Earnings Call Transcript
NatWest Group plc (NWG)
Earnings Call Transcript - NWG Q1 2022
Operator, Operator
Ladies and gentlemen, welcome to the NatWest Group Q1 Results 2022 Management Presentation. I want to remind you that this call will be recorded. Today's conference call will be hosted by Alison Rose, CEO of NatWest Group. Please proceed, Alison.
Alison Rose, CEO
Good morning, and thank you for joining us today. As usual, I'll start with a brief strategic update. Katie will take you through the results, and then we'll open it up for questions. Clearly, since we last spoke, the world has changed considerably. Russia's invasion of Ukraine has led to greater macroeconomic and geopolitical uncertainty. Our customers now face higher inflation, rising rates, and energy costs, as well as ongoing supply chain disruption. Whilst many of them have built up healthy savings and balance sheets during the pandemic, and we are not seeing any immediate signs of distress, we are acutely aware of the pressures our customers face. So just as we did during the pandemic, we are supporting them as they navigate this period of uncertainty. For example, we continue to deliver around 1 million free financial health checks a year, we help customers to understand the impact of different scenarios on their credit rating and improve their score, and we regularly refer our more vulnerable customers to citizens advice. Our business customers benefit from having access to dedicated relationship managers with sector expertise in all of our regions. As the invasion of Ukraine continues, together with our customers and colleagues, we have donated over 9 million pounds to the Disaster Emergency Committee, Ukraine Humanitarian Appeal. We are also offering practical assistance to Ukrainian refugees in the UK. For example, we are using one of our headquarters as a welcome hub, and we are providing help with opening bank accounts. We have no operations in Russia or Ukraine and minimal direct exposure to Russia. We believe that our focus on building deeper relationships with our customers, together with two years of strong strategic progress, makes NatWest Group well positioned to deliver sustainable growth and returns in the years to come. So let me now turn to the financial headlines. We are reporting a strong performance with profit before tax of 1.3 billion, up 36% from the first quarter last year. We generated attributable profit of 841 million, up 36%, and our return on tangible equity was 11.3%, up from 7.9% in the same quarter last year. We are delivering on our income growth, cost reduction, and capital targets. Income was up 8.6%, costs were down 4.6%. Though we continue to expect an annual reduction of around 3%, and this resulted in positive jaws of 13.2%. Our CET1 ratio is now 15.2%, which includes £1.5 billion of distributions. As you know, we have committed to make annual dividend distributions of at least £1 billion this year. Our CET1 ratio includes an accrual of 250 million toward that commitment. And we made another directed buyback in March of 1.2 billion, bringing government ownership to around 48%, which is clearly an important milestone. We have also executed 377 million of the additional 750 million on-market buyback announced in February. We continue to focus on delivering our strategic plan and our targets. Despite the macroeconomic uncertainty, we are updating our income target as we now expect to deliver income that is comfortably above £11 billion, as a result of faster than assumed rate increases. As I said earlier, we plan to reduce costs by roughly 3%, both this year and next, taking into account cost inflation and our investment in the business as we continue strong cost discipline, and we are targeting a CET1 ratio of 13% to 14% with a return on tangible equity comfortably above 10% by 2023. So let me turn now to other ways in which we are supporting our customers to drive sustainable growth. We want to deepen relationships with existing customers by serving them at all the key stages in their lives, whether it's to buy a house, save for the future or set up and grow a business. We are also acquiring new customers by delivering a wider range of products and services more effectively across our franchises. For example, by successfully extending our asset management expertise to customers in retail as well as private banking, we increased our affluent investment customer base by 40% in 2021 and grew assets under management and administration by 17% to 35.6 billion in the same period. Total AUMA were down in the first quarter as they were impacted by market volatility, but net new inflows were up 33% on the first quarter last year at 800 million, and this included 137 million via digital platforms. In retail banking, we added 159,000 new current accounts during the first quarter this year, and we continue to invest in the SME ecosystem. As the leading bank for small and medium businesses, we offer both digital solutions, as well as an extensive network of locally based sector specialist relationship managers. As we build a comprehensive digital payments proposition for these businesses, the number of customers using our merchant acquiring platform till has more than doubled in each of the last three years. We are also diversifying our income through product innovation, such as our buy now, pay later proposition due to be launched this summer. Demand for buy now, pay later has grown rapidly since the start of the pandemic, and we want to provide a product that is both better and safer for our customers. A new proposition will offer fixed credit limits, clear structured repayments, credit scoring, and affordability checks, as well as the ability to keep track of payments on our mobile app. Unlike many providers, transactions will also be covered by all the protections customers expect from a fully regulated bank. Turning to Slide 7. This is the second year of our 3 billion pound investment program, 80% of which is being invested in data, digitization, and technology. The majority of our customers now interact with us digitally. 61% of retail customers are entirely digital, 90% of retail customer needs are met either online or by mobile, and 83% of customers in our commercial business use digital banking. We continue to make good progress on improving customer journeys. 79% of retail accounts are now opened with straight-through processing, and 99% of unsecured applications are fully automated, and commercial customers made 73,000 digital service requests in the first quarter, compared to just 6,000 in the whole of 2019. Our digital transformation is helping us acquire new customers. For example, our digital bank for business customers, Mettle, has gained 50,000 new customers since launch. And our acquisition of RoosterMoney last year, which provides families with an app that helps children to learn about managing money, added 130,000 new customers. Improving the customer experience has also resulted in a significant improvement in net promoter scores, with retail at 16, up from four in 2019, affluent at 26, up from minus two in 2019, and a business banking mobile NPS of 48. Of course, this improvement creates a virtuous circle which results in the acquisition of more new customers. Turning now to capital management on Slide 8. We continue to proactively manage capital at risk and have reduced the capital intensity of the business from 54% in 2019 to 48% in the first quarter this year. Our phased withdrawal from the Republic of Ireland is progressing, and we are pleased with what has been announced. We are also managing risk well with a low level of defaults and strong risk profile. 94% of our personal lending is secured and we are growing unsecured in a responsible way. 92% of our retail mortgage book is fixed with an average LTV of 54%, and we have a well-diversified corporate portfolio with limited exposure to at-risk sectors that we monitor closely. We are focusing on capital efficiency in order to maximize shareholder returns. And as I said earlier, we have booked total distributions in the quarter of 1.5 billion pounds for 2022. And with that, I'll hand over to Katie to take you through the results.
Katie Murray, CFO
Thank you, Alison. I'm going to talk about the performance of the Go-Forward Bank using the fourth quarter as a comparator. We reported total income of £3 billion for the first quarter, up 15.8% from the fourth. Within this, net interest income was up 5% at £2 billion, and non-interest income was up 46% to £964 million. Excluding all notable items, income was 2.8 billion, up 9.8% from the fourth quarter. Operating expenses fell 22% to 1.7 billion, driven by the absence of the annual UK Bank levy, lower conduct costs, and, of course, ongoing cost reduction. The net and payment release of £7 million compares to a release of £328 million in the fourth quarter. This reflects a continued low level of defaults and an increase in our post-model adjustment for economic uncertainty of £69 million due to increased cost of living and supply chain challenges our customers are facing. Taking all of this together, we reported operating profit before tax of 1.3 billion for the quarter. Attributable profit to ordinary shareholders was 841 million, equivalent to a return on tangible equity of 11.3%. I'll move on now to net interest income on Slide 11. Net interest income for the first quarter of 2 billion was 104 million higher than the fourth as a result of the higher UK base rates and strong lending. Net interest margin increased by 15 basis points to 246 basis points, driven by wider deposit margins, which added 22 basis points. This reflects the benefits of the higher UK base rates, which increased to 75 basis points on the 17th of March from 25 basis points at the start of the year and higher spot rates on our hedge deposits. Lower mortgage margins on the front book reduced them by four basis points and were partly offset by a positive mix in unsecured, which added two basis points. However, as you can see, these impacts were more than offset by higher personal deposit margins, and net interest margin in both retail banking and private banking has increased in the quarter. In commercial and institutional, changes in loan mix reduced bank NIM by three basis points as growth was driven by lower-margin large corporates, while smaller businesses continue to repay. As in retail, wider commercial and institutional deposit margins more than offset this, and the CNI NIM increased in the quarter accordingly. Turning to the yield and cost trends on Slide 12, you will be familiar with this slide. But this quarter we have presented the customer loan and deposit rates for our new CNN — CNI franchise. I want to highlight two key points. First, commercial and institutional loan yields increased by eight basis points to 283, as the majority of these loans are variable rates with an automatic reprice. And secondly, deposit costs were broadly stable. We expect deposit costs to increase further in the second quarter, following rate changes taking place in April. Turning now to look at mortgage margin dynamics on Slide 13. The chart at the top will be familiar to you. However, we are now showing you quarterly average metrics for the group and not just retail banking. We have increased average customer mortgage rates by around 30 basis points in the first quarter. Of course, we also recognize there is considerable pressure from the swap curve. The average five-year swap increased by around 60 basis points in the quarter. Customer deposit rates, however, were broadly stable as customer rate changes only took effect in early April. This led to an increase in customer spreads, the difference between what we charge customers for their mortgage and what we pay for deposits. Of course, higher swap rates are good for hedge deposit income. As you know, we increased the product and other hedge notional by £39 billion to £185 billion during 2021, reflecting growth in customer deposits. In the first quarter, we increased this by a further 8 billion. If we assume deposits remain at the same level as the first quarter, then we expect this to increase by a further £5 billion over the next 12 months. The structural hedge yield of 72 basis points is up slightly from 71 in the fourth quarter. Moving on now to look at volumes on Slide 14. Gross loans increased by £6.6 billion or 1.9% in the quarter to £362 billion. In retail and private banking, mortgage lending grew by 2.8 billion or 1.5%, and unsecured balances increased by a further 100 million despite typical seasonality. In commercial and institutional, gross customer loans increased by £2.3 billion. This comprised £3 billion of growth in large corporate and institutional customers as a result of increased capital markets activity and higher facility utilization, as well as an increase of £500 million in invoice and asset financing within our commercial mid-market businesses. This growth was partially offset by the continued repayments on government lending schemes. I'd like to turn now to non-interest income on Slide 15. Non-interest income, excluding notable items, was £740 million, up 24% on the fourth quarter. Within this, income from trading and other activities increased fivefold to 205 million as we benefited from higher volatility in our currencies business and good issuance volumes in capital markets. Fees and commissions fell overall by 4% to 535 million, driven by normal seasonality. I will look on now to look at costs on Slide 16. Other operating expenses were 1.6 billion for the first quarter. That's down £78 million or 4.6% on the same period last year as we continue to work to meet our targets, which, as you know, is a reduction of around 3% for the full year. And I remind you that this will not be linear. Turning now to impairments on Slide 17. We're reporting a net impairment release for the Go-Forward Group of £7 million, compared to a release of £328 million or 37 basis points in the fourth quarter. This reflects a continuing low level of defaults across the group. We continue to see further improvements in underlying credit metrics in the good book with positive migration of stage two loans back to stage one driving ECL releases. However, we have decided to allocate these releases to our post-model adjustment for economic uncertainty, which increased by £69 million to £653 million, as we recognize our customers face both increased cost of living and supply chain challenges that are yet to impact the data. The economic assumptions we presented in February are unchanged and we include these on the slide appendix. We will update these in line with our usual practice in the second quarter. We continue to expect a loan impairment rates below 20 to 30 basis points in both '22 and '23.
Alison Rose, CEO
Thank you, Katie. We have delivered another strong set of results for the quarter. As a purpose-led bank focused on people, families, and businesses up and down the country, we are acutely aware of the challenges our customers face, and we continue to support them in every way we can in an uncertain environment. Despite the macroeconomic uncertainty, we remain well positioned with a diversified lending book, strong risk management, and an ongoing investment plan in digital transformation that underpins our growth plans. Our capital strength gives us the flexibility to invest for growth and consider other options that create value, as well as return capital to shareholders. And we remain fully committed to the targets we have set out today. Thank you very much, and we’ll now open it up for questions.
Operator, Operator
We'll take our first question from Aman Rakkar of Barclays. Please unmute and ask your question.
Aman Rakkar, Analyst
Good morning, Alison. Good morning, Katie. Hopefully, you can both hear me OK.
Alison Rose, CEO
We can. Yes.
Aman Rakkar, Analyst
Great. Thanks. I have a question on your revenue guide, first of all, and interest income, if I could. Could you help us understand the guide around comfortably in excess of £1 billion per month? And you were telling us that the year '21. But I guess it lends itself to quite a wide range. If I was to take 2022 consensus and bank the net interest income, I mean, that number should be about 11.5 billion, I think so. Any kind of refinement of that guidance would be really helpful. The second was on net interest income. You're clearly benefiting from a really rich tailwind in '22 from rate hikes supporting deposit income this year. If I could ask you to cast your gaze perhaps forward into '23. Ultimately, my question is, do you think net interest income can continue growing in '23? And as part of that, could you help us understand your expectations for the structural hedge in '22 or '23? I think that could be a nice tailwind for '23, and that's going to be an important defense against mortgage margin compression. Thank you very much.
Alison Rose, CEO
Great. Thank you, Will. I'll get Katie to take you through those in a little bit more detail. But I guess in terms of comfortably above, we are feeling much more confident in terms of those numbers. But, Katie, do you want to walk through those questions?
Katie Murray, CFO
Yes, definitely. I'll start by mentioning that the interest rate we are considering is one of the elements factored into our guidance. I am confident that our total income will exceed £11 billion. The extent to which it surpasses this figure depends on both the scale and the timing of U.K. base rate increases. Our estimate of comfortably above £11 billion assumes additional rises in the Bank of England base rate this year, reaching 1.25% in the fourth quarter of 2022. We observe that current market expectations for further increases exceed our own estimates, and we are incorporating two more rate hikes this year into our assumptions. Although this is lower than what the market anticipates, we are aware of the heightened uncertainties in the economy, and we feel secure at this level. We are actively managing both sides of the balance sheet and have experienced ongoing increases in deposits. In the first quarter, there was limited pass-through, which has positively impacted our guidance. However, I would mention that the last deposit rate change we observed in April reflected a 40% pass-through. There are also more attractive deposit options available to customers. The interest rate disclosures displayed are unchanged since the full year and will be updated again in the first half, but they provide a useful reference for potential impacts of rates exceeding our estimates. As for our projections, they are around 1.25%. I won’t provide an exact number, but it’s important to understand that the rapid rate increases in the first quarter and the lower-than-expected pass-through of those rates have influenced our additional revenue guidance compared to our expectations from February. In terms of the structural hedge, it is definitely beneficial as we progress. You can see that the yield rose slightly from 71 to 72 for the entire portfolio, a small yet significant change, indicating the benefits now reflected in our figures. When comparing where we are with the structural hedge now versus before, the rates are significantly more favorable. A year ago, it was around 20 basis points; now, it’s over 200 basis points. This is a positive development as we move forward. We added £8 billion in the quarter and plan to add another £5 billion over the next year if deposit levels remain stable. While we haven't seen explosive growth in deposits, the increase has not ceased, which provides a basis for optimism. I’m not going to make any predictions about net interest income for 2023, but you can rely on our interest rate guidance to navigate from there.
Aman Rakkar, Analyst
Sorry for the echo in my line.
Operator, Operator
Thank you very much. And our next question comes from Andrew Coombs of Citi. Andrew, if you could please unmute and go ahead.
Andrew Coombs, Analyst
Good morning. Can you hear me?
Alison Rose, CEO
Yes. Good morning. We can hear you. Hi, Andrew.
Andrew Coombs, Analyst
Yes. Hi. Good morning. A couple questions for me. First basically is a simple one which is given the AIB announcement today with another 6 billion of trackers moving across. Is that change any of your guidance on Ulster Bank in terms of withdrawal, costs, disposal losses, and so forth? And second question on capital, and you've seen the direct buyback already, you've still got a couple of billion of excess capital, in fact, 14% on ratio and you're still guiding to get to 40% by the year-end. On Slide 30, you flag a couple of moving parts, regulation, and dividend in pension contribution. But perhaps you could just give us a bill for what this implies for buybacks, in your view, because aside from that, I don't think there's any other major capital charges to come through from here. So can we look at that 2 billion of excess capital you have today as on market buyback potential?
Alison Rose, CEO
Great. Thanks. And you will let me take the Irish question. No change to guidance, obviously. Really pleased with the announcements today. And I think just continuing progress with our guidance on costs and disposals remain unchanged. But I think good momentum there and pleased we could announce that today. Katie, do you want to pick up the second question?
Katie Murray, CFO
Buybacks? I know. Absolutely. So look, as you know, there's kind of four ways that we can distribute capital. It's a combination of the ordinary special dividend. So we said it's a minimum of a billion for '22 and '23 buybacks. We're halfway through the buyback that we announced in February. So we're pleased with the level of liquidity that we've seen in the stock, this enables us to kind of progress that quite quickly. And I would remind you that we reflected that in our year-end numbers. So we like buybacks. They work well, they make good economic sense for our balance sheet, and that's something that I think you could anticipate that we would continue to utilize. Clearly, decisions were made by the board at the right time in terms of that piece, we've obviously done the right to buyback with the government so that window’s closed, now, as you all know, for the rest of this year.
Operator, Operator
Thank you very much. Next question comes from Rahul Sinha of J.P. Morgan. Rahul, if you could please unmute and go ahead.
Rahul Sinha, Analyst
Hi. Good morning. Can you hear me, Katie?
Katie Murray, CFO
Yes. Fine. We can hear you.
Rahul Sinha, Analyst
I was hoping to get more details on your 40% pass-through point. Can you tell us about the deposit beta assumptions for both retail and commercial deposits separately? I'm interested in how the margin evolution is split between the two divisions and how you expect the commercial pass-through to differ from the retail side in relation to the 40% pass-through. That’s my first question. My second question is for Allison. I believe you mentioned you would explore options to create value beyond capital return, potentially through acquisitions. You've been clear on this in previous calls, but I'm curious if there has been any change in your thinking about areas where additional value could be created. I'd like to know what areas you believe could benefit from bolt-on M&A. Thank you.
Alison Rose, CEO
Great. Thank you. On the M&A, no change to my approach as my preference is distribution to shareholders. If there's anything of compelling shareholder value and strategic rationale, then we would look at that. I think if you look at what we've done so far, things like the metro mortgage book or we recently raised money which was aligned with our strategy. So there's a pretty high bar of things that we would look at. It's got to be compelling shareholder value, but our preference remains distributions, and we have, obviously, the very strong position where in that I'm able to invest in the business with the 3 billion investment program, continue to drive positive jaws with operating leverage and have a strong distribution story, and then look at other things that are compelling. So no evolution beyond what I've told you before. Katie, do you want to pick up the pass-through point?
Katie Murray, CFO
Absolutely, Rahul. It's really dependent on what's happening in the market. Let me provide a more detailed perspective. When we discussed the sensitivity earlier, we built it from the ground up, taking into account various pass-through assumptions for different products across all franchises. Those assumptions have changed as rates increased. The actual pass-through rate will rely on liquidity levels and the current market conditions, including expectations regarding the pace and number of rate hikes. In the first quarter, we had two rate increases. We implemented a rate change in March that took effect in April, which represented 40% of the most recent rate increase or about 20% of the first two combined. This distinction is significant because it really depends on the market dynamics and how much liquidity is present. Additionally, when examining the book, we need to consider the ratio of fixed to variable components. In retail banking, most of our loans are fixed rate, so they are unaffected by these changes. For CNI loans, we see a reference rate that adjusts immediately, allowing us to benefit. However, for deposits, nearly all of our retail and corporate deposit rates are managed, meaning there aren’t automatic adjustments based on external rate changes. Our retail banking deposits total between 187 and 189 billion, with 40% in current accounts and 60% in savings accounts, averaging a cost of five basis points in the first quarter. We expect a slight increase in the second quarter due to the changes. For CNI, the average cost is two basis points, which we will manage going forward. If you're a consumer seeking a better rate, we offer an attractive digital account with a 3.25% interest rate, and in business banking, there’s an enhanced account option yielding around 40 basis points. So there are options available, but we continuously assess the market and our customers’ needs.
Operator, Operator
Thank you. Our next question comes from Omar Keenan from Credit Suisse. If you could please unmute and go ahead.
Omar Keenan, Analyst
I have two questions. The first is a broader inquiry regarding the outlook on interest rates and asset quality. I understand that your revenue guidance is based on Bank of England base rates being at 1.25% by year-end. Current expectations suggest that these rates could rise to around 2.5% in a year and stabilize at about 2% in three years. This raises a challenging question: at what interest rate level do you believe the through-the-cycle guidance might be at risk? Many people seem to struggle with understanding when higher interest rates might shift from being a positive to a negative influence. My second question pertains to NatWest markets. I appreciate the ongoing updates regarding NatWest markets. It's clear that revenues have increased year-over-year, and it appears that some benefits from capital management units and funding costs are starting to emerge, yet fixed income revenues are still facing challenges. Could you provide an update on the restructuring of NatWest markets? Additionally, with 150 million in revenues reported, can we expect this level to be sustainable on a quarterly basis moving forward?
Katie Murray, CFO
Okay, great. Well, thanks for the question. So, on NatWest market, I think what I talked about is we would expect to see a sort of stabilization of the performance of that business on the restructuring of NatWest markets that's largely complete, we've made all the decisions around products and capital and the businesses are very much on the front foot now in terms of growing. I think coming into Q1 NatWest markets has had a strong quarter, total income of 219, I think the disclosure, and as we said, we would keep showing you the performance there, shows that both capital markets and currencies had good performance increasing by 64% and 34%, respectively. In terms of the rates business, I would categorize it as the start of the year pre that extreme volatility we saw created by the geopolitical events. So it started well and had a more difficult environment as a result of the volatility from Ukraine, and a small loss. But overall, I'm very happy with the performance of NatWest markets. And I think if you look at it from the three business lines, it's up 15% versus Q1 ‘21. So I think we're very comfortable that the business managed well during the volatility, and I'm really pleased with the refocusing. So I think we would expect that business, obviously, it has different movements throughout the year, but I think that stabilization I talked to, restructuring largely complete, it's performing well. On your interest rate and asset quality point, I think in terms of interest rate rises and at what point does it become a negative, very, very significantly higher than any of the forecast on interest rates, and what we can see when we look through both leverage that's sitting with our customers and the level of liquidity, we have no concerns from a credit perspective caused by interest rates at these levels or forecast levels. I think as I look at it, our book is largely secured, good quality. You can see our RWA intensity continues to reduce and we actively manage the capital, but we are not seeing the interest rate rises as anything that would cause us a concern on credit events across our work. And so we're very comfortable with our through the cycle guidance that we gave you.
Operator, Operator
Next question comes from Guy Stebbings of Exane B&P Paribas.
Guy Stebbings, Analyst
Hi, good morning. The first one is back on the above 11 billion guidance. And if I take your rate assumptions and the rate sensitivity and where we start from today, I'm deriving an I figure approaching 9 billion this year. Net fees and commissions were up 10% year-over-year in Q1. And guessing that might moderate call it, 5% or so, that's another 2.2 to get to that 11 billion just from that. And then trading other income was 200 billion in Q1, one would hope that grows over the year. So it looks like you could end up near a 12 billion and 11 billion, even on some pretty conservative assumptions. Am I missing something or is this just conservative, which is understandable given the very uncertain environment? Then I have a follow-up just specifically on sort of managed margin. If I talk assets spread compression to one side and focus on the tailwinds that you outlined in Slide 11, I mean the benefits from managed margin look to be roughly doubling scale what was captured in the rate sensitivity explosion, just wondering how much we should be tempering that sort of benefit on future heights as you pass on most depositors? I think you mentioned the change in the income guidance reflected lower pass through today and quicker hikes. But I'm guessing your assumption around deposit with some future heights hasn't changed, perhaps. Thanks.
Alison Rose, CEO
Thanks. Regarding your first point, I believe Katie's response addresses it well, and the assumptions we've made about interest rates and the mix look good. We feel quite confident about that number, which is why we've made a slight adjustment. Katie, would you like to add anything?
Katie Murray, CFO
I believe the next point to consider is that we are currently at 125 basis points. Our assumptions regarding pass-through effects prior to this are already accounted for. If I assume that the forward curve is where we will eventually land, it leans more towards the two and a half pieces. We've provided guidance on the managed margin aspect, which we discussed in February, and that was already based on expectations exceeding 100 basis points. This means we have reached a normalized level of pass-through. This information can help you gauge how much further we might go, particularly if we exceed our guidance, as market consensus might suggest. However, we will need to monitor how the year unfolds.
Guy Stebbings, Analyst
Can I come back briefly on other operating income, as it was down quarter-over-quarter? I think we may have overlooked seasonality during COVID due to some distortions, but it was up 10% year-over-year. Will that 10% be tempered as the base gets tougher later in the year? Ultimately, we are seeing good underlying momentum in other operating income now. If we adjust for seasonality, is that correct?
Katie Murray, CFO
Yes, I think what we're seeing is good kind of recovery in the underlying kind of businesses, and there is always a little bit of seasonality in that Q1. So there's nothing to read into that. So I'll leave you to make your own view on the 10%. So I'm not going to be commenting on that specifically, but if I just look even at the slides on 15, you can see that the Q1 is often that little bit lower.
Operator, Operator
Our next question comes from Jonathan Pierce of Numis.
Jonathan Pierce, Analyst
I've got two questions. The first one is on this pass-through comment, again. Apologies to come back to this. Just slightly surprised that you're talking about a 40% pass-through on the latest rate hike, if I've understood you correctly. I mean, we can see you've pushed ICE rates up by that 10 bps in some of the business, reserve account by about 10 bps, but most of the other bigger portfolios look to be unchanged. Can I just make sure I understand what this pass-through rate is being applied to? You've got 465 billion in deposits in the Go-Forward Bank? You're hedging about 193 of those now. So maybe there's 250 billion unhedged. Is that what you're referencing when you talk about a 40% pass-through, so you'd pass-through 40% of the latest 25 basis point hike to 250 billion of balances? Is that how I should think about it?
Katie Murray, CFO
Can I just add to that quite quickly, Allison, in terms of that. So I think the one you've missed is the main retail instance saver change, and it's up 10 basis points in terms of that. So obviously no change on current accounts. And then you saw across our various savings accounts, different changes. The main one you've not picked up on is the retail saver change, and that went up.
Jonathan Pierce, Analyst
I may have missed that. It’s on the website, I think it was still talking about one, but that's one up to 10 basis.
Katie Murray, CFO
So that's it. I apologize for any confusion regarding the websites. The changes will take effect in early April, so it should be updated then. We'll ensure someone follows up on that point. But that’s the key update you missed. If I analyze the situation, there isn't anything fundamentally obstructing progress. Regarding the capital hedge, it might still present a slight challenge, but we anticipate further improvement as time goes on. The hedging will be evident in a gradual manner, especially over the one, two, and three-year timelines. The first year's impact will be quite mild, with growth expected in the second and third years. It's also worth noting that the timing of implementation in recent years can create some variability. However, there are no major concerns, and you will notice an upward trend.
Operator, Operator
Our next question comes from Ed Firth of KBW.
Ed Firth, Analyst
I would like to revisit the topic of credit. This seems to be a challenge for many of us. When I look at Sterling, it stands at 125. Your share prices suggest there is an expectation of some significant downturn. I heard your initial remarks regarding the cost of living and acknowledged that people are under pressure. However, regarding interest rates, it appears that you suggest there is no concern at all, as rates of 2%, 2.5%, or 3% don't seem to make a difference. I'm genuinely struggling to reconcile this with the general narrative in the sector, where leadership indicates there are no worries, yet the market suggests otherwise. Can you clarify what scenario would cause you to feel concerned? At what point would you consider that a credit downturn may occur, requiring you to adopt a more cautious lending approach and increase provisions? I noticed that your non-performing loans have risen slightly, even when excluding the regulatory adjustments. I'm curious if this increase is related to any specific factor. Please help us understand the apparent conflict between these two perspectives.
Alison Rose, CEO
Let me clarify. When we examine our portfolio, we see that we primarily operate with a prime book that is largely secured. The shape of the book is significant, and currently, we are not observing any concerning trends in the market based on leading indicators. Specifically, we’re not seeing increased calls to our financial health and support lines, requests for deferments, or any movements indicating heightened monitoring or increased drawdowns on credit cards or overdrafts. Additionally, there is a substantial amount of cash, approximately £186 billion, that has accumulated in people’s savings and deposit accounts since the pandemic, and consumer debt has decreased by £26 billion. This indicates that liquidity is present across corporate balance sheets as well, and we are not noticing any signs of distress. However, we remain attentive to concerns regarding the cost of living, inflation, and supply chain issues. While we are proactively managing these challenges, there are no indicators of distress at this time. In terms of our portfolio management, the primary factor we monitor is unemployment, which currently remains high. An increase in unemployment would likely impact affordability and lead to credit migration. When considering expected credit losses, unemployment is the key factor. While interest rates are fluctuating, they are not expected to significantly impact credit impairment, and our book appears to be in good shape. Therefore, focusing on unemployment will be crucial. We are committed to supporting our customers actively through our teams and relationship managers, but we have yet to see any signs of distress. Unemployment remains the focal point of our attention.
Ed Firth, Analyst
Yeah. No, that's very helpful. But, so in your internal modeling, et cetera, then do you have a sense at what level interest rates would have to be for unemployment to start going up, because I guess there will be a correlation at some point?
Alison Rose, CEO
I believe that when we analyze the book unit, interest rates play a significant role in affordability, which will impact it. Unemployment is also a factor in affordability. If unemployment increases and people are not receiving wages or salaries, that will certainly create challenges. However, when we consider the cash reserves that have been accumulated and the overall level of liquidity that exists on corporate balance sheets and within businesses, we see that it is quite substantial. For instance, in our small business banking sector, 50% of our small business customers are on fixed rates. Many of the bounce back loans are also on fixed rates, and a large proportion of our mortgages are fixed as well. Therefore, while rising interest rates will influence affordability, the impact of unemployment will be much more significant. At this moment, we are not worried about interest rates adversely affecting affordability.
Katie Murray, CFO
And I think, Alison, the only one thing I would add is just to repeat our guidance. What we have said to you is, we expect our impairment charge to be below our 20% to 30% through the guidance in 2022 and 2023. So, while we recognize the cost of living crisis, what we think in terms of the level provisions we have and where we are, it's not something we are expecting to manifest, particularly in our own impairment rates.
Operator, Operator
Thank you. And next question comes from Rob Noble of Deutsche Bank. Please unmute and go ahead.
Rob Noble, Analyst
Good morning everyone, I appreciate you taking my questions. Regarding inflation, is the underlying cost performing as you expected, or is higher inflation putting pressure on your cost targets for this year? I understand you mentioned that interest rates don't pose a concern for credit, but you did make a post-model adjustment for cost of living and inflation. Which areas of your financials are you most apprehensive about? How does inflation negatively affect your revenues? Furthermore, you mentioned that people have considerable excess savings, but there is a cautious perspective in the UK that these savings are predominantly held by wealthier individuals and corporations with liquid assets. Do you have data on what proportion of your customers are actually holding these excess deposits?
Alison Rose, CEO
So let me start on the costs question. Yes, costs are performing as we expect them to. We've taken out 78 million or 4.6%. And so we are very comfortable. We're on track for the 3%. We obviously considered inflation when we set our cost target and we remain comfortable with the 3%. I've always said this, the costs will not be linear. The takeout will not be linear. I know last year I said that as well, and everyone still times the first quarter by four. So our guidance is 3%, but the cost performance is performing as we expect it to. Katie, do you want to pick up the next question?
Katie Murray, CFO
Yes, I understand the contrast between below 20% and 30% basis points guidance. Katie, you've set aside £69 million in your PMAs due to the cost of living and supply chain issues. I see this as a cautious step as we assess the situation. While it's not a large amount, we believe it's wise to be careful at this stage. We will provide updates on economic conditions in Q2 and revert to a more standard consensus. For now, we aren't overly worried. Inflation is reflected in our projections, but it’s just one of many factors we consider. We've tested our assumptions against current economic conditions and feel comfortable with them, but we decided to hold back a bit. It's not a significant figure. Regarding excess savings, they are concentrated among the wealthy but are also distributed across our retail and small business sectors, which accounts for our slight increase. In an inflationary environment, discretionary spending is affected first. We've focused on managing our retail real estate and leisure exposures to mitigate impacts. Although we are not immune to the effects of the cost of living crisis, our lending clientele is not the most severely impacted. We must remain vigilant, with a particular focus on unemployment, which currently shows strong statistics in the UK.
Operator, Operator
Thank you. Our next question comes from Chris Cant of Autonomous.
Chris Cant, Analyst
Good morning. Thanks for taking my questions. If I could come back to NII please. So if I think about your NII run rate, it's about 8.2 billion for the quarter, and the average change in rates that we saw that generated something like a 730 million benefit based on the deposit margin improvements you show us in the slides. So if I trim that down for the most recent 25 bps and assume the 40% pass-through that you've indicated, even allowing for a bit of incremental mortgage pressure. And I think it was 4 bps on average for the quarter, so maybe another two to get to the end of the quarter. It feels like your NII exit run rate at March coming into April would've been about 8.5 billion, and that's before we have any further rate hikes, am I missing something there? Because I'm trying to think about this in the context of your comfortably above 11 as with some of the other questions, it feels like it could quite easily be close to 12 if market rate expectations prove to be correct. And I appreciate what you said on the 1.25, but just in terms of where you actually were as of March, is that about the right level at sort of an 8.5 billion annualized run rate for NII in the Go-Forward bank? And I had a question on NatWest markets as well if that's okay.
Katie Murray, CFO
Let me address this first, and then we can return to the market discussions. From our perspective, Chris, we are comfortably above where consensus estimates sit at 8.2, and we believe we can push a bit further than our previous position. We have seen slightly faster rates coming through. We have incorporated the interest rate increase into our deposits, and you understand the difference between deposits and current accounts, which affects our costs. We anticipate two more rate hikes ahead, with the last one expected by Q4. Consensus views this differently. Considering your timing, we are thinking of maintaining a level comfortably above 11. I won't provide an exact figure, but it is promising to see our optimistic outlook for the year and the ongoing income we are generating as we progress. Would you like to ask your question regarding NatWest markets?
Chris Cant, Analyst
Yes. You've mentioned that the volatility in rates caught you off guard. Are you anticipating that the rates business will generate a positive revenue figure in the upcoming quarters, assuming there's no further unexpected volatility? I'm not looking for a prediction of a large revenue increase, but will the rates business stop being a loss in the near future? It has experienced a series of poor quarters, and since you indicated that the restructuring is complete, I assume you expect the business to begin generating some positive revenue soon. Thank you.
Alison Rose, CEO
Thanks. So I think that the volatility was managed really well by the NatWest markets team. My reference to the volatility was as a result of the invasion of Ukraine; you saw very extreme volatility in the market and our team managed that volatility very well. I'm very pleased with the performance of the rates business as I said to you in Q3 and Q4. It was a disappointing performance in a combination of market and us doing the restructuring. The restructuring is complete. That business has stabilized. You can see the contribution from NatWest markets into this quarter. And the rates business has continued to trend and perform positively. So it is not loss-making, and I don't expect it to be loss-making. So I think that stabilization I expect is there. I didn't actually forecast the volatility in the market caused by the invasion, but the team handled it very well, and we have a much less volatile business as a result of the restructuring we've completed. So I'm very comfortable with how that business is performing.
Katie Murray, CFO
And I think, Alison, if you look at our accounts in capital markets, they increased their income by over 200 million in the quarter. I think we're pretty pleased with how they've managed volatility; it's benefited them overall.
Chris Cant, Analyst
If I could just ask one follow-up on the first question. If I put it slightly differently, what was your exit NIM for Q1, please? The 246 is obviously a period average, what was your exit now?
Katie Murray, CFO
I provided a lot of information and various figures about exits, and I believe we should focus on what I've shared. I won't disclose the exit NIM at this moment. In terms of NIM for the entire year, we certainly expect it to keep increasing. Considering the anticipated rate hikes, which include two more, I expect to see further improvements as we experience a full quarter of their impact. Our deposit base is both strong and growing, which is beneficial. I've mentioned how much more we'll add to the structural hedge, allowing you to calculate the additional benefits from ongoing rate increases. However, I prefer not to discuss exit NIM, as I believe it could complicate things in the coming quarters. Overall, we are very satisfied with our performance.
Operator, Operator
Our next question comes from Martin Leitgeb of Goldman Sachs.
Martin Leitgeb, Analyst
Thank you for taking my question and congratulations to the good set of numbers. First of all, I wanted to ask on mortgage pricing, and in the release, you stated application margins have fallen around 44 basis points in the quarter down from around 67 in the prior period. And I was just wondering if you could comment a little bit on the outlook for mortgage pricing here. Are you comfortable writing business at this level? Would you expect some of this pricing normalizes and bounces back as banks increasingly pass on swap rates? Or could there be a scenario that banks just are more on the liability side, liability margins, and that we could be heading into this kind of new normal here in terms of mortgage pricing? Thank you.
Katie Murray, CFO
Thanks for asking. I was willing to worry we weren't going to get to mortgages at all on the call. So thanks for bringing up. Let me talk about the mortgages specifically and we can do any follow-up if you need more a bit. So as we highlighted in our group, and then we increased by 15 basis points, and our retail bank NIM increased by 16 basis points in Q1. We expect to continue to see that NIM expansion based on the interest rate assumptions and market consensus as well, based on the rate sensitivities we've talked about a lot on the call. But I guess all of that said, our mortgage application margins at 44 basis points for the quarter are not where we want them to be and are below what we consider a sustainable level despite the overall profitability improvements that you see in retail, and the group. So I think you shouldn't expect to see our application margins remain at these low levels. We don't have a lot of appetite to write business at this level for sustained periods of time. The market conditions in Q1 were exceptional, with swaps increasing very steeply in the latter part of January and then through the rest of the quarter. In response to that, we increased our mortgage pricing 12 times in the quarter, increasing customer rates by over 50 basis points in Q1 and by over 100 basis points since mid of Q4. However, that still was not enough to keep pace in terms of the movements we were seeing in the swap curve. So as I've said, we don't see these levels of sustainable for long periods of time. And you should expect to see us continue to kind of price up. If I look at the Q2 application margins, I'm comfortable that they are going to continue to improve as we move forward. And we've stated doing more holistically, there are clearly large positives to the rate environment which more than offset this pressure overall, not least the rollover of the structural hedge, which we've talked about, the benefits, the swap increases there, another that puts pressure on the mortgage application. That combined with the base rate rises, it's something that’s very positive for us. And the business overall, are under 23% ROE, even on the basis of their uplifted M capital. So clearly a very strong in there, but we would expect to continue to kind of price up to work to a more kind of normalized level. And I think we're kind of aiming for Q2 margins in the 60s, for the group in terms of those applications. So you should start to see them come through.
Operator, Operator
Our next question comes from Robin Down of HSBC.
Robin Down, Analyst
I got one question, one request. Maybe if I start with the request first, which is obviously with the cost of living crisis. I think, one of the key elements is that it feels like it's the low income households who are going to be most impacted. And I just request that maybe in future, you give us a bit of a demographic breakdown, maybe of your mortgage book in terms of kind of income levels. Any kind of FICO scores you've got for the credit card book might just make it easier for us to see kind of where your customer base is positioned relative to those low-income households. Coming on to the question. Can we come back to the 40% deposit beta? I just wondered what the rationale was for raising rates. And I appreciate this, there'll be a number of factors that go into that. But is that to do with you seeing kind of deposit flow slowing during the quarter? Or do you feel there's some kind of political pressure to kind of raise rates? I'm just curious as to what the sort of fundamental drivers were to decide to raise rates? Because otherwise, we haven't really seen that, I think, elsewhere from your peers.
Alison Rose, CEO
Well, just on our customer base, one of the things I would say is, we're a large lender, so our demographics largely reflect the UK, but if you look at the diversification of risk on our book, it is well diversified and like a predominantly secured book. We're relatively low and unsecured and we're a prime book, and you can see the shape of that. And also, what we can see as it's been very, very resilient in terms of its performance. So we're very comfortable with where we sit. We're also very active with our customer base in terms of helping them manage the challenges, but I would look at the risk diversification.
Katie Murray, CFO
In terms of the deposit, I think it's important. There has been a 65 basis points hike. Our deposit franchise is incredibly valuable to us, and in reality, we've passed through 10 of that 65 basis points hike. We believe it's the right approach. It's an important franchise. If you look at our overall cost of funding, it's still very low. So I don't have much more to add beyond that. Thanks.
Robin Down, Analyst
Can I just come back on the mortgage point? I think, what the demographic data shows is that, the low-income households don't have a great deal of mortgage borrowing. But it would be nice to be able to see that if you like, within your kind of data disclosures. So if we could see kind of medium income levels, for instance, for your mortgage customer base, that would be kind of helpful just going forwards. But, maybe it's something I can take offline with the IR guys.
Katie Murray, CFO
No. I mean, Robin, very happy to have a chat with you on one-to-one. I mean, always happy to look at requests. I think we do and you recognize this as in good disclosures of a lot of information. But I know you have been doing a lot of work on this, so very happy to have a conversation offline on it.
Operator, Operator
Thank you very much. And I would now like to hand back to Alison for any closing comments. Alison, over to you.
Alison Rose, CEO
Thank you. We are very pleased with our strong performance this quarter. We have consistently delivered on our plans, showing growth in income and adhering to our cost reduction strategies. Our capital base is robust, and we have a clear plan for distribution and strong performance ratings. We are confident in the risk diversification of our portfolio. While we acknowledge the challenges faced by our customers, we see no signs of defaults or distress in our portfolio, which remains well-diversified and well-managed. We have slightly strengthened our income guidance to provide more assurance on our outlook. Both income and profits have significantly increased compared to last year, coupled with strong capital and growth across our diversified loan portfolio. The strategic capital restructurings in our West market have performed well, with the restructuring concluding at the end of the year. Additionally, our Irish business shows continued momentum, with nearly 90% of assets allocated and agreed for sale. We are dedicated to supporting our customers through these economic challenges.