is in connection with our ambition to increase mass affluent balances by more than 10% over the 2024-2026 period, a key part of it. The third part of it is around new propositions. We've talked before about our embedded finance proposition, which is labeled FlexPay. We talked before about our transportation ecosystem. This is about enhancing our proposition development with customers in pursuit of our broader ambitions from a franchise and ultimately return point of view.
All of that is then underpinned by strengthening of the distribution, by which I mean in particular, obviously, the mobile proposition. We had in excess of GBP 6 billion transactions conducted on, or logons, I should say, in the course of 2024. The ambition for 2025 and 2026 is to build out that mobile proposition, both in terms of its inherent capabilities and also in terms of its franchise reach, most notably insurance, pensions, and investments as an example of that, where we're looking to make the bank insurance link much, much tighter and much, much more effective.
Let's pick up on that final point on the insurance, pensions, and investments. You have a growing workplace franchise. You've discussed increasing your protection market share as well. I mean, what do you think is the sort of key signposts on the evolution of that business over the medium term?
Yeah, yeah. It's an important business for us, clearly. I mean, the key signposts at a very direct level and those that clearly matter to shareholders, I think, are being manifested in the context of OOI contribution from insurance, which was up 8% year on year in quarter one. Likewise, within that, there are specific components that are performing particularly well. General insurance, net of claims income, up 38% year on year in quarter one. Those, I think, Ben, are the kind of direct manifestations, if you like, of performance. What's going on beneath that? What's driving that performance? I think three or four points that I would make. One is about market share gains. We've re-engineered the intermediary platform. Likewise, we've re-engineered effectively the digital platform within general insurance.
This has been a material driver of market share gains within important areas to us, either intermediaries or in the context of direct relationships, GI. That's one. The second one is I mentioned the bank insurance relationship just a second ago. That is key. There's no point in us owning an insurance company and a bank under the same holding company unless we can actually make the two work together. So what are examples of that? One is take-up rate in the context of mortgages. Where a customer takes out a mortgage with us, we've now managed to double in the last two years the take-up rate of a protection product alongside of that. In terms of specific numbers, 2023 take-up rate protection with mortgages circa 7%. Now take-up rate in excess of 15%. Frankly, we think we've got a lot further to go in that respect.
You should hold us to a higher standard in that respect, and that's what we expect to deliver. Similar point, really, in terms of connecting the two. The workplace pensions product is an operating leverage product. That is to say, the more scale you get, it drops through to the bottom line. We've now got CIB working together with the workplace pensions proposition such that CIB is a major distributor for workplace pensions going forward. There's more that we can do for sure, but these are examples of where we're trying to get the two businesses to work much more effectively. That's the second big driver for our performance in this area. I think the third one is pretty mechanical, I suppose, for want of a better word, which is the unwind of the CSM, the contractual service margin, which is the IFRS 17 now standard.
My colleagues at insurance describe it as deferred profit, which hopefully gives you an idea as to where they're coming from. Nonetheless, this is a relatively mechanical unwind and indeed is contributing to growth and performance, strength and performance within IP&I. It's about one third of the overall OOI that is coming from insurance stemming from that CSM point. What we're looking for going forward is strategic focus from this business. Workplace savings or rather investments, I should say, general insurance, enhancing the franchise in a way that I just described. That's where the business is strategically focused. You should expect to see growth in earnings. You should expect to see it being manifested in terms of market metrics. We've set an ambition, top three protection advisor, for example.
We've set an ambition, Scottish Widows app being engaged with by more than 1.5 million of our customers, for example. We set an ambition of scale and operating leverage in workplace per my earlier comments, for example, where we've now got in excess of GBP 100 billion in assets. These are the kind of outward manifestations of market impact, which in turn lead to the expected growth that we want to see in other operating income from this business.
Okay. If we pivot next to commercial banking, Lloyds is a leader in U.K. infrastructure and project finance and has building momentum in other operating income more broadly. What do you see as the key strengths of that business and what are your main objectives for it as you look ahead?
Yeah, yeah. It's a third of our businesses, not necessarily in that particular order, but commercial banking is a really important area for us. The way that we see it is that it is completely consistent with our purpose, the help bring prosper purpose. It is one that allows us to make strategic and financial progress off the back of broadening the proposition. In line with that, it is one that should offer us and does offer us really quite attractive financial returns. It kind of fits from a purpose, strategy, financial perspective. As you know, we split our commercial banking business into two components, Ben. The first of which is CIB. Now, to be clear, we're never going to be a Goldman Sachs and nor do we aspire to. Actually, our competitive advantages in that area, I think, rest upon that distinction.
If I think about what is it about CIB that is a strength, that is a strategic advantage that gives us a kind of a right to succeed, if you like, the first one is strategic focus. When we set out with CIB in 2022 and we laid out the strategy, we specifically focused the business on cash, debt, risk. That's it. We're not going to aim to do anything else. We're not going to aim to do many of the areas that the larger investment banks do. It is that cash, debt, risk focus that is a discipline for the business. Alongside of that, you get the benefit of the group resources. You get the benefit of the group brand. You get the benefit of the group breadth of products. I just mentioned workplace in the context of the IP&I linkage.
These are material benefits, if you like, that strengthen the backbone of the CIB business. The third, and obviously most importantly to people like me, is around capital discipline. Capital discipline is incredibly important for us in the context of CIB simply because it is an area that historically has led to an erosion in returns or at least been at risk of that. We're determined not to allow that to happen. How have we seen it happen? We've seen it happen off the back of improved OOI growth, 30% OOI growth since 2021, 45% ambition by 2026. We've done that in the context of pretty strict RWA discipline. RWAs expanded, but only by about GBP 3 billion in the context of that OOI growth within CIB. That has allowed it to steadily improve its returns on capital going forward.
Now, looking forward, we expect income over RWAs to hit 5.25% by 2026. That's the metric that we've got out there, which you'll have all seen. That comes off the back of 3% for the same metric in 2021. Therefore, that's pretty material improvement over that time. It gives us confidence that the returns trajectory is going to consistently be in excess of cost of capital. That's where we want the business to be. The final point that I think is a strategic strength for this is around building of propositions. Our propositions have typically been quite narrow, probably achieving less leverage than we might otherwise be able to do so. Building out things like transaction banking, things like FX, things like DCM capabilities, these are well within our grasp. Indeed, that is a key, that is a part of the strategic strength.
That is the CIB picture. The BCB picture, the strategy there is to be a digitally led relationship bank, which is a bit of a mouthful, but you get the two key points, which is to say digital leadership number one, backed up by relationship banking where it matters number two. What are the strengths there? Naturally, digital capabilities. Mobile onboarding, for example, is now 15 x faster than it was when we took the strategy forward in 2022. The franchise, we have relationship managers up and down the country. That is indeed what you would expect of us, and that is what we have, and we aim to build on that. Finally, product breadth. You know, that is to say we have been developing transaction banking capabilities. We have been developing deposit propositions, likewise working capital capabilities.
It consistently borrows off of the CIB stable of products as well. That product breadth is a key part of it. Where does that take us financially? I think, number one, this is an attractive return business. I mean, we want to succeed in this business because it is and always has been and always will be an attractive return business. Secondly, some of those of you who follow us closely will have seen we've actually been stalling slightly on the lending front in this. That is because government-backed lending repayments have exceeded new lending in some of the areas that we're trying to grow in. That is now starting to inflect. We're starting to see the lending picture plateauing over the course of this year as government repayments taper off and as the lending that we're trying to do continues.
That is a good balance sheet picture to see, albeit to be clear, we are at the beginnings of it and we would like to see, you know, some pace injected into that going forward. Those are the financial manifestations of the strategy, if you like, Ben.
Very ample color. Let's wrap it all together and think through the P&L. NII, you're targeting around GBP 13.5 billion in 2025. Could you talk through some of the moving parts there and what gives you confidence in achieving it?
Yeah, absolutely. Of course, a critically important part of our P&L. The GBP 13.5 billion in 2025 shows decent growth over the course of 2024, as you know, about 6% over GBP 12.8 billion in 2024. The big moving pieces of that, and you have heard us talk about this before, net interest margin expected to increase over the course of this year. AIA is expected to show solid growth over the course of this year. Then non-banking net interest income, which is basically the fuel, or at least part of the fuel for expansion in other operating income, expected to grow this year, but not at the same pace, i.e., at a slower pace versus 2024. Those are the three big pieces. If you will forgive me, just to tackle each of those pieces in order.
Net interest margin, as said, expected to increase kind of resolutely, if you like, over the course of this year, pretty much in every quarter. It will change in its pace. Last quarter, we had a six basis point increase. This quarter will be slightly less, but it will still be an increase. We do expect that increase to continue in its patterns. Again, some quarters being bigger than others in terms of the jump up in net interest margin. What is going on behind that? It is the three big moving pieces that we have talked to the market about a lot before. Structural hedge, first of all, GBP 4.2 billion in 2024, GBP 1.2 billion growth over the course of this year, as maturities refinance and as deposit volumes are at least stable and ideally actually improving slightly over the course of this year in terms of their hedge eligibility.
That's the structural hedge piece, which is a strong tailwind for net interest margin this year, stronger tailwind over the course of next year and indeed continues to be part of the pattern in the years thereafter. Mortgages headwind, again, pretty mechanical, but mortgages were coming off the balance sheet at about a percentage point, i.e., the yield on the mortgages during the course of Q1. They were coming on the balance sheet at about 70 basis points, i.e., that's our completion margin in Q1. That headwind continues to play itself out over the course of this year. It actually starts to taper during the course of this year. By the time we get to the middle of next, it's kind of more or less extinguished. Overall, it's a continued headwind for the course of this year and therefore is a factor.
Deposits, two factors to bear in mind there. One is churn. We've had a pretty strong ISA season actually over the course of quarter two, which has been a contributory factor to that churn. The second is bank base rate reductions. Bank base rate reductions, as many of you will know, effectively have a lag effect in terms of our ability to pass those on to the market. Now, we've been doing a lot to actually reduce that lag effect through management of terms and conditions of deposits. That has been successful, and it's reduced our negative interest rate sensitivity, which is great. Nonetheless, that deposit movement, churn and bank base rate lag effects, that's a headwind for the course of this year.
It will taper out as we go through the year, and it will taper out certainly into next, but it will be a headwind for what it's worth. That's the margin picture. As said, kind of resolute and robust improvements right the way through this year. Some quarters bigger than others in terms of the specifics as to the margin improvement. AIAs, solid growth, I think, over the course of this year. When you look at our AIAs in quarter one, GBP 455.5 billion, those were decent. They were going to then be caught up by the significant lending that I mentioned in the course of quarter one, the GBP 7.1 billion. The new lending in the course of quarter two, the activity point that I mentioned earlier on, is still fine.
It's still pretty decent growth, but it's not at the pace of quarter one for the reasons that I mentioned around catch-up relating to stamp duty and the like. AIA is showing solid growth, but again, quarterly strength coming off the back of Q1 lending and an ebb and flow depending upon our patterns of new lending during the course of the year. Finally, non-banking net interest income. You should, although it's a negative number in our net interest income makeup, you should want non-banking net interest income to grow because it is a support for other operating income. What we'll see during the course of this year is growth, but actually most of that growth coming from volume as opposed to from rates. That's obviously a good thing because it fuels insurance, pensions, and investments. It fuels corporate banking.
It fuels, again, the vehicle business, the transportation business. This is all delivering our ROI growth patterns. As said, more a volume story than a rate story and at a slower pace of growth versus 2024. I think, Ben, when we look at that, to be clear, we feel pretty good about our circa GBP 13.5 billion net interest income guidance this year. As always, there are risks around things like customer activity and behaviors. There are risks around competition, I suppose. There are risks around rapid bank base rate reductions. Actually, we stand back and we say all of those risks notwithstanding, we feel pretty good about that GBP 13.5 billion over the course of the year and feel able to cope with any of the issues, if you like, or risks that the market might throw at us.
Very clear. Let's shift to other income. You've seen pretty strong growth there with Q1 up 8% year on year. Yeah, we've touched on some of the strategic initiatives across the various businesses. If we wrap that together and think about the trajectory for revenues moving forward beyond just NII.
Yeah, really important area for us. Just take a step back. I think as everyone in this room knows, our strategy is effectively to diversify from net interest income dependency. Net interest income is great, but on the other hand, you do not want to be solely dependent upon it. Our strategy is very much to diversify and thereby do that through other operating income in pursuit of that higher and more sustainable return ambition that I have talked about. That is what the strategy is all about. That is why we have had significant incremental investments over the course of this strategic period in basically OOI generating activities. It is also why by the time we get to 2026, you should expect to see about 50% of that incremental GBP 1.5 billion of strategic initiative revenue that I mentioned earlier on landing in the OOI space.
That is in contrast to the OOI share of our P&L makeup right now, which is more like 25%. You can see we're disproportionately weighting investments towards OOI generation, which in turn will disproportionately weight revenues towards OOI balance. That is very deliberate. You mentioned growth, and we would expect growth. We obviously hold the investments to pretty strict return disciplines. We've seen growth within OOI over the course of 2024 of 9%. We've seen it in quarter one of this year of 8%. We expect that to see a continuation of that pattern over the course of 2025. To be clear, it'll ebb and flow a bit in component parts over the course of any given quarter. Right now, I think in common with many banks, we're seeing slightly slower growth in CIB, other operating income, for example.
That's coming off the back of slightly slower markets. You are going to see that in any given quarter. What do you think, Ben?
Clearly, Berlin doesn't like other operating income, but I'm not entirely sure.
Is it this room or is it hotel-wide, do you think?
Okay, relieving to know there's no fire, but okay.
Are we carrying on?
I think we carry on, but.
If you're all brave enough, I'm brave enough. Up to you.
Let's hope the noise stops fairly shortly.
Okay. If you don't mind, I'll just take over the noise and we'll get on with it. Yeah, it'll ebb and flow with respect to component parts within any given quarter. Overall, we have a lot of confidence in this trajectory. It's sort of petering out, isn't it? One of the reasons why we have confidence in this overall trajectory is the fact that it's very broad-based. You'll have heard us talk before, for example, about the strength within retail, transportation, and cards as two drivers within that business. You'll have heard us talk before about commercial markets and transaction banking, for example. Likewise, around insurance, I mentioned GI a second ago, likewise the unwind of the CSM.
Finally, a business that we call Lloyds Banking Group Investments, which is basically the equity investments parts of the business, LDC, Lloyds Development Capital, alongside Lloyds Living, the home ownership rental business that we run. That means that the OOI streams are relatively broadly based, which gives us comfort, if you like, and confidence in the OOI trajectory going forward. That is where we stand on OOI, key part of our strategic story, delivering financially, and we expect it to continue to be the pattern as we look forward.
Brilliant, brilliant. Okay. Costs hopefully won't trigger another alarm. But you target around GBP 9.7 billion this year. That implies something around a 3% increase. Could you run us through the moving parts there, particularly as you're looking forward to a sub 50% cost income ratio in 2026 and how you're balancing investments and inflationary pressures?
Yes, absolutely. Absolutely no cause for alarm on costs. I hope that is testified to by the fact that our track record on costs has been pretty good. That is to say, when we set out a target, we deliver on it. That is the expectation for the GBP 9.7 billion that you mentioned this year. That is what we will do. A couple of comments to make in respect to that GBP 9.7 billion, first of all. That GBP 9.7 billion is up 3% on last year. If you strip out national insurance, it is actually up 2% on last year, which gives you a better idea, if you like, of the run rate. There are a couple of different things going on within that overall cost trajectory, that dynamic. I will just go through them. First of all is investment.
You expect us to, off the back of what we've said, but also in the interest of securing a long-term success of the bank, to continue with investments. That's exactly what we're doing. That's driver number one. Driver number two is volume increases. We talked just a second ago about OOI, likewise net interest income generating activity. Those are driving volume increases. It's kind of healthy cost growth, if you like. Of course, there's inflation, which we're all having to deal with. It's ebbing away a little bit versus what it was, but it's still a factor. The fourth driver then is efficiencies, which are significantly eating into inflation and volume-led cost increases. Those are coming off the back of investments. They're coming off the back of BCB measures.
It is a roll forward effectively of the GBP 1.2 billion in gross cost saves that we achieved in 2024. We expect that to tick up by another circa GBP 500 million over the course of this year. It is allowing us to attack the sources, attack rather the sources of cost growth. I'll carry on if that's okay. When you look at quarter one, quarter one costs were GBP 2.55 billion. That is up 6% year on year. You might ask, how does that fit with our overall 3% up over the course of this year? The reason for that is because that GBP 2.55 billion was influenced by front-loading of severance costs.
If you strip out that front-loading of severance costs, which are quite material, about GBP 80 million of incremental front-loading versus what it was quarter one of last year, then the underlying cost increase was more like 3%. Therefore, you can reconcile it with the overall cost expectation for increases this year. Once you strip out that front-loading of severance costs, it will not be the same in quarter two. I'm glad there's a bit of humor in this discussion. It hopefully makes it more lively. The cost saves, three or four points within cost saves that are worth mentioning. Where are we getting these cost saves from? In summary, strategic investments, a big part of our program is not just to generate income, but also to generate cost saves. Property, for example, technology, for example. That's point one, strategic investments. Point two, change-driven saves.
We've got a huge change agenda. We're trying to make that change agenda progressively cheaper to achieve any given unit of change. One example of that is that we've opened Lloyds Technology Center in Hyderabad in India. That offers us more capability at lower cost versus the historic alternatives and therefore reduced cost of change as a second big driver of cost saves. Third is our usual stuff, you know, third-party management, matrix management, what I'd describe as BAU cost saves. The fourth bucket is basically other. By other, I mean productivity changes, which is people like me saying to their teams, look, I want you to deliver the same for, let's say, one or two FTEs lower than what you did last year. That type of routine productivity change.
Finally, the bucket of other also encompasses things like defined benefits where we've been saving a bit of money off the back of basically assumption changes. Nothing more exciting than that. It is those four components that are delivering the cost saves that we expect to see over the course of this year and indeed into next. Ben, to link it up to your question there on cost income ratio, it is the roll forward of those types of cost saves as mentioned, the GBP 1.2 billion in 2024, further GBP 500 million this year, and then going into next year, which allows us to deliver a cost base, which is not flat, but it is flatter in terms of its trajectory going into 2026 than it has been in recent years.
You add that to the income generation that I've described, both at net interest income level and at the other operating income level. You see those two together give us significant operating leverage, which in turn gives us confidence to getting just below the 50% mark for our cost income ratio in 2026. To be clear, it isn't going to be below by much, but it will be below.
Brilliant. I think we should open up audience Q&A very soon. Just one final question before we do, asset quality. Your guidance is roughly 25 basis points this year. What factors do you see driving that? How do you judge the quality of the loan book overall at the moment?
Yeah, yeah. You know, in two words, perhaps, pretty good, Ben, would be the way I'd summarize it. Now, you know, what do I mean by that? What I mean by that is that asset quality has been very strong and consistently so across retail and across commercial banking for some time. If anything, the trajectory, the direction of travel in Q1 and indeed in Q2 so far is at the margin a little bit of improvement. It's not by much because it's already pretty good, but it's a little bit of improvement. Now, specifically, what's driving that? I think there's effectively a strong franchise, a low risk appetite, and despite this morning's soft news, a pretty stable macro. You know, it's those three things that effectively are delivering that asset quality outcome. AQR in quarter one, 27 basis points.
That is driven by, as many of you will have seen, by effectively an MES charge that we took in the context of tariff volatility. If you strip that out, it is more like 24 basis points. I mentioned earlier on that we will be looking to kind of integrate stroke release that point over the course of quarter two. Stripping out that tariff-related overlay, 24 basis points, which is basically consistent with our full year guidance. Interestingly enough, if you actually take a closer look at the numbers and you say, actually Q4 retail benefited from some model calibrations, which is kind of technical Q4, sorry, quarterly visitation that we do. If you strip that out, the direction of travel underlying in retail was more benign going into quarter one.
Likewise, if you strip out fiber from commercial, which is effectively a function of government policy around implementation of the fiber network in the U.K., if you strip that out, the direction of travel in commercial likewise is improvement in Q1. This is what I mean by the underlying being benign stroke improving over the course of quarter four into Q1. Indeed, we've seen that direction of travel basically be maintained going into quarter two. Looking forward, new to arrears, again, stable to down, down in mortgages, for example, but you know, really very benign in the course in the context of the retail business. Stage three within commercial, strip out fiber, very flat, nothing going on that we can detect. All looking pretty good.
The early warning indicators, you know, whether that is things like cards, minimum repayment levels, whether that is things like working capital utilization or liquidity within the BCB book, very, very benign. Nothing that we're seeing that causes us any cause for concern, if you like. I do think that's off the back of a decent book. Strong foundations, you know, mortgages, we're lending to people with in excess of GBP 80,000 household income. Unsecured, we're lending to people with on average GBP 45,000 income. LTVs within mortgages, 43%. Over 70% now of our mortgage customers are paying a rate in excess of 3%. So they've all, not all, but they have three quarters normalized for the high rate environment that we're in with no detectable sign of increases in arrears. In fact, if anything, quite the reverse.
Some strong foundations, and that's all built off of a very well-provisioned book, as you know, the ECL of GBP 3.75 billion, which is actually higher like for like than it was pre-pandemic. Ben, when we look at the AQR and more importantly, everything that's going on behind the AQR, we feel really comfortable.
Brilliant. Let's see if there are any questions from the audience. Okay. Maybe two, if we can take them quite quickly. Conscious we have 29 seconds left.
No, but you can't be alarmed, Ben.
Unfortunately, I have two questions, if possible. The first one is, could you describe a bit the benefits of removing reinforced banks for clients and for bank? The second one is about your comment of opening some IT center in India. Yeah, just theoretically speaking, isn't it a bit against your Lloyds Bank's ideal of help U.K. prosperity or growth?
Yeah. Can I just make sure I understood the first question before you?
In terms of a reinforced bank, removing this structure, what's the benefits for your clients?
Yeah, absolutely. Maybe just to deal with the second first and then come back to reinforced banks. No, I do not think it is inconsistent at all really with the Help Britain Prosper purpose of the bank. In fact, I think it is consistent with, because what we are doing is effectively complementing the U.K. setup, the U.K. workforce and skill set. We are able to access, as I say, a broad range of skills at efficient price points, which in turn helps us to deliver ultimately very competitive and I hope compelling customer propositions. It is that kind of breadth of capability that delivers better propositions. It is that efficiency that delivers, if you like, more keenly priced propositions. Again, it is complementary to the setup that we have in the U.K. I think we are really pleased with the developments there. We see it as totally consistent with the workforce.
In fact, the level of integration of the U.K. and the Indian setup is growing all the time. You know, to be clear, to an extent here, we're somewhat catching up with competitors, to be clear, but we see it completely compatible with the purpose. The reinforcing point is interesting. I mean, the debate on reinforcing is effectively to say, look, what we've seen since reinforcing was conceptualized and introduced is a significant change in terms of resolution and recovery, in terms of capital levels, liquidity levels, funding levels, in terms of derivative central clearing. These types of things have materially reduced the risk in the system and, of course, with respect to any individual bank. Therefore, it is only natural to reconsider what the role of reinforcing might be given that evolution.
Now, realistically, I think it is more likely that we see changes around the edges of reinforcing, such as the SCIA report introduced, and maybe, you know, one or two things that might go beyond that. That is helpful. You know, we will take that type of change. I think over the longer term, it is appropriate in the context of everything else that is going on or has gone on to have a debate about whether the reinforcing regime is still appropriate in that context. I think that is going to take time. You know, we are not looking at that to progress change or force change in the near term. It is more a longer-term picture. Ultimately, what will it help us deliver? It will be about reducing customer friction, giving us more strength, if you like, to deliver on what we are aiming to do.
Maybe quick fire.
Hi, William. I was wondering what your thoughts were on the outlook for U.K. deposit growth. As a second part of the question, specifically for Lloyds, I think you mentioned in your comments that you were talking about the stability of the deposits and that they were even improving in terms of hedge eligibility, I think you said. I just wondered if you could remind us what the sort of structural hedge capacity is and, you know, might we even, you know, see the notional start to grow again, which might add stability to future revenues.
Yeah, maybe a couple of points on deposits. Ben, I appreciate that we're coming up against time. In that context, a GBP 5 billion deposit increase in quarter one. We expect to see continued growth in deposits in quarter two. Two points to make around that. One is it will not necessarily be at the GBP 5 billion pace within retail at least. We may see a bit more strength actually in commercial banking. The retail pace, which is responsible for most of that GBP 5 billion, is not necessarily going to carry on at quite that pace in Q2, but growth to be sure.
The second point is that I think in the context of, you know, perhaps what the Chancellor said about potentially ending ISAs, as well as the market customers, that is, feeling that now's the time to get a fixed rate if you're going to before fixed rates start to come down. We've seen a strong ISA season, frankly. We've also seen terrific market share in that ISA season, which is brilliant. You know, we expect to see 20%+ market share in the ISA season. It is a slightly stronger ISA season than we'd expected, which in turn is what led me to make the comment earlier on about, you know, a little bit of churn going on there, which in turn is a non-hedge eligible deposit.
Now, where that leads us, I think, is for the hedge in territory that is very similar actually to where we were at the full year and at the quarter one. We do expect to see not just stability, but a pretty modest tick up in terms of hedge eligible deposits, which should enable us to build on volumes in the hedge as we go through the year. That remains our base case.
Brilliant. Thank you so much for joining us, William.
Pleasure. Thank you very much indeed for taking the time.