Risk Awards 2016
At the end of 2012, Lloyds Banking Group was feeling the heat. Just over 40% of the bank was still in the hands of the UK government, which had spent £20.5 billion bailing Lloyds out in 2008, and its performance remained dire: return on risk-weighted assets (RWAs) for its core business was 1.4%, with total RWAs of £125 billion, and non-core assets of £48 billion.
"When the strategy was looked at in 2012, it was clear we had a number of inherent strengths in our business. But we also identified some weaknesses. We were generating insufficient returns for shareholders, which also then questioned our ability to support clients throughout a business cycle. And we had legacy challenges from long-duration loans with fairly low margins," says Andrew Edwards, managing director, head of client asset management at Lloyds Bank Commercial Banking.
The bank made some promises: to push return on RWAs above 2% in 2015, in part by cutting core RWAs; but also to cut the capital consumed by the non-core business. Investors were told Lloyds would improve its capital discipline and get better at credit portfolio management.
The audience – inside the bank as well as out – was not convinced.
"There was scepticism about our ability to do this. It was considered to be very challenging internally, and there was a similar investor response. But I think it was well understood that it was vitally important we did this. No business can persist with a return on RWAs that doesn't meet the requirements of investors," says Edwards.
Despite the scepticism, Lloyds reached – and surpassed – its targets. In the first half of 2015, return on RWAs reached 2.29%, with core RWAs at £103 billion and non-core assets down almost four-fifths to under £10 billion.
But getting there was a challenge, requiring some fundamental changes in the way the CPM function interacted with the business, and the way the bank interacted with its clients.
I think it was well understood that it was vitally important we did this. No business can persist with a return on RWAs that doesn't meet the requirements of investors
Andrew Edwards, Lloyds Bank Commercial Banking
The first change was to the front end of the business, with control around approvals and pricing for new loans given to the client asset management team, via a committee structure. Most transactions are approved in the investment committee, which is chaired by client asset management; the function is also represented on the commitments committee, which considers the largest deals the bank handles, and is chaired by the chief executive officer of commercial banking. Smaller deals are also approved within the client asset management group, but using an intranet-based pricing tool called EPC+, which was launched in mid-2014.
The second – and more awkward – change was to look at every client and assess whether it was meeting Lloyds' new return requirements. This was based on qualitative criteria, as well as a set threshold the team is unwilling to disclose but says is aligned to meeting the 2% return-on-RWA target. If a client was not performing, it entered a review process during which client asset management would decide whether there was any way for returns to improve – or be ‘managed up'. If not, the client would instead be ‘managed out'.
"In some cases, the returns we were generating were not sufficient. So, we began a process, client by client, based on individual conversations between relationship directors and each client, to assess whether we could work with them to improve the returns. That led to us no longer doing business with a few clients. We followed a very rigorous process to do that, with a particular focus on our global corporate business," says Edwards.
In March 2014, Lloyds put 350 global corporate clients under review, of which 257 were placed on the ‘manage up' list, with the rest slated to be managed out. By the end of 2014, the stock of ‘manage up' clients was reduced to 138, while ‘manage out' was reduced to 53. In other words, in 119 cases, Lloyds found a way to get more business out of the client or otherwise improved returns, but the bank waved goodbye to 40 customers for which returns were not adequate.
Ending that business was accomplished in a number of ways. In most cases, it was agreed with clients that at the next refinancing date, the customer would refinance the trade with one of its other bankers. In a few cases, it was agreed that Lloyds could sell its share in a syndication to another willing participant, and some loans related to project finance were also sold – as the method of financing in those transactions means there is no ongoing banking relationship, says Edwards.
Edwards says he's proud of the way the bank managed to deal with a difficult situation.
"Had it been handled the wrong way, it would not have been good for clients or the bank. What was very important to us was if that decision was reached, we then undertook the exit of that client relationship very sensitively and carefully – and at no point would we put the client in any difficulty. That was something we were successful at," he says.
Overall, the number of clients from which the bank generates good returns has increased from 2,350 in 2012 to 2,850 in 2015, and RWAs allocated to those clients have grown from £11 billion to £18 billion. Clients with weak returns have been cut from 1,700 in 2012 to 1,250 in 2015 – and RWAs allocated to that segment of the business have dropped from £53 billion to £32 billion.
Our experience with the team has been very positive. They've been on a journey over the past three years, and this year we've really been bearing fruit
Jon Howarth, Lloyds
The process required good teamwork between client asset management and the global corporates business – both to ensure the bank had a better understanding of client performance and to increase returns. The head of capital for the business praises the risk managers.
"Our experience with the team has been very positive. They've been on a journey over the past three years, and this year we've really been bearing fruit – both in the quality of the underlying management information system and in terms of greater sophistication that we can bring to assessing where the profitability on our clients is," says Jon Howarth, global head of capital management for global corporates at Lloyds in London.
In the non-core portfolio, cuts have been achieved either by refinancing or restructuring the bank's positions, or by selling parts of the portfolio. In August 2015, client asset management was involved in disposing of almost the entirety of the bank's wholesale banking portfolio in Ireland. Approximately 1,750 Irish small and medium-sized enterprise (SME) commercial real-estate clients, with facilities relating to 3,500 properties were sold. The deal resulted in a £0.5 billion reduction in net external assets.
As a capital management tool, the commercial banking division has also tried to more actively transfer risk. Scottish Widows, the pension fund and insurance provider, is a Lloyds subsidiary that needs long-term assets to match its long-term liabilities. Lloyds therefore sells some of its existing loans or assets to the insurance division of Scottish Widows. In some cases, the bank will source new loans specifically for sale to the insurance division.
Lloyds has also completed a total of three first-loss risk-transfer trades – the most recent on December 11, 2015 – on portfolios of social housing, global corporates and SME commercial real-estate loans. The aggregate notional value of those three trades totals £4.4 billion.
"What's important about this is it enables us to manage our capital position and improve our returns, but it also means investor clients are able to get exposure to risk that we're able to originate and which is attractive to them – and it enables us to maintain the client relationships," says Edwards.