NatWest Group plc Q2 FY2025 Earnings Call

Good morning, and welcome to NatWest Group's H1 2025 Results Management Presentation. Today's presentation will be hosted by CEO, Paul Thwaite; and CFO, Katie Murray. After the presentations, we will take questions.

Good morning, and thank you for joining us. I'll start with a brief business update. Katie will take you through the numbers, and we'll then open it up for questions. You will all be aware that since our first quarter results, the government has sold its remaining stake in NatWest Group. So we are now privately owned for the first time in 17 years. This is clearly an important milestone. With government ownership and a significant restructuring of the bank behind us, we are attracting new investors and driving growth. Customer activity has helped to deliver a strong first half. So let's turn to the financial headlines. Customer lending grew 3.2% to GBP 384 billion. Customer deposits were up 1% to GBP 436 billion, and assets under management and administration grew 5.9% to GBP 52 billion. This has driven strong financial performance. Income grew 13.7% to GBP 8 billion, while costs reduced 1.4% to GBP 3.9 billion. This resulted in operating profit of GBP 3.6 billion and attributable profit of GBP 2.5 billion. Our return on tangible equity was 18.1%. Earnings per share were up 28% at 31p. We have announced an interim dividend of 9.5p, up 58%, reflecting our higher payout ratio, and TNAV per share grew 16% to 351p. Our CET1 ratio is stable at 13.6%, with strong levels of capital and liquidity. Successful execution of our strategy is driving strong capital generation, which allows us to invest in the business, support customer growth and deliver attractive returns for shareholders. We are pleased to announce a new share buyback today of GBP 750 million. Together with the interim dividend, this brings total distributions declared to shareholders in the first half to around GBP 1.5 billion. The chart on the right shows how the dividend and TNAV per share have grown year-on-year. Our new buyback program will deliver further share count reduction in the future. I'm also pleased with the progress we are making on our strategic priorities. So let me update you starting with disciplined growth. We continue to grow our customer base across the bank. We attracted over 100,000 new customers as a result of organic growth during the first half. In addition, the Sainsbury's transaction completed in May, adding around 1 million new customers with about GBP 2.4 billion of savings and GBP 2.2 billion of unsecured lending. We have grown across all 3 of our businesses. In Retail Banking, we grew lending 3%, including both mortgages and unsecured lending, and deposits increased 1%. We continue to build out our mortgage proposition, including for first-time buyers, which has driven a 4% increase in our application share of this market since early last year. During the first half, we helped 24,000 people buy their first home. And we recently launched family-backed mortgages to help customers get on the property ladder by enabling them to add a second person to their mortgage while retaining independent ownership. Our share in credit cards increased from 9.7% to 11% as a result of the Sainsbury's transaction. And we launched a whole-market offer for personal loans at the end of last year, extending them beyond our own customers following our successful extension of credit cards to the whole market. In Commercial & Institutional, we grew lending 4% and deposits 2%. In Corporate & Institutional, growth was driven by project finance, infrastructure, sustainable finance, and funds lending. In commercial mid-market, we grew in a number of areas, including social housing, where we delivered another GBP 2.7 billion of lending. In private banking and wealth management, we grew lending 2% as well as attracting new assets under management, where net new inflows of GBP 1.5 billion represented 8.1% of opening AUM. You will remember from our first quarter results that we have overdelivered on our GBP 100 billion target for climate and sustainable funding and financing and have now reached GBP 110 billion. We're announcing a new target today to deliver GBP 200 billion of climate and transition finance by 2030. We have extended the scope to include transition finance in line with the government's transition finance strategy. Our second priority is bank-wide simplification, where we continue to enhance customer and colleague experience and increase productivity. Let me talk you through some examples. We have digitized over 30 customer journeys during the first half. In retail, this includes being able to change credit card and ATM limits as well as accessing our new U.S. dollar travel accounts. In Commercial & Institutional, we made it possible last year for business banking customers to access up to GBP 100,000 of unsecured lending within 24 hours. We have now extended this to our commercial mid-market customers, making life easier for them as well as our colleagues who save on average around 2.5 hours on each application. And in our private bank, this includes the automatic renewal of fixed-term deposits. We continue to streamline our systems and modernize our technology estate. In Commercial & Institutional, we have moved our commercial customers onto a new modern bank line platform, which has allowed us to start decommissioning the old one. And our private bank is rehosting their core banking platform from a third-party provider in Switzerland to the group's data center in the U.K. This both reduces spend and increases capacity. We are accelerating the use of data and AI. For example, we have just announced a strategic collaboration with AWS and Accenture to modernize our data capabilities. This includes the creation of a platform that uses AI to give us a single view of customer data across the bank. This will enable greater personalization, faster onboarding, better protection against fraud, and stronger customer engagement. We also continue to simplify our operational model as we streamline our legal entities and branches in Europe, reduce the number of branches we operate in the U.K., and relocate our private bank investment operations and technology teams from Switzerland to the U.K. and India. And as a result of growing income and lowering costs, we have reduced the first half cost to income ratio from around 56% last year to around 49% this year. Finally, as we actively manage our balance sheet, we have generated 101 basis points of capital in the first half, including 139 basis points from earnings. And we have taken action to reduce risk-weighted assets by GBP 2.9 billion through a range of measures, including 3 significant risk transfers. As a result of our strong performance, we are upgrading our 2025 guidance for both income and returns. We now expect income greater than GBP 16 billion and a return on tangible equity above 16.5%. We continue to target returns greater than 15% in 2027. And with that, I'll hand over to Katie to take you through the results.

Thank you, Paul. I'll cover our second quarter performance using the first quarter as a comparator. Income, excluding all notable items, was up 1.5% at GBP 4 billion. Operating expenses were 3% higher at GBP 2 billion, and the impairment charge was GBP 193 million or 19 basis points of loans. Taking this together, we delivered operating profit before tax of GBP 1.8 billion. Profit attributable to ordinary shareholders was GBP 1.2 billion, and the return on tangible equity was 17.7%. Turning now to income. Overall, income, excluding notable items, grew 1.5% to GBP 4 billion. Excluding the impact of one additional day in the quarter, income across our 3 businesses increased 1.1% or GBP 43 million. Net interest income grew 1.6% or GBP 50 million to GBP 3.1 billion. This was driven by volume growth across lending and deposits, including portfolios added from Sainsbury's. It was also supported by margin expansion as tailwinds from the product structure hedge more than offset the impact of the base rate cut in May and lending growth. Net interest margin was up 1 basis point at 228, mainly reflecting deposit margin expansion. We continue to assume 2 further rate cuts this year with rates reaching 3.75% by the year-end. Noninterest income across the 3 businesses was down 0.8% compared with a strong quarter and up 2% compared to the prior year. Retail Banking and Private Banking and Wealth Management benefited from higher debit and credit card fees. And in C&I, our currency business continued to perform well given the heightened volatility. Given the strength of the first half total income, we now expect full year total income, excluding notable items, to be greater than GBP 16 billion. And as a result, we now expect return on tangible equity to be greater than 16.5%. Moving now to lending. We continue to be disciplined in our approach, deploying capital where returns are attractive. Gross loans to customers across our 3 businesses increased by GBP 8.4 billion to GBP 384 million, evenly balanced across our personal and wholesale customers. Taking retail banking together with private banking, mortgage balances grew by GBP 1.3 billion, with growth improving throughout the quarter following the stamp duty deadline at the end of March. Our stock share remained stable at 12.6%. Unsecured balances increased by GBP 2.7 billion, mainly reflecting the addition of the credit card and personal loan portfolios from Sainsbury's Bank. In Commercial & Institutional, gross customer loans, excluding government schemes, increased by GBP 4.6 billion. Within this, loans to corporates and institutions grew by GBP 2.1 billion, mainly driven by project finance, sustainable financing, and funds lending. And loans in our commercial mid-market business grew by GBP 2.1 billion, reflecting increased lending across social housing and residential commercial real estate. I'll now turn to deposits. These were up GBP 2.4 billion across our 3 businesses to GBP 436 billion, continuing the quarterly growth trend. Retail Banking increased deposit balances by GBP 0.9 billion to GBP 197 billion. The addition of GBP 2.4 billion of deposits acquired from Sainsbury's Bank was partly offset by a reduction in current accounts. Private banking balances increased by GBP 0.1 billion, and the increase in Commercial & Institutional of GBP 1.4 billion was mainly from larger customers in Corporate & Institutions. Deposit mix was broadly stable as the proportion of noninterest-bearing balances remained at 31%, and term accounts increased slightly from 16% to 17%. Turning now to our product structural hedge. The strength of our deposit franchise, combined with our mechanistic approach to managing the structural hedge is an important driver of income. The product hedge notional was stable in the first half at GBP 172 billion, and we continue to expect it to be broadly stable in 2025, which means a reinvestment each year of around GBP 35 billion. As we show in the chart for 2025, more than 90% of the hedges are already written, and we have GBP 4 billion locked in. We expect 2025 product hedge income to be GBP 1 billion higher than 2024, given reinvestment rates. And in 2026, we expect product hedge income to increase by more than GBP 1 billion when compared with 2025. We continue to expect the hedge to be a further tailwind in 2027. Turning now to costs. Fees increased 1.6% to GBP 2 billion in the second quarter. Our annual wage awards and higher national insurance contributions both took effect in early April. We also incurred GBP 27 million of our guided one-time integration cost during the quarter, bringing the total to GBP 34 million for the first half. We remain on track for other operating expenses to be around GBP 8 billion for the full year, plus around GBP 100 million of one-time integration costs. This means expenses will be higher in the second half, driven by further business transformation, the remaining one-time integration costs, and the bank levy. Our focus remains driving cost savings to create capacity for further investment to accelerate our bank-wide simplification. I'd like to turn now to impairments. Our diversified prime loan book continues to perform well. We are reporting a net impairment charge of GBP 193 million for the second quarter, equivalent to 19 basis points of loans on an annualized basis. This includes an GBP 81 million one-time charge on acquisition of balances from Sainsbury's Bank, equivalent to 8 basis points. Excluding this, the charge was GBP 112 million or 11 basis points, benefiting from post-model adjustment releases of GBP 64 million. We retained post-model adjustments for economic uncertainty of GBP 234 million. We have reviewed and updated our macroeconomic assumptions with minor changes that drove GBP 10 million of additional expected credit losses. Overall, we have no significant concerns about the credit portfolio at this point. And given the current performance of the book, we continue to expect a loan impairment rate below 20 basis points for the full year. Turning now to capital. We ended the second quarter with a common equity Tier 1 ratio of 13.6%, down 20 basis points on the first. We generated 53 basis points of capital before distributions, net of the 15 basis points impact from Sainsbury's. Strong earnings added 69 basis points and other CET1 capital changes added 11 basis points. Risk-weighted assets increased by GBP 3.1 billion to GBP 190 billion, including GBP 4.6 billion of business movements, which broadly reflects our lending growth, including Sainsbury's Bank, and GBP 1.4 billion from CRD IV model inflation, partly offset by a GBP 1.7 billion reduction as a result of RWA management and a GBP 1.2 billion reduction in other RWA movements, including FX. RWA growth, excluding Sainsbury's, consumed 12 basis points of capital. This brings our CET1 ratio pre-distributions to 14.3%. As you know, we increased our ordinary dividend payout ratio from around 40% to around 50% and have announced an interim ordinary dividend of 9.5p per share, up 58% on last year. We've also announced a share buyback of GBP 750 million. Together, these accruals consumed 72 basis points of capital. Post accruals, our CET1 capital increased in the quarter and is up GBP 900 million since year-end to GBP 25.8 billion. Our CET1 ratio, however, is stable since year-end at 13.6%, in line with our target range of 13% to 14%. Turning now to guidance for 2025. We now expect income, excluding notable items, to be greater than GBP 16 billion. And based on the strength of income, we anticipate return on tangible equity to be greater than 16.5%. Our cost, impairment, and RWA guidance remains unchanged. We expect other operating expenses to be around GBP 8.1 billion, including around GBP 100 million of one-time integration costs. The loan impairment rate to be below 20 basis points and RWAs to be between GBP 190 million and GBP 195 billion. Where the figure lands within this range still depends on the CRD IV model outcomes. With that, I'll hand back to the operator for Q&A. Thank you.

Our first question comes from Alvaro Serrano of Morgan Stanley.

Regarding the deposit flows, we are currently experiencing the ISA season, which has generated significant activity. However, there has been a loss of some current accounts. Can you elaborate on this? It appears to be a strategic approach to managing yields. What trends did you observe during the quarter? Looking ahead, I assume this will not impact the hedge notional going forward. Could you also comment on any changes in market share? On the cost front, the second quarter shows substantial improvement. I know you mentioned the restructuring charges for the second half, but it seems like the underlying performance is much better. Can you clarify the scale of these restructuring charges and how they stack up against a typical year?

Okay. Thank you, Alvaro. That's great. So I'll share a bit on deposits and then maybe, Katie, you come in on deposits around the hedge notional...

Yes. Sure, certainly.

So regarding deposits overall, Alvaro, your assessment is quite accurate. We have grown our base, although part of that growth was due to the Sainsbury's acquisition. We've discussed previously the competitive ISA season, which was largely influenced by media and policy discussions concerning potential changes to ISAs. This competitive ISA season normalized fairly quickly from our standpoint. When examining our market share, we observed an increase in our ISA balances, and our market share remained consistent and stable. Similarly, our overall deposit share has also been stable. As highlighted in Katie's slide, our mix has stayed largely consistent, with no significant shifts. As you pointed out, we have been very strategic and disciplined regarding our pricing, especially amidst the volatility in the swap curves around tariff dates. We have been careful about where we price our products, and we feel confident about our deposit strategy and the deposit base. Katie, would you like to address the hedge and notional?

Yes, absolutely. In terms of the hedge and notional, it moves relatively small. We're not expecting that to provide any guidance. Overall, NIBBs are down GBP 1 billion, which is very stable in the first half, while the hedge is GBP 172 billion. We anticipate that by the end of the year, and we see no reason to change our outlook. The increase in the hedge is due to higher average rates, which allows us to raise our reinvestment rate for the year to 3.7%. We expect to achieve GBP 1 billion this year in income and more than GBP 1 billion as we approach 2026 on the hedge, indicating good stability in our income. Regarding operating costs, our guidance remains unchanged. I mentioned the transformation costs from the integration with Sainsbury's, where we spent GBP 34 million of the GBP 100 million allocated for the first half, with more spending expected in the second half. Our cost narrative has been consistently similar; we expect to reach a base of GBP 8 billion this year along with an additional GBP 100 million in costs.

What Katie and I work really hard to do is to create capacity so that in the second half of the year, we can kind of go to our investment kind of shopping list and go back so we want to invest in these things to help accelerate the simplification of the business. So I would just sort of see that lumpiness will come through. We're very clear on the number we're aiming for at the end of the year, making sure we're delivering real benefit for the simplification of the business. Thanks, Alvaro.

Our next question comes from Sheel Shah of JPMorgan.

Two questions, please. First on the lending outlook. I mean the performance was quite strong in the quarter at just under 2% underlying, excluding Sainsbury's. How should we think about the outlook? Is this something we should be annualizing especially in the context of the U.K. economic backdrop, which looks a little bit more challenging compared to the start of the year? Secondly, on capital, could you talk through some of the moving parts we should be thinking about? I'm particularly interested as to how you're thinking about potential M&A and maybe holding a bit of a buffer against that and how that plays into operating within the range and when we come towards the year-end, how are you thinking about the definition of a surplus capital position?

Thank you very much, Sheel. I'll address both points, Katie. Regarding lending overall, I’m pleased to report a strong quarter. It's encouraging to see growth continue in the second quarter following the first. This growth is broad-based, evident in our Commercial & Institutional business, along with our continued expansion in mortgages and unsecured lending. Additionally, we've benefited from our partnership with Sainsbury's. Year-to-date growth is just over 3%, which is promising. While we don't provide guidance on future lending, I want to highlight our consistent track record of delivering lending growth that surpasses market growth, particularly in the U.K. Looking at our performance over the past couple of years, you can see how we stack up against the wider market, both in business and consumer lending. We are confident in our ability to sustain growth in lending. On the topic of capital, we ended the half-year at 13.6%, which is significantly above the regulatory minimum of 11.7%. This figure includes the accrual for our ordinary dividend and the buyback announced today. We demonstrated strong capital generation in the half-year, with 101 basis points overall, and 53 basis points in the second quarter, driven by earnings and effective capital management. That's allowed us to increase the interim dividend but also announced the buyback. We're very mindful in terms of the investment case and how important kind of return to shareholders is, and we hope that's a strong signal. I guess the context, the second part of your question is really around, I guess, the broader allocation. I'd reiterate very clearly, no change there. We're happy to move between the 13% and 14%. We think that gives us good balance in terms of being able to invest in the business, support customers, but also return to shareholders. So very much a balanced approach is what I'd say. What you should expect from us with the Board, we'll review at the half-year, and we'll review at the full year in terms of surplus capital and distribution. We obviously have a model that's generating a lot of capital, which is great. And as I alluded to earlier, we understand the kind of investment case and the thesis and the importance of distributions and to be explicit, not building any buffer or war chest in respect to inorganic. Our approach hasn't changed there. Very happy with the organic growth in the plan and the growth that we're delivering.

Our next question comes from Guy Stebbings at PNB Paribas Exane.

So I was going to ask around the sort of structural hedge, but also how it sort of interplays with the other parts of the balance sheet. So it's clearly working through very nicely and thanks for some of the update disclosure, which only reinforces conviction support into '26 and '27 too. I guess a debate out there is how much this flows straight through the P&L or whether we see any giveback on other line items given that plenty of other banks also seeing similar support. And we have seen mortgage spreads tighten slightly this year, you report a couple of basis points decline in the lending margin in the Q2 bridge. So one could argue it's starting to happen already a little bit. So just interested to get your view there as we work through that hedge benefit, whether you see any giveback elsewhere, whether that slight tightening of mortgage spreads will hold around these levels? Or if you see a risk of it drifting lower offsetting some of that hedge support? Or if you think the market should retain enough discipline to keep the sort of floor on spreads? And then just a follow-on to that question is just around what you're seeing on current application spreads in the mortgage book or whether you could give us maybe what the back book spread is now on mortgages?

Thanks, Guy. So mortgage margins on that spread, Katie and then you probably lead out with the hedges as well...

Yes, absolutely. Thanks, Guy. It's great to see that we are achieving what we aimed for. We have a very systematic approach, and it's encouraging to witness the increase in yield, which we expect will continue to rise as we move forward. Looking ahead to 2025 and 2026, we're on track to deliver over GBP 1 billion, with expectations for additional growth into 2027. While I won't provide specific guidance for that year, our slides indicate that 50% of the hedges are already established, locking in GBP 3.8 billion of income as we progress. In terms of how this flows through, we prioritize returns as our key metric and manage those within individual product categories. There is some level of cross-subsidization to consider, especially since lending margins are somewhat lower, contributing to our net interest margin (NIM) of 228 basis points. Thus, mortgages will slightly affect that figure. However, we focus on ensuring each product stands alone in terms of returns while acknowledging some inherent subsidization in the profit and loss statement. Regarding mortgage spreads, currently, we see a minus 2% on the lending side, which affects the overall accounts. However, there doesn’t appear to be a significant disparity between the back book and front book. Mortgages remain competitive, even during this challenging period, though the market shows rational behavior. We are writing below the 70 basis points that we often reference, but it seems to be stabilizing at that level, with the potential for improvement as other factors shift. Overall, we're pleased with our mortgage book's performance and the returns we're achieving at this time, which is essential.

Thanks, Katie. I'd like to add that we're expanding our mortgage offerings, which is evident in our slides. We've enhanced our first-time buyer options and improved our market share by 4% in buy-to-let and first-time buyer areas compared to last year. Additionally, there's a larger margin associated with these compared to traditional low LTV mortgages. As Katie mentioned, the overall dynamics are encouraging. With a stock share around 12.6%, we see opportunities in the mortgage market, and broadening our offerings allows us to capitalize on that. We have been and will continue to leverage these opportunities. Thanks, Guy.

Our next questions come from Aman Rakkar from Barclays.

I have two questions. First, I want to take your upgraded revenue guidance at face value. It suggests a significant increase in revenue for the second half of the year compared to the first half, likely surpassing consensus expectations. Can you provide insights into the factors driving this? I suspect there may be a stronger net interest income run rate in the second half contributing to this upgraded guidance. Could you clarify your perspective on that? Second, I’m curious about your thoughts on the current situation. It seems that the assumptions behind your revenue guidance regarding interest rates haven't changed much since February. When I compare it to your original guidance, it appears the rate curve is similar, although perhaps swap rates have improved slightly. We might exceed your revenue guidance by about GBP 1 billion compared to what you initially indicated. What specific factors are performing better than expected? Is it due to volumes or perhaps an improved market? I ask this because I believe your guidance has been conservative, and I want to understand it better. Any insights you can share would be greatly appreciated.

It's great to hear from you, Amandeep. We're guiding you to over GBP 16 billion, which indicates at least GBP 8 billion in the second half of the year. Of course, we are projecting even higher than that. There are several variables to consider, including net interest income and noninterest income. We anticipate continued volume growth in H2, and with the completion of Sainsbury's on May 1st, we have some additional days contributing to our numbers. While it can feel unscientific to mention extra days, they do have an impact, adding roughly GBP 100 million to second-half income. We've locked in about 90% of our structural hedge for next year, which means we expect to see about GBP 1 billion from higher hedge income. Our economic performance has remained consistent, though the swap curve was particularly favorable in the first quarter, which has contributed to our updated guidance. There are, however, some challenges ahead. We expect two more Bank of England rate cuts this year, lowering rates to 3.75%, with a 6-month effect from the two cuts in H1. Overall, our noninterest income rose by 15.4% in H1 '24, and for our central business area, it was up by 5%. We do anticipate seasonal fluctuations in Commercial & Industrial, particularly in April and August, but we've been pleased with how it's performed amid market volatility. Additionally, we have some contra revenues from planned capital actions in the second half that will slightly impact income across retail and C&I. Overall, we have a strong start with a 13.7% increase from last year, and we feel more confident about our full-year outlook, expecting income to exceed GBP 16 billion. Paul, would you like to share some reflections?

Yes, I think you've accomplished a lot, which is great. Aman, looking at the bigger picture, I can say there haven't been any fundamental changes to our interest rate assumptions. What has changed as we've moved from the end of the first quarter into the second quarter is that our volumes have remained very strong, particularly in the retail banking sector for mortgages and unsecured lending. Our non-net interest income has shown two strong quarters, which is encouraging and supported by high levels of customer activity. We now have two quarters of that data. Additionally, the reinvestment yield and hedge have both been slightly higher. These factors have contributed to our confidence in the income and returns outlook. As you may have noted, we've explicitly stated expectations of income exceeding GBP 16 billion and returns greater than 16.5%. I would also like to mention that our tangible equity is expected to grow during the second half of the year, which will influence the returns outlook. Overall, the second quarter has not only delivered strong performance but has also boosted our confidence regarding the year’s outcomes. Thank you, Aman.

Is it possible to ask a follow-up if so.

You've got the mic, so go for it.

You've increased the return on tangible equity guidance for this year, and I want to highlight the greater than 16.5% return on tangible equity. Looking ahead to next year, is there any reason to expect a significant drop from that level of return? Even if you achieve 17% this year, considering the rate cuts and other factors, I still see strong momentum in terms of hedging and volume growth. I don't foresee any significant rise in return on tangible equity that would align with the greater than 15% aspiration.

Yes. Let's discuss the income outlook for 2026, as it is a key factor. We expect annual growth leading into 2027 and are confident in the growth trajectory beyond 2025. The primary drivers for 2026 include strong growth across our three businesses, which is outpacing sector growth. Our diverse business portfolio positions us well to capture demand. We remain disciplined with our return on tangible equity guidance, deploying capital only when returns are appealing. Additionally, we anticipate a stronger structural hedge tailwind in 2026 compared to 2025, expecting over GBP 1 billion more than the previous year. We foresee one more rate cut in 2026, bringing the terminal rate to 3.5%. Although this is lower than the rates this year, we expect some averaging effect to influence 2026. In terms of noninterest income, we are pleased with this year's performance, which reflects the strength of our customer base and our central treasury activities. Our strategic initiatives to engage more customers are paying off in noninterest income. Overall, we are confident about the income as we enter the second half of the year and beyond. Regarding the tangible net asset value, we anticipate growth despite upcoming regulatory changes related to the Basel number remaining unchanged at GBP 8 billion, so we feel comfortable moving forward. Paul, do you have anything to add?

No, we won't get into specifics right now, as February will be the time for 2026 guidance, Aman. However, you can sense from Katie's comments that we are pleased with the momentum and the outlook as we begin to look ahead to 2026 and 2027.

Our next question comes from Amit Goel of Mediobanca.

So I have one question. In the central items, there's negative net interest income and positive other operating income. It appears this relates to foreign exchange risk management derivatives. I wanted to clarify what those are, their contribution, and what to expect moving forward. My second question is regarding the leads reforms. I'm curious if there's anything that might change your outlook and if you anticipate any additional volume from the loan-to-income cap and related factors.

Sure, absolutely. We have discussed the FX arms several times before. It's interesting to note the greater volatility in the FX markets because, with treasury, we identify opportunities on our surplus FX cash positions to exploit that volatility. While this can negatively impact net interest income, we have an offset in noninterest income. It creates some noise in our numbers, but overall, it's beneficial for income. I haven't provided specific guidance on the extent of this effect, since it depends on market volatility, which isn't consistent. When analyzing total income, it's useful to focus on the overall picture rather than line items. In this period, net interest margin is flat in terms of funding and other factors. However, two main elements are at play: a positive impact from repositioning our liquidity portfolio into gilts, and a negative effect from the NII drag associated with treasury FX activity, which accounted for a decrease of 2 basis points. It's challenging to predict exact impacts for the upcoming quarter since it will depend on ongoing activity, but it represents a meaningful adjustment in our figures, and I'm glad to accept that. Paul, can I give you...

Yes. Regarding lead reform, we are supportive of the direction it is heading. We believe these changes are beneficial for the sector and ultimately for the U.K. Specifically, in relation to mortgages, we've already made adjustments based on the FCA's earlier affordability changes, which have increased the borrowing capacity for some of our first-time buyers. We view this positively. Additionally, the ongoing consultations should also help advance progress in the market. It's important to note that while the mortgage market is already quite large, these changes may open more opportunities for people to enter it, although it's just one part of the broader market. Furthermore, the reviews concerning capital and ring-fencing could enhance the level of support we can provide to customers and the economy. As I mentioned previously and discussed during our wealth investor spotlight, the reviews on advice guidance and boundaries, as well as those concerning savings and investments, present a significant opportunity to offer more financial advice to a larger number of customers at a lower cost, assisting them with their savings and investments. We see this as a positive development, and we are actively working on it, though many of these reforms are still in the consultation stage. Thanks, Amit.

Our next question comes from Christopher Cant of Autonomous.

Two sort of follow-up questions really. First, just on growth. I know it's relatively small now, but the BIBLs book is looking quite small in the context of the overall commercial book. And I guess we're starting to see the underlying growth come through a bit more strongly with that runoff tapering. It seems to be a pretty consistent GBP 0.4 billion a quarter of runoff on the government-guaranteed loan book. Is that what we should expect continuing for sort of the next 6 quarters and then it's gone? Or do we get down to a sort of ramp of the book where the remaining customers are going to take the full term. And I think some of them could take 10 years. I think it was extended, wasn't it? So that was the first question just in terms of understanding the growth dynamics we might see coming through. And then I just wanted to follow up, Paul, on your comment there about the Prudential reviews and particularly around capital. I mean I read the FTC minutes earlier this month and didn't really make much of it given that they said they think that the level of capital is broadly correct. But the fact that the Chancellor in her speech talked about the treasury working with the Bank of England to assess the right level of capital for the system suggested maybe there's going to be a bit of downward pressure there. So I'm just curious to know whether you have a view on what form that might take? Do you think we might have a revisiting of the through-the-cycle 2% countercyclical buffer calibration, for instance, which is quite high relative to many other countries? And if we did get something like that, how would you think about this as a management team in the context of your own capital target calibration? So I think you're already targeting a higher level of buffer to MDA than one of your nearest domestic competitors. How much would you actually want to take into how you think about the capital target? Or is really that 13% minimum just your management view of this is where the bank should run and it sort of doesn't matter if the underlying MDA changes?

Thank you, Chris. It's been a while since I discussed this, so thanks for bringing it up. Regarding the bounce-back loans, your assumption is correct about the consistent roll-off we see from quarter to quarter. Customers have little motivation to pay off their loans early due to the low borrowing costs. Unless a significant economic event occurs, I don't foresee any reason for customers to extend their loan terms. You’re right that borrowers have the option to extend to 10 years, but your perspective is accurate. On the larger topic of Prudential review and capital, I believe the emphasis on maintaining international competitiveness is crucial. In our discussions, we will focus on the importance of consistency from both EU and U.S. viewpoints. There are specific differences to address, such as the countercyclical buffer, which will definitely be one of the topics for discussion, among others. Your reasoning reflects how we are contemplating the areas that need review. It's still early days since the announcements were quite recent, making it challenging to provide deeper insights at this time. If any changes arise, we will consider them in the context of our overall capital levels, specifically our CET1 ratio against the regulatory minimum. However, those considerations would be secondary to the broader review of capital. Would you like to add anything?

A little bit. So we do look at capital risk appetite and buffers versus the supervisory minimum. Clearly, if that changes, then we would look to review that. I think the other thing, Chris, is as we look at the RWAs increasing over the next 18 months, that will increase our nominal capital requirement without a change in the risk of the balance sheet. As these things change, I think we might start to look and think about actually what kind of level of capital targets and buffers you might need given that that target is now based on a much higher level of nominal capital. So we'll have to think about things as it evolves. Thanks, Chris.

We're on the right track, Chris. Thank you.

Our next question comes from Jonathan Pierce of Jefferies.

I've got 2 actually. One is sort of a follow-up to the last question, but coming at it from the impairment angle. The metrics on every front are still extraordinary really. Your ECL in the downside, extreme downside scenario is now only GBP 2 billion. That's with GDP down 4% and unemployment up at 8%. I mean even if all that came in 1 year, that's only 45 basis points of loans or 1/4 of your current pre-provision profit. I see that the commercial book, you had more loans flowing back to Stage 1 than you have flowing into Stage 2 in the first half. I'm just really looking for a comment around how you're thinking on the through-the-cycle impairment charge today after a number of quarters now of very benign, very low levels of impairment coming through. Is it really 15 to 20 basis points, not sort of 25 to 30 we might have talked about in the past? And linking it into the capital question, presumably, if your ECL calculations are right and that feeds into this year's stress test, your Pillar 2B buffer is going to be very small. So again, is that putting downward pressure on your equity Tier 1 target, the way that you think about it?

I'll address your second question first. Yes, we are taking advantage of that opportunity. We might explore it further as we progress, but it's contributing positively to our income, particularly through our equity hedge positions, which we haven't discussed much lately. I'm very pleased to see this development. Regarding the impairment and its changes through the cycle, our current guidance is between 20 and 30 basis points. I completely agree with you, Jonathan, that given our experience over the past few years, our guidance this year is lower than that range. We're not updating the guidance today, but we've been providing annual insights, and it appears to be on the lower end. For instance, this quarter's figure is 19 basis points, with 8 of that linked to the recognition of Sainsbury's good book, leaving us with a more relevant figure of 11 compared to last year's 9. We'll keep monitoring this, and if there's more interest, we can refresh our assessment. As for Pillar 2B, we don't disclose that, but you can see that our nominal CET1 capital is growing significantly, having added GBP 900 million in the first half of the year. We anticipate more write-offs related to RWAs, which won't indicate increased risk on the balance sheet. We'll be looking at this holistically as we move forward. Thank you, Jonathan.

So sorry, but it seems you are directly suggesting that the 13% to 14% equity Tier 1 ratio target is being closely reviewed. Is that correct?

I think we've discussed this several times. We expected Basel to be implemented by the end of this year, but it has been delayed by a year. Once we received clarity on CRD IV and the changes associated with Basel, as well as the developments in Pillar 2A, we will evaluate these aspects as they progress. We still need to finalize some elements of Pillar 2A, but we are always attentive to how these changes unfold and the current market situation. We are pleased to see the growth and development of our nominal capital in light of these ongoing changes.

I think it's responsible for management to do that given all the changes that have come through. And as Katie says, once you through the back end of that, you have to decide where you think the right level of absolute capital.

Our next question comes from Ed Firth of KBW.

Yes, I just had 2 questions. One was, could I just take you to the structural hedge slide on Slide 12?

Absolutely.

And it's possible that I dislike discussing the structural hedge because you have your eyes on it. But just to clarify my understanding, in 2026, you're indicating that there will be a higher redemption yield and a lower reinvestment yield, yet the benefit is larger.

Yes.

Even though the roll-off is the same amount. And I'm just trying to work out how that works. So that would be my first question because it's probably just an understanding one. And then the second one is in terms of M&A, I think in the past, when you've been asked about this, you said that you look at things that would add a skill to what you have was one of the criteria. But I guess if one looks at what's happened in the first half, clearly, you've been looking at stuff that would be tough to argue that some of that stuff added any skills to you at all. So I'm just trying to get a sense as to how do you look at acquisitions now? Has that shifted a little bit? Or should we take the buyback as a sort of indication that they're pretty much off the table for the foreseeable future?

Thanks, Ed. Very clear. we nail the first one.

2026, it's quite simple. You've got the averaging effect there, and also importantly, the lack of the offset from reducing the notional that we had through 2024. So you've got a stable notional and deposit build is important there as well. And also, we've done 70% of the hedge already. So it's already that portion that's already locked in.

Yes. Regarding the M&A discussion, I wouldn't fully agree with your characterization of our previous stance. I've consistently stated that when we evaluate potential opportunities, we consider whether they can provide scale or enhance our capabilities, which aligns with the point you made. That perspective remains unchanged, and I understand this might sound repetitive. Our assessments are always viewed through those two aspects. The returns generated from our organic plan set a high financial and operational standard that we must meet compared to pursuing organic growth or buybacks. We will keep exploring opportunities, but we will do so with a disciplined approach. It's important to maintain a balanced strategy that involves investing in the business while also ensuring strong returns and distributions for our shareholders, along with considering potential opportunities for either scale or capabilities. There is no shift in our philosophy, and to clarify, our focus has always been on scale or capabilities, not solely on capabilities.

Our next questions come from Jason Napier.

I have just one question regarding the continued outperformance compared to market expectations on costs. I can understand how factors like bank levies and other expenses might contribute to the 7% or 8% half-on-half growth in operating expenses that you're projecting. However, I wonder if you could elaborate on your plans for simplifying the bank in light of this success. Specifically, how extensive is your list of potential improvements, what opportunities do you see, and do you believe that your cost base should continue to grow at around 2% on an ongoing basis? Investors seem eager to share in the benefits of your success in managing operating expenses, as it appears we are heading towards a better bank rather than just seeking immediate profitability.

Thank you, Jason. Your question was a little unclear, but I understand it was about costs. I want to emphasize that we view our costs as an all-in number, including wage inflation, national insurance inflation, tech contract inflation, significant investments in the business, and restructuring costs. This approach is transparent. As Katie mentioned earlier, we focus on managing operational costs and efficiency, which creates capacity for investment in the business, building a better bank for the future. We've simplified our technology architecture and digitized more customer journeys, which helps us manage costs effectively and supports our investments. This year, we've reduced our cost-income ratio by 7 points to 49% at the end of the first half. The balance between income growth and cost reduction shows a strong performance. Based on our guidance around income, we're anticipating high single-digit jaws, indicating good cost discipline alongside significant investments. We continue to see opportunities for digitization to improve our cost base and enhance customer experience. We are also simplifying our technology estate and operational model, reducing the number of applications and branches, and completing our exit from Poland. Overall, we believe we have several strategies in place that will help us build a better bank while maintaining an aggressive and disciplined cost management approach. This gives us optimism about making the necessary investments for our future.

Thank you for all your questions. I would now like to hand over to Paul for closing comments.

Okay. Thanks, everybody. We appreciate your time on the call. So to wrap things up, I hope you've got a sense that we're pleased to that, we see opportunities across all 3 businesses to continue to take market share and grow. We've updated income and returns guidance today. If we don't see you, I wish you a very good summit, and I'm sure we'll speak to you shortly. Thank you.

That concludes today's presentation. Thank you for your participation. You may now disconnect.