Group Chief Financial Officer's review

The Group delivered a strong performance in the first quarter of 2021

Summary of financial performance

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Change is the basis points (bps) difference between the two periods rather than the percentage change

3 Not meaningful

The Group delivered a strong performance in the first quarter of 2021 with underlying profit before tax improving 18 per cent.  Positive business momentum, very low credit impairment charges and operating cost efficiencies more than offset the impact of lower interest rates, a $305 million reduction in the debit valuation adjustment (DVA) and increased investment. Income declined 3 per cent excluding DVA and on a constant currency basis, with a record performance in Wealth Management as well as 4 per cent growth in Loans and Advances to Customers in the quarter nearly offsetting the impact of a 30 basis point decline in net interest margin. Expenses increased 4 per cent at constant currency mainly due to the normalisation of performance-related pay accruals, with underlying cost efficiencies funding an increase in investments. Credit impairment charges were exceptionally low reflecting the improving economic backdrop. The Group remains well capitalised and highly liquid with a CET1 ratio of 14.0 per cent - at the top end of the 13 to 14 per cent target range - an advances-to-deposits ratio of 62.7 per cent and a liquidity coverage ratio of 150 per cent.

All commentary that follows is on an underlying basis and comparisons are made to the equivalent period in 2020 on a reported currency basis, unless otherwise stated.

•  Operating income declined 9 per cent and was down 3 per cent on a constant currency basis and excluding a $305 million reduction in DVA. The impact of lower interest rates was partially offset by balance sheet growth and strong performances in Wealth Management and Financial Markets, excluding the reduction in DVA

•  Net interest income decreased 10 per cent with a 9 per cent increase in average interest earning assets more than offset by a 20 per cent (30 basis points) decline in net interest margin

•  Other income decreased 9 per cent, but was up 4 per cent excluding the negative impact of movements in DVA, with a particularly strong performance in Wealth Management partially offset by lower Treasury realisation gains

•  Operating expenses were up 6 per cent and up 4 per cent on a constant currency basis, with performance-related pay accruals normalising and increased investment into transformational digital initiatives. The cost-to-income ratio excluding DVA increased 5 percentage points to 63 per cent, due to the impact of the significantly lower interest rate environment on net interest income

•  Credit impairment declined by $936 million to $20 million. There was a $35 million release in Stage 1 and 2 impairments reflecting the impact of improvements in the macroeconomic variables incorporated into expected credit loss models, additional collateral received on a few credit grade 12 clients and a $14 million release of the judgemental management overlay relating to stage 1 and 2 loans. Impairments of Stage 3 assets of $55 million were down $450m, with no significant new exposures in the quarter

•  Other impairment increased by $170 million with the non-repeat of a $165 million release in 1Q'20 and a $16 million charge in the quarter primarily in relation to the aviation lease portfolio

•  Profit from associates and joint ventures was down 15 per cent to $47 million primarily reflecting the reduction in the Group's shareholding in China Bohai Bank from 19.99 per cent in 1Q'20 to 16.26 per cent

•  Charges relating to restructuring, goodwill impairment and other items decreased $303 million to $33 million, with lower restructuring costs and a non-repeat of $258 million goodwill impairment primarily in India booked in 1Q'20

•  Taxation was $314 million on a statutory basis, with an underlying year-to-date effective tax rate of 22 per cent down from the prior year rate of 30 per cent reflecting a change in the geographic mix of profits and higher profits diluting the impact of non-deductible costs and withholding tax

•  Underlying return on tangible equity increased by 220 basis points to 10.8 per cent due to higher profits partly offset by increased tangible equity reflecting profit accretion and the impact of favourable FX movements on the translation reserve

Operating income by product

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Following a reorganisation, there has been a reclassification of balances relating to Corporate Finance, Financial Markets and Lending & Portfolio Management including prior period numbers. There is no change in the total income

3 1Q'20 published results included $0.5 million (4Q'20: $1 million) of income within Foreign Exchange; $6 million (4Q'20: $6 million) within Rates; $(3) million (4Q'20: $1 million) within Commodities and $(1) million (4Q'20: $(1) million) within Global Credit now reported in Financing and Security Services

4 1Q'20 published results included $3 million (4Q'20: $3 million) of income in Commodities now reported in Credit Markets

5 Not meaningful

Reflecting the updated organisational structure that came into effect on 1 January 2021, the Group's Financial Markets business has been expanded and reorganised, with the Group integrating the majority of its Corporate Finance business within Financial Markets. The remaining elements of the Group's Corporate Finance business - primarily M&A Advisory - have been transferred into Lending & Portfolio Management.

Transaction Banking income was down 20 per cent. Cash Management declined 32 per cent as double-digit volume growth and increased fee income was more than offset by significant margin compression due to the lower interest rate environment. Trade increased 7 per cent due to double-digit growth in balances and increased margins benefiting from improved mix with a switch from financial institutions trade loans into corporate trade loans.

Financial Markets income declined 14 per cent but was up 7 per cent excluding the reduction in DVA. Credit Trading was up strongly compared to a $25 million loss in 1Q'20 which was due to mark-to-market movements resulting from the elevated levels of market volatility at that time. There was high single-digit growth in Structured Finance and Financing Solutions & Issuance, while positive movements in XVA resulted in a doubling of Financing & Security Services income. Macro Trading declined 19 per cent from lower FX and Rates income due to reduced client demand and lower trading gains compared to the exceptional volatility experienced in 1Q'20. This was partly offset by strong double-digit growth in Commodities which benefited from higher commodity prices.

Lending and Portfolio Management income was up 14 per cent with increased fee income, improved margins and balance sheet growth.

Wealth Management recorded a record quarter, with income up 21 per cent. There was a particularly strong sales performance in FX, equities and structured notes, supplemented by clients increasingly using digital channels, driving income excluding bancassurance up 28 per cent. Bancassurance income, which is currently around a quarter of total Wealth Management income, grew 3 per cent, despite sales being negatively impacted by reduced branch footfall due to COVID-19.

Retail Products income reduced 10 per cent on a reported basis and was down 12 per cent on a constant currency basis. Deposits income declined 51 per cent as margin compression more than offset increased volumes. Balance sheet growth and increased margins benefiting from lower funding led to 82 per cent growth across Mortgages & Auto and a 44 per cent increase in Other Retail Products. Credit Cards & Personal Loans income increased 5 per cent with increased personal loan volumes and improved margins partly offset by lower credit card spend.

Treasury income declined 21 per cent to $257 million, primarily from a $94 million reduction in realisation gains to $104 million, partly offset by a non-repeat of prior period negative movements in hedge ineffectiveness.

Profit before tax by client segment and geographic region

1 Comparisons presented on the basis of the current period's transactional currency rate, ensuring like-for-like currency rates between the two periods

2 Following a reorganisation, there has been an integration of segments and regions (Corporate & Institutional Banking and Commercial Banking to Corporate, Commercial & Institutional Banking; Private Banking and Retail Banking to Consumer, Private & Business Banking; Greater China & North Asia and ASEAN & South Asia to Asia) including prior period numbers

3 Not meaningful

Reflecting the updated organisational structure that came into effect on 1 January 2021, this is the first reporting period in which the Group is reporting on its new structure. The new structure results in the creation of two new client segments; Corporate, Commercial & Institutional Banking serving larger companies and institutions and Consumer, Private & Business Banking serving individual and business banking clients. From a regional perspective, Greater China & North Asia and ASEAN & South Asia have been combined to form a single Asia region.

Corporate, Commercial & Institutional Banking profit increased 19 per cent, due to lower impairments, and doubled excluding the reduction in DVA. Income declined 2 per cent excluding DVA, with a 7 per cent increase in Financial Markets more than offset by a 32 percent reduction in Cash Management due to lower interest rates.

Consumer, Private & Business Banking profit increased 70 per cent with lower impairments and lower expenses. Income increased 1 per cent, flat on a constant currency basis, as strong double-digit increases in Wealth Management and Mortgage & Auto income more than offset the impact of lower interest rates on Retail Deposits.

Central & other items (segment) profit more than halved to $82 million with income down 21 per cent reflecting lower realisation gains within Treasury.

Asia profits increased 21 per cent as lower credit impairments more than offset a 5 per cent reduction in income and a non-repeat of a $165 million other impairment recovery in 1Q'20.

Africa & Middle East profits increased four-fold due to a $204 million reduction in impairments. Income was down 11 per cent, or 8 per cent on a constant currency basis while costs increased 1 per cent on a constant currency basis.

Europe & Americas income increased 1 per cent, or 42 per cent excluding a reduction in DVA, which along with $149 million lower impairments resulted in profits more than doubling.

Central & other items (region) recorded a loss of $211 million with income declining $175 million due to lower returns paid to Treasury on the equity provided to the regions in a lower interest rate environment and increased expenses reflecting a normalisation of performance-related pay accruals.

Adjusted net interest income and margin

1 Variance is better/(worse) other than assets and liabilities which is increase/(decrease)

2 Adjusted net interest income is statutory net interest income less funding costs for the trading book and financial guarantee fees on interest earning assets

3 Change is the basis points (bps) difference between the two periods rather than the percentage change

4 Adjusted net interest income divided by average interest-earning assets, annualized

Adjusted net interest income was down 14 per cent driven by a 20 per cent reduction in net interest margin to 122 basis points, falling 30 basis points year-on-year and 2 basis points compared to 4Q'20. On an underlying basis, excluding the impact of the one-off Korea interest credit in 4Q'20, the net interest margin was flat quarter-on-quarter:

•  Average interest-earning assets increased 3 per cent in the quarter, driven by increased balances in Treasury Markets, Mortgages and Trade. Gross yields declined 14 basis points compared with the average in the prior quarter due to an asset mix and the impact of lower interest rates on both the returns earned on the Treasury Markets portfolio and yields on loans and advances to customers

•  Average interest-bearing liabilities increased 4 per cent in the quarter. The deposit mix continued to improve with a reduction in Retail Products time deposits and growth in individual current accounts and corporate operating accounts. The rate paid on liabilities decreased 13 basis points compared with the average in the prior quarter reflecting interest rate movements, repricing initiatives and the improvement in the liability mix

Credit risk summary

Income Statement

1 Variance is increase/(decrease) comparing current reporting period to prior reporting periods

Balance sheet

1 Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2 Includes reverse repurchase agreements and other similar secured lending held at amortised cost of $3,197 million at 31 March 2021, $2,919 million at 31 December 2020 and $2,903 million at 31 March 2020

3 Change is the percentage points difference between the two points rather than the percentage change

Asset quality remained resilient and stable in the first quarter, although the Group continues to remain alert to the continued impact of COVID-19 and the likelihood of uneven economic recovery across markets and industries.

Credit impairment was a $20 million charge in the quarter, with a $35 million release in stage 1 and 2 impairment and a $55 million charge relating to stage 3 impairment.

The $35 million release in stage 1 and 2 impairment reflects an improvement in the macroeconomic environment, additional collateral received relating to a few credit grade 12 clients and a $14 million release of the judgemental stage 1 and 2 management overlay. The management overlay is $339 million as at 31 March 2021.

Stage 3 impairments of $55 million primarily relate to higher charge-offs within Consumer, Private & Business Banking in India and Malaysia after the payment moratoria relief schemed ended with no significant new exposures within Corporate, Commercial & Institutional Banking in the quarter.

Gross stage 3 loans and advances to customers of $8.7 billion were 5 per cent lower compared to 31 December 2020 primarily due to repayments and write-offs more than offsetting new inflows, which were 76 per cent lower in Corporate, Commercial & Institutional Banking compared to the previous quarter. These credit-impaired loans represented 2.9 per cent of gross loans and advances, a decrease of 27 basis points compared to 31 December 2020.

The Stage 3 cover ratio of 58 per cent was stable compared with the position as at 31 December 2020, and the cover ratio post collateral at 77 per cent increased by a percentage point from additional collateral within Consumer, Private & Business Banking.

Credit grade 12 balances have increased 2 per cent since 31 December 2020 primarily from new inflows from Early Alert accounts.

Early Alert accounts of $9.8 billion have reduced by $0.9 billion since 31 December 2020, reflecting the net impact of downgrades into credit grade 12 and regularisations of accounts back into non-high risk categories. The Group is continuing to monitor its exposures in the Aviation, Metals & Mining and Oil & Gas sectors particularly carefully, given the unusual stresses caused by the effects of COVID-19, however rising commodity prices have eased credit pressure for certain sectors.

The proportion of investment grade corporate exposures has remained stable since 31 December 2020 at 62 per cent.

Restructuring, goodwill impairment and other items

The Group's statutory performance is adjusted for profits or losses of a capital nature, amounts consequent to investment transactions driven by strategic intent, other infrequent and/or exceptional transactions that are significant or material in the context of the Group's normal business earnings for the period and items which management and investors would ordinarily identify separately when assessing underlying performance period-by period.

Restructuring charges of $33 million primarily relate to redundancies and impairments on property as the Group adapts to new ways of working post-pandemic.

Balance sheet and liquidity

1 Variance is increase/(decrease)comparing current reporting period to prior reporting periods

2 The Group now excludes $15,996 million held with central banks (31.12.20: $14,296 million, 31.03.20: $9,947 million) that has been confirmed as repayable at the point of stress

The Group's balance sheet remains strong, liquid and well diversified:

•  Loans and advances to customers increased 4 per cent since 31 December 2020 to $292 billion despite the impact of adverse foreign exchange movements. Buoyant corporate activity led to growth in Financing Solutions & Issuance within Financial Markets, Corporate Lending - which in part benefited from a $2 billion temporary increase in balances relating to upcoming initial public offerings - and Trade. Retail Mortgage balances grew for the fourth successive quarter

•  Customer accounts of $442 billion increased 1 per cent since 31 December 2020 with an increase in corporate operating account balances partly offset by lower retail deposits

•  Other assets were stable in the first quarter of 2021 with increased balances at central banks and investment securities offset by a reduction in derivative balances. Other liabilities increased 4 per cent from increased repurchase agreements and issued debt securities partly offset by reduced derivative liabilities

The advances-to-deposits ratio increased to 62.7 per cent from 61.1 per cent at 31 December 2020 reflecting the growth in loans and advances to customers from client demand and supportive market conditions. The point-in-time liquidity coverage ratio increased
7 percentage points to 150 per cent as a reduction in net outflows more than offset a reduction in high quality liquid assets in the period, in part reflecting improvements in the deposit mix, and remains well above the minimum regulatory requirement of 100 per cent.

Risk-weighted assets

1 Variance is increase/(decrease) comparing current reporting period to prior reporting periods

Total risk-weighted assets (RWAs) increased 3 per cent or $7.8 billion since 31 December 2020 to $277 billion, broadly similar to the rate of increase in 1Q'19 and 1Q'20:

•  Credit Risk RWA increased by $6.3 billion in the first quarter to $227 billion with asset growth mostly due to increased client demand and activity partly offset by FX movements and RWA optimisation actions. Credit migration increased RWAs by $0.6bn in the quarter

•  Operational Risk RWA increased $0.3 billion primarily due to an increase in average income as measured over a rolling three-year time horizon, with higher 2020 income replacing lower 2017 income

•  Market Risk RWA increased by $1.2 billion to $23 billion due to a seasonally higher level of Financial Markets activity

Capital base and ratios

1 Variance is increase/(decrease) comparing current reporting period to prior reporting periods

2 Change is percentage points difference between two points rather than percentage change

The Group is well capitalised with low leverage and high levels of loss-absorbing capacity. Its capital metrics remain well above regulatory requirements.

The Group's CET1 ratio of 14.0 per cent was 43 basis points lower than at 31 December 2020, 4.1 percentage points above the Group's latest regulatory minimum of 9.9 per cent and at the top of the 13-14 per cent medium-term target range. The Group's minimum CET1 requirement decreased to 9.9 per cent from 10 per cent at 31 December 2020 as the Group's Pillar 2A requirement (which is fixed in absolute terms) was reduced by higher RWA in the period.

The primary driver of the decrease in the CET1 ratio was the increase in RWAs, principally due to balance sheet growth, which resulted in a decrease in the CET1 ratio of approximately 50 basis points which more than offset approximately 40 basis points of CET1 accretion from profits in the quarter.

The CET1 ratio was reduced by 10bps from a net reduction in fair value through other comprehensive income (FVOCI) reserves mainly relating to a reversal of prior year unrealised gains on debt securities as a result of higher market yields. The reduction in FVOCI reserves was also driven in part by Treasury realisation activities; the gains on which were reflected in profits.

The Group spent $255 million purchasing 37 million ordinary shares of $0.50 each, representing a volume-weighted average price per share of £4.92. These shares were subsequently cancelled, reducing the total issued share capital by 1.2 per cent and the CET1 ratio by 9 basis points.

The Group is accruing a provisional interim 2021 ordinary share dividend over the first half of the year which is calculated formulaically at one-third of the ordinary dividend paid in the prior year or 3 cents a share. The Group is expecting an update from the Prudential Regulation Authority before the half-year results regarding the extent to which an interim ordinary dividend can be paid.

The expiration of the prudential valuation adjustment temporary regulatory diversification benefit at the start of 2021 reduced the CET1 ratio by 5 basis points. This was offset by a 6 basis points increase in the value of the revised treatment of software assets in CET1 reflecting an increase in capitalised software assets. The total benefit to CET1 from the revised treatment of software assets is now 28 basis points. The PRA is currently consulting on the potential removal of this benefit.

The Group's UK leverage ratio of 5.1 per cent is slightly lower than the 5.2 per cent ratio as at 31 December 2020. The Group's leverage ratio remains significantly above its minimum requirement of 3.7 per cent.

Outlook

We believe that some of our larger markets will continue to drive the global economy out of recession over the coming quarters. While the scale of the US fiscal stimulus and speed of vaccine roll-out have significantly lifted global economic prospects, we still expect the recovery to be volatile and uneven.

This positive backdrop reinforces our confidence in our previous guidance for FY'21, in particular:

•  With the net interest margin having broadly stabilised, we expect income to start growing again in 2H'21 compared to 2H'20. Income is expected to be similar in FY'21 to that achieved in FY'20 at constant currency and to return to our medium-term guidance of 5-7% growth from FY'22

•  We still expect FY'21 expenses to increase slightly compared to FY'20, as we continue to invest in our digital capabilities, but should remain below $10 billion at constant currency

•  We now expect impairment charges to reduce significantly year-on-year in FY'21 with the loan loss rate likely to be in or below our 35-40 basis point medium-term guidance range

Andy Halford

Group Chief Financial Officer

29 April 2021