Earnings Call Transcript - NWG Q2 2023

Operator, Operator

Good morning and welcome to the NatWest Group H1 Results 2023 Management Presentation. Today's presentation will be hosted by Chairman, Howard Davis and CFO, Katie Murray. After the presentation, we will open up for questions. Howard, please go ahead.

Howard Davis, Chairman

Good morning. And thank you for joining us today. I'll start with a short introduction before Katie takes you through our financial performance. On Wednesday, we announced that Alison Rose had agreed with the Board to step down as Chief Executive with immediate effect by mutual consent. It was a sad moment. She has dedicated all her working life to date to NatWest and leaves many colleagues who respect and admire her greatly. Subject to regulatory approval, the Board has appointed Paul, the current CEO of our commercial and institutional business, as Interim Group Chief Executive. Before Paul became CEO of our commercial institutional business, he led the Group's commercial banking division. He is a very experienced banker with a track record of success in senior roles in wholesale corporate, international, retail banking and risk, and has worked across the U.K., in Europe, and in the U.S. He has been a member of our executive committee since 2019 and has played an important role in delivering our current strategy, which remains unchanged. Paul will present the results from Q3 onwards and looks forward to meeting investors on a one-to-one basis in the near future. The Board began the process of appointing my successor in April, as I will have been in post for nine years by July 2024, the maximum recommended tenure under the U.K. corporate governance code. My successor will be responsible for leading the process to select a permanent CEO, and we fully expect Paul to take part in that process. With that, I'll hand it over to Katie to run through the results.

Katie Murray, CFO

Thank you, Howard. The business continues to perform well, and we have delivered a strong first half, with growth in lending of £6 billion and new customer acquisition in key areas. We delivered first half operating profits of £3.6 billion and attributable profit of £2.3 billion. Income grew to £7.4 billion, and costs were £3.8 billion. Our strong capital generation gives us flexibility to invest in the business, consider other value-creating strategic options, and return capital to shareholders. We are proposing an interim dividend this year of 5.5 pence, up from 3.5 pence last year. We have completed the £800 million on-market buyback, which started in February. Today, we are announcing another own-market buyback of up to £500 million, which we expect to start next week. Together with a directed buyback of £1.3 billion in May, this brings our CET1 ratio to 13.5%, within our target range of 13% to 14% for the first time. Our return on tangible equity was 18.2%. We have updated our economic forecasting since we last spoke. Although the U.K. economy has been stronger than expected, inflation remains relatively high, and rates have continued to rise, resulting in ongoing economic uncertainty. We now expect peak rates of 5.5% this year, up from 4.25% in our previous forecast. We are also seeing liquidity in the banking system introduced. In the face of ongoing inflation and rising interest rates, customers are behaving rationally; corporates are deleveraging, and overall demand for borrowing is muted. We are seeing customers adjust their spending habits, and some are using deposits to pay down more expensive debt. Given the macroeconomic environment and higher rates, we've taken the decision to strengthen payment reserves by around £210 million. Against this backdrop, our strong balance sheet is more important than ever, with robust liquidity, a high-quality deposit base and a well-diversified loan book, enabling us to continue to support our customers and fuel the U.K. economy. I'll now take you through the second quarter performance using the first quarter as a comparator on Slide six. Total income was stable at £3.9 billion. Income excluding all notable items was £3.6 billion, down 6.7%. Within this, net interest income was 2.7% lower at £2.8 billion and non-interest income was down 19.5% at £739 million. Operating expenses fell 3.1% to £1.9 billion. The impairment charge increased to £153 million or 16 basis points of loans driven by higher post-model adjustments. Taking all of this together, we delivered an operating profit before tax of £1.8 billion. We incurred some notable charges bringing the profit attributable to ordinary shareholders to £1 billion, and return on tangible equity was 16.4%. We are pleased to have delivered further net lending growth in the quarter. Gross loans to customers across our three businesses increased by £0.3 billion to £356 billion. Taking retail banking together with private banking, mortgage balances grew by £1.9 billion or 1% in the quarter. Gross new lending was £8 billion, representing flow share of around 15%. Our stock share has increased from 12.3% at the start of the year to 12.6%, demonstrating how we are delivering on our growth strategy. Given volatility in swap rates during the quarter, our average application margin was below our intended range of around 80 basis points. However, we are back at this level at the beginning of July, as we have repriced customer rates. Unsecured balances increased by a further £600 million to £15 billion, driven by additional card issuance and ongoing share gains. In commercial and institutional, gross customer loans decreased by £2.3 billion. At the mid to large end, we saw some demand for asset finance and revolving credit facilities; at the smaller end, demand does remain muted. Customers with surplus liquidity continue to deleverage, including repayment of government scheme lending. Let me now turn to deposits on Slide eight. Customer deposits across our three businesses were stable in the quarter at £421 billion. As expected, outflows in retail banking and private banking slowed following tax payments made in the first quarter. In commercial and institutional, deposits increased by £1 billion. Our loan-to-deposit ratio of 83% allows us to manage our deposit base for value, and importantly, allows us to support customers and grow our share in target areas. The U.K. base rate has increased by 75 basis points to 5% since we presented Q1 results, and customers are increasingly moving balances from non-interest bearing to term accounts. Non-interest bearing balances have reduced from around 40% of the total to 37%. Term deposits are now 11% of the total, up from 6% at the beginning of the year. Customer behavior is difficult to predict; however, we do assume some level of ongoing migration. Turning now to what this means for income on Slide nine. Income excluding notable items was £3.6 billion, down 6.7% on Q1. Net interest income was 2.7% lower at £2.8 billion driven by lower bank NIM in the quarter of 3.13%, driven by lower margins on mortgages and deposits and lower group average interest-earning assets which reduced by 1.5% to £514 billion driven by a reduction of liquid assets, which more than offset loan growth. You will find our usual disclosure on net interest income in the appendix. Non-interest income excluding notable items was down £179 million to £739 million. Around half of this was due to lower market volatility. We continue to expect full-year income excluding notable items of around £14.8 billion. However, we now expect bank net interest margin of around 3.15%, down from 3.2%. This assumes the U.K. base rate increases by a further 50 basis points in Q3 to 5.5% and remains there for the rest of the year, with the average reinvestment rate of our product structural hedge for the full year at 4.4%, up from 3.6%. The benefit from higher rates bank NIM is more than offset by our expectation of further deposit mix changes and a reduction in the product hedged notional from £202 billion to around £190 billion by the year end, reflecting a catch-up with eligible spot deposit balances. Moving on to costs on Slide 10. Other operating expenses were £1.9 billion for the second quarter. That's down £57 million or 3% on the first quarter, driven by lower severance and consultancy costs. In Ulster Bank, we have incurred £163 million of direct costs in the first half. We continue to guide to around £300 million for the full year. We continue to expect other operating costs of around £7.6 billion for the full year in line with our guidance. This cost performance is delivering a cost income ratio of 49.3% for the first half, benefiting from the notable income gains. Excluding these, the cost income ratio is 51.6%. I'd like to turn now to impairments on Slide 11. We booked a net impairment charge of £153 million in the second quarter, equivalent to 16 basis points of loans on an annualized basis. This was driven by an increase in our post-model adjustment for economic uncertainty of £129 million to £462 million, together with further reserve building that more than offset the £98 million expected credit loss release from the update to our economic assumptions. The PMA increase is largely against our wholesale book to cover potential cash flow issues as a result of higher interest rates and inflation. Excluding this, we would have had further net impairment releases in our commercial and institutional business. In retail, overall, Stage 3 charges and defaults remain stable. The impairment charge driven by new Day 1 provisions relates to unsecured lending growth. Our 2023 impairment guidance is 20 to 30 basis points; we see this as prudent and we need to see a material deterioration in performance to be inside this range. I'd like to talk a bit more about the composition and quality of our loan book on Slide 12. We have a well-diversified prime loan book, which is performing well and which demonstrated its resilience in the recent Bank of England stress tests. Over 50% of our Group lending consists of mortgages, where the average loan to value is 55%, or 69% on new business. We continue to have low levels of arrears and forbearance in our mortgage book; 91% of our book is fixed, 5% are trackers, and 4% is on a standard variable rate. Over two-thirds of mortgage balances are fixed for five years, and less than a quarter are fixed for two. The composition of our mortgage book means a lower proportion of our customers will face a change to their mortgage repayments in the second half relative to the sector average. The majority of our customers are rolling off five-year fixed rates, where the uplift is lower than those rolling off two-year rates. Since mortgage rates began to rise in Q4 last year, more than 70% of our customers in the pre-roll-off window have taken advantage of the opportunity to refinance early and had the advantage of lower rates. Our personal unsecured exposure is less than 4% of Group lending and is performing in line with expectations. Our corporate book is well diversified, and we have brought down concentration risk over the past decade, including reducing commercial real estate, which is less than 5% of the group loans with an average loan to value of 48%. As one of the largest lenders to business in the U.K., we were pleased to see in the Bank of England's recent financial stability report recognized that corporate indebtedness is at its lowest point in the past 20 years. Turning now to look at returns on capital generation on Slide 13. We are pleased to have delivered a 16.4% return on tangible equity this quarter, driving capital generation of 50 basis points, excluding non-recurring impacts such as our acquisition of Cushon. This brings capital generation to 100 basis points for the first half. We ended the quarter with a common equity Tier 1 ratio of 13.5%, down 90 basis points on the first quarter. This was driven by distributions which account for 114 basis points in the quarter or £1.3 billion directed buyback, consuming 71 basis points of capital. We accrued 40% of second-quarter attributable profits, equivalent to 15 basis points in line with our 40% payout ratio. This excludes the foreign exchange recycling gain, which is neutral for capital. Our £500 million on-market buyback program accrued in our 13.5% CET1 ratio. Turning now to our balance sheet strength on Slide 14. Our CET1 ratio of 13.5% is now within our target range of 13% to 14%, which includes a buffer above our minimum requirements. Our U.K. leverage ratio of 5% has reduced from 5.4% in line with a decrease in Tier 1 capital and remains well above the Bank of England minimum requirements. Our liquidity coverage ratio was 141% at the end of the first half on a spot basis and 145% on a 12-month average basis; this remains well above our minimum requirements. Turning to 2023 guidance, we expect income excluding notable items to be around £14.8 billion at a U.K. base rate of 5.5%. Net interest margin of about 3.15%, and Group operating costs excluding litigation and conduct to be around £7.6 billion, delivering a cost income ratio below 52%. We anticipate a loan impairment rate in the range of 20 to 30 basis points. Together, we expect this to lead to a return on tangible equity at the upper end of our 14% to 16% range. I'd like to now to talk more broadly about the first half and our strategy, which is delivering and remains unchanged. So we retain our focus on responsible targeted growth, continued costs and investment discipline, together with effective capital allocation, to enhance shareholder returns. I'll start with our progress against targeted growth on Slide 17. The strength of our balance sheet and risk management means we retain the capacity to grow, even in challenging market conditions. And we are doing this in three ways. First, we are focused on driving customer lifetime value. We are the leading high street bank for entrepreneurs and startups, with a share of 17.7%, up from 13% this time last year. We added 55,000 new startup accounts during the first half as we continue to strengthen our offering. In retail banking, we continue to grow our customer base with a focus on personalization, and particular segments such as youth and affluent. For example, we have significantly strengthened our youth offering with the acquisition of Rooster Money, which we have extended by connecting it with our app. Rooster Card subscriptions increased by 93,000 during the first half, and we now serve around 20% of the youth market. In wealth management, despite more volatile markets, we grew assets under management and administration during the first half, including net new money of £1 billion. Secondly, we are helping customers transition to a net-zero economy, which remains a strong commercial opportunity. Across the Group, we have delivered over £48 billion of climate and sustainable funding and financing towards our ambition of lending £100 billion between 2021 and 2025. This includes £16 billion in the first half this year. Thirdly, we continue our digital transformation, which is delivering value for customers, employees, and the bank. Our services for small businesses such as Mettle are great examples. Mettle is our digital-only business bank account with a customer base of around 100,000, including 17,000 acquired during the first half. Our award-winning payments platform tool has carried out £2.2 billion of transactions in the first half, up 64% on the same period last year. In retail banking, we have recently extended our credit card offering to the entire market, not just our own customers, taking our flow share to 9.6%, up from 5.7% this time last year. From a range of measures, whether it's customer acquisition, net new money, or share, our targeted approach is delivering organic growth to achieve a sustainable medium-term target of 14% to 16%. We continue our disciplined approach to cost and investment. We expect to invest around £3.5 billion between 2023 and 2025 to future-proof the business as our ongoing digital transformation helps to drive efficiencies, improve customer experience, and deliver future growth. We have been reengineering customer journeys since 2019 and expect this to deliver a run rate savings of around £250 million by the end of 2023. As a result of this simplification, 99% of our loans are delivered with straight-through processing. Our net promoter score for this journey has improved from 42 at the end of 2020 to 57 today. We believe the responsible use of artificial intelligence will be a game changer as we embed it into our journeys and processes. We are accelerating its deployments. We are now using natural language processing to analyze around 560,000 conversations a week covering telephone and chat channels so that we serve our customers better. Additionally, we use AI to analyze around 36 million events a day to help predict patterns of behavior and identify financial crime or fraud. Finally, we're investing for long-term growth by deepening and diversifying future income streams. I've already spoken about how we're growing in startups, wealth, and the youth market. We're also expanding into new areas. We recently announced the acquisition of a majority stake in a fintech called Cushon, which allows us to enter the fast-growing workplace savings and pension markets. We have also entered a strategic partnership with Vodeno Group in order to create a leading U.K. banking-as-a-service business branded as NatWest Box. While we continue to keep tight cost control, we're also investing in the future. Let's now return to capital on Slide 19. Over the past three years, we have significantly improved the allocation of capital to higher returning businesses. Our face withdrawal from Ulster Bank has contributed to this. We have now closed all our branches around 95% of deposit accounts to the Republic of Ireland. In July, we completed the transfer of the asset finance business to Permanent TSB, and we're migrating the majority of performing tracker and linked mortgages to Allied Irish Bank. We expect the remainder of this migration to complete by the year-end. We have also received a dividend of €800 million in the second quarter, the first since 2019. We have made or accrued distributions of £13.5 billion to shareholders since 2019, and expect to make significant returns to shareholders this year as we continue to generate capital through organic growth. We are building on the strength of our existing franchise to create value for shareholders. We serve over 19 million customers across the Group. We are the number one commercial bank supporting businesses in the U.K. economy. We play a leading role in sustainable financing. We are the second-largest U.K. mortgage lender, and we have a strong and growing wealth business. As we continue to grow our franchises organically, we are delivering a significant improvement in return on tangible equity, which in turn is driving strong capital generation allowing us to deliver distributions to shareholders. Through our buybacks, we have reduced our share count by 26% since the end of 2019, which in combination with profitable growth means our interim dividend per share has more than doubled. The business continues to deliver a strong performance. This is underpinned by the strength of our balance sheets, which positions us well in the current economic environment, and enables us to support our customers as well as the U.K. economy. We continue to drive operating leverage with disciplined investment in digital and technology transformation and cost management. We are benefiting from our focus on effective capital allocation with an €800 million dividend from Ulster Bank. We have significantly improved our return on tangible equity over the past three years and maintain guided range of 14% to 16% over the medium term. This gives us scope to return significant capital to shareholders; we have made or accrued distributions of £2.5 billion during the first half while remaining well-capitalized. Thank you very much. And we're happy to open it up for questions now.

Operator, Operator

Our first question comes from Aman Rakkar of Barclays.

Aman Rakkar, Analyst

Couple of questions, please. Firstly, on the hedge, I just wanted to double-check your comments around the structure of the hedge. I think you said that the product hedge would be coming down from £202 to £190 billion by year-end. I just wanted to check the comment around the deposit experience. I think you talked about it being a catch-up. So is that based on kind of the backward-looking experience on deposits tells you that the hedge needs to come down by £12 billion in H2? And to what extent does that capture any kind of forward look around your expectations on depositor behavior into H2? And as a kind of related question on that, what then have you naturally assumed for things like mix shift as part of this? How many current accounts are you assuming to have at year-end? And how did that drive into your full-year '23 NIM guide? And then the second question was just on non-interest income. So I know that you're kind of sticking with the £14.8 billion revenues this year. That looks like it's going to be less net interest income, then consensus has probably a bit more non-interest income. Indeed, I think the kind of H2 run rates that you're effectively pointing to suggest a better outlook for non-interest income through the second half of this year, so I guess can you confirm or kind of deny that thinking? And does that give you confidence if NII looks like it's a bit softer here than what we were looking for before? Do you feel more confident around non-interest income? And if so, where is that coming from?

Katie Murray, CFO

Thanks, Aman. You managed to pack a lot into two questions there. Look, in terms of the hedge, as we look at it, we're going from £202 to £190 is very mechanistic, as you know. We basically looked backwards over the last 12 months. Obviously, we had three quarters where we failed this last quarter; we stabilized on deposits, and that's the impact of that coming back through. What's interesting, as we raised our rates, we expect the spot rate to be around an average of 4.4. What you see on the income side is although you've got this fall-off in the hedge, the 4.4 versus the 3.6 we talked about the last time we spoke, is actually, it kind of balances itself out. So it doesn't have a particular income effect. I haven't taken any forward look in terms of that; we do on a 12-month roll backwards. In terms of the mix shift that we have seen some mix shifts, you can see that very clearly, obviously in the 40% to 37% of non-interest-bearing. And then if you look in the financial supplement, you can see that across private, which is actually a little bit further and then in the retail bank as well, in terms of that piece. I'm probably not going to go into specifics in terms of the exact percentages that we've picked on that, but I have taken thoughts of some further kind of migration as we go into there. In terms of income, specifically on the non-NII, I would say H1 trends were positive, and we do expect to grow non-NII into H2. But the numbers are impacted by volatility. What we can see in the C&I business is more normalizing into H2, following some lower volatility in the trading business in the second quarter, particularly due to things like the U.S. debt ceiling, because we just didn't see that volatility in FX; that number is a little bit lower. Obviously, we know and you know that people kind of held back a little bit from the capital markets; that will normalize in our early performance in July is confirming that view. Hope that helps. Thanks, Aman.

Operator, Operator

Thank you very much. Our next question comes from Alvaro Serrano of Morgan Stanley.

Alvaro Serrano, Analyst

I wanted to follow up on deposit balances and the outlook. When I compared your term deposits to those of your competitors, it seems like you've enhanced your offerings in June with a 5% term. Do you acknowledge that this is reflected in your balances, which might be reasonable? Following the last rate hike, have you noticed an acceleration in migration? What trends are you observing? Perhaps you could clarify this further in July. Additionally, how confident are you in your visibility? You've reduced the NIM guidance today, and I'm curious if you can provide any insight regarding how low the proportion of non-interest-bearing balances might be. Thank you.

Katie Murray, CFO

Lovely, thanks very much, Alvaro. If I look at it, when I look to see what's kind of happening in terms of those customer deposits, what we do see is this kind of catch up in customer deposit rates. That was very much because of the impact on some of the pricing changes that we did during the second quarter. Effectively if you look at those last couple of rate rises, we passed through 75%. So that was a bit higher, that's taken our cumulative pass-through to date to kind of 50% of all of the rate rises. We do think we're now competitive on rates as we move through. When you look at our sensitivity in terms of what we think of the impact of that competitiveness would be, we have changed the structural hedge sensitivity, which I'm sure we'll talk about more later and to your 60% pass-through rather than the 50% model that we had done previously. I think that reflects a little bit more. As I look at what's happening in July, it's all the mix and move is kind of in line with our expectations. I think it would be a brave person to say today where we think the NIBS and NIBS might land. It has been interesting for us in the last number of quarters; there was so little movement, but then what we saw is customers really then moved into the fixed term that we did see a movement from that 40% down to the 37%. That was people really moving straight from non-interest-bearing kind of all the way into term deposits. That's why we saw that step-up happening in that space. But I'm probably not going to look to call in terms of where I think that that might go; I think it will take some time to kind of get there.

Operator, Operator

Thank you. Our next question comes from Rob Noble of Deutsche Bank.

Rob Noble, Analyst

I ask on the credit card and the growth in cards, what's the EIR that you assume against that now that you've gone whole market and kind of the quality of the customers that you're adding as you grow? And secondly, thanks for all the information on the risk profile of the mortgage book. Do you give what proportion of your book is on high loan to income multiples that are also refinancing soon as well? Obviously, those are the customers that are more at risk. Thank you.

Katie Murray, CFO

Yes, sure. Absolutely. So if we look at the credit card book, what we have seen as we've gone to more of the whole of market, what we're actually seeing is, it's actually slightly better quality that's coming in. It's kind of lifting the quality of that book, which we're pleased about. If I look at the EIR, it depends on the card and how you're looking at it, but it will be low single digits in terms of EIR; it's quite conservative in our approach on that piece, so certainly a better quality. When you can certainly see as we looked at mortgages, in terms of that risk profile of the refinancing of the high ones. I'm not giving you the split of the book in that way. But you can see that our average loan to value is 54%. I think less than 3% is sitting at that high LTV level. It's a relatively small piece of the book. Given the structure of our book, it's much more of a five-year-book these days; you've heard me say earlier that only about 20% of the group is actually refinancing this year. I think given that high LTV is small, and the lower level of refinancing, that's not something we consider a particular risk for our book moving forward. Thanks, Rob.

Operator, Operator

Thank you. Our next question comes from Jonathan Pierce of Numis.

Jonathan Pierce, Analyst

Couple of questions. The first on the margin, the margin looks now to be stabilizing a bit based on your guidance in the second half. So down a few basis points, but nothing that significant versus what we have been seeing. I was just wondering if you can talk to the moving parts in H2, the ups and the downs, but particularly into 2024, because one would assume that mortgage refinancing pressure is easing, maybe deposit churn isn't quite as significant as you're expecting for the second half of this year, whereas you've still got obviously the tailwind from the asset repricing from the structural hedge. So I'm wondering about margin dynamics particularly into next year. Could we start seeing it move back up a little bit again? And just a supplementary to that, the other banks have told us now what the yield on the maturing hedges next year is; it'd be helpful if you could give us that. The second question is on non-interest income weakness. I heard your comments on FX and volatility, but the NatWest markets subsidiary disclosure showed actually not bad performance again in the second quarter. There was, though, I think deep in the group announcement, talked to us about page 83 or something, and noted a big drop in FX trading revenue at the group level. I'm just trying to square the circle here. I'm wondering whether this is anything to do with this FX management of U.S. surplus deposits that you talked about just after Q1? If it is, you told us at Q1 that there was a sort of natural offset in net interest income. So if we get a recovery in non-interest income in the second half, if this is the reason for it in the past, is that captured within the net interest income guidance as well? Thanks very much.

Katie Murray, CFO

Yes, sure. Thanks very much. Let me deal with the end of that question. First, you're absolutely at page 84, and it talks about the foreign exchange; it's gone from £258 million down to £125 million. I think what you've got to remember as well, NatWest markets is a subsidiary level of the Group. So it's important that you actually look when you're trying to look at the Group result is to look at the Group piece because obviously, they've got revenue share and things that go on in different kinds of lines. So it's not anything to do with the FX management of the U.S. surplus; it is the volatility of our numbers. There is a little bit of in the notable items side, we mentioned some things about £23 million, but that's not material in that space. As I look at that, I do see the strengthening of that performance, given that FX; we know we expect to be more volatile this quarter, given the change in that. As I go then onto margins, I think certainly, we're at 313, for this quarter 320 for the half; we're saying 315 for the full year in terms of that the average now rather than the 320 we had originally said. So I definitely do see some stabilization in terms of that piece. What will happen in terms of that piece is subject to a number of different factors, as you'd be aware of. The timing of the U.K. base rate, and we're assuming a 50 basis points increase at the August MPC meeting, if that comes through in August and September, that will have a little bit of an impact on it. Obviously, the pass-through to customer deposit rates, both the timing and the quantum, as well as the customer behavior. I've talked about that already in terms of that move from the NIBS to the IBBS and then from instant access to fixed term as well has an impact on it. I'm not going to give you the exact what I think on Q3 and Q4; but I think you're in the right kind of space; it will move around a little bit as we move forward from here. In terms of 2024, I do see the mortgage pressure easing, as we sort of see the roll through of the kind of COVID piece come to the end. We'll start to see that at the end of '23 and into '24 as we move forward in that piece. That is a benefit, certainly, to NIM. My last point, I just need to hit on your question. And Jonathan, if I've missed anything, let me know at the end. In terms of the roll-off yields, for 2023, we're rolling off it at kind of 1.1 because our hedge is so mechanistic; it's easy for you to kind of work this out, look at what the swap is, what recurs, where it's going five years ago, and you can get a feel for in terms of what's happening. So 2023 roll-off is 1.1; and then 2024, the roll-off rate is lower at around 80 basis points, and 2025 is even lower, again at around 50 basis points. That means that even as a five-year swap rate reduces, we do expect through to 2025 that the uplift from the hedge activity remains sizable, particularly with our narrative of this stabilization of deposits.

Operator, Operator

Thank you very much. Our next question comes from Guy Stebbings of BNP Paribas Exane.

Guy Stebbings, Analyst

One, on mortgages, then one back on deposits, that's right. So I guess you're growing quite strong, actually mortgages relative to many of your peers in what is quite a tough volume and spread backdrop. So can you talk about your approach there and how you weigh up, spreads versus volumes, whether you're driven by return hurdles, volume metrics, or market share, or a combination of all three? And also, what you're seeing in terms of customary payments of balances right now and sort of the mix of lending between internal refinancing versus new-to-bank. And then on deposits? Thanks for the comments. Slide 8 was appreciated. I just wonder if I could maybe push you on that, dip movement from 40% to 37%. Do you have any updated views as to where that might eventually settle? Thank you.

Katie Murray, CFO

Thank you. Let me begin with mortgages. We manage this group based on income and royalty, so our decisions are influenced by those factors. We aim to manage mortgages at 80 basis points, and while writing more mortgages may slightly reduce our net interest margin, we believe it’s manageable since we're focused on income and royalty. During the second quarter, we noticed that the curves changed quickly. There was a time when our writing levels were below our target, but overall, we still met our metrics, even though we weren't at the desired 80 basis points. By the end of the quarter, we returned to our target and are currently performing slightly better. Regarding customer repayments, we have observed an increase; since mortgages began to rise in Q4 of last year, over 70% of eligible customers have taken the opportunity to refinance early within the six-month window we offer to secure lower rates. Approximately 35% of customers are making overpayments at refinancing. In absolute terms, we recorded lump sum repayments of around £500 million in Q2, which is about double compared to last year. Customers are definitely looking to pay off more. It's noteworthy that mortgage balances increased by £1.9 billion in the quarter, after accounting for the elevated repayments. We believe the macroeconomic outlook will play a bigger role in mortgage balances moving forward, and we see customers using some of their deposits for these payments, which makes sense. As for non-interest bearing accounts (NIBs) and interest-bearing accounts (IBBs), we expect a slight further reduction in NIBs. It’s challenging to predict where they will stabilize since there isn't a historical reference to guide us. We are closely monitoring various customer groups while noting factors like wage inflation and a resurgence in savings, alongside a shift in deleveraging growth. Currently, we have made some projections regarding where things might head, but we remain confident in the £14.8 million income guidance for this year, which aligns with the upper end of our 14% to 16% royalty range. There are many moving parts involved, and I hope Slide 8 clarifies things. Thanks again.

Operator, Operator

Thanks. Our next question comes from Andrew Coombs of Citi.

Andrew Coombs, Analyst

I have a question for Howard and Katie. Howard, could you share your thoughts on the permanent CEO succession planning and how you see the process unfolding moving forward, including any insights on timing? And for Katie, regarding the liquid asset buffer and the exclusion of the AIEA from the bank NIM, it has decreased from 162 to 152. What do you anticipate for its trajectory in the future? Thank you.

Howard Davis, Chairman

Yes, thanks, Andrew. Let me take you through it as clearly as I can. I've been here for just over eight years. If you look at the corporate governance code, which says that nine years is pretty much effectively the maximum norm. We decided to begin the search; we announced in April that the senior independent director would begin the search. They appointed headhunters then, and that's a matter for them. I'm not directly involved in that. So that's underway. This, of course, has come in the middle of that period. Therefore, since I think the replacement for me in due course will need to be behind a choice of long-term CEO. We decided that we would implement what was already our contingency plan and asked Paul to take over as Chief Executive. A good few months ago, we reviewed our contingency arrangements, and the board agreed that Paul was the short-term successor; then a sort of Number 11 Bus scenario hasn't been a Number 11 Bus exactly, but something a little bit similar. That was all agreed with the regulator. We implemented that. Paul and I agreed that the sensible way of doing it was to say he would be CEO for 12 months. An initial period of 12 months, which could be extended, which would allow time to find my successor and get my successor in, and that successor, then to decide how he or she wants to proceed, whether they want to have open contest, looking at external candidates, or what they want to do. I think the position is quite stable for 12 months. Thereafter, my successor will have to take a view. I'm very grateful to Paul for agreeing to do it. On that basis, he's very experienced in the bank, and the mood in the Executive Committee and elsewhere is positive about this. I can't say it's exactly what one would normally have done, but I think it's a pretty good interim solution.

Katie Murray, CFO

Thanks, Howard. And then, Andrew, in terms of that liquid asset buffer question, the labs, average interesting assets reflect changes in the customer funding surplus, so of course, deposits. We think the deposits are broadly stable, so you should see stabilization in the lab, AIEA as well as a result. Thanks, Andrew.

Operator, Operator

Thank you. Our next question comes from Chris Cant of Autonomous.

Chris Cant, Analyst

Good morning. Thanks for taking my question. Sorry, I was struggling with my other device. Can you hear me okay now?

Katie Murray, CFO

Yes. Perfect, Chris. That's great. Thank you, I'm glad you got through.

Chris Cant, Analyst

Two sort of follow-up questions, really? Firstly, there was an earlier question around trends on deposits during July. I'm just conscious you did also hike your fixed-term deposit rates in response to the swap moves in June. Just keen to understand whether what we're seeing as we look into the third quarter is a continuation of trends you'd already been seeing during the second quarter or whether you are actually seeing accelerating terming out. Obviously, you've given us the sort of deposit split at the end of 2Q, but conscious that could be accelerating potentially into 3Q. Any further commentary there would be helpful. And then, I also just wanted to return to a comment you made, Katie, around peak NIM. I mean, the idea of peak NIM has sort of, I think, been plaguing the U.K. banks broadly for a little while now. It comes down in part to the timing of the different pressures, puts and takes on the NII line. In the short term, you're obviously seeing this beta catch up you've referred to during the second quarter. But as we look into '24, I think you're sort of indicating actually the net of forces may then become a net positive relative to where we're exiting this year, just in terms of fewer mortgage pressures, deposit trends stabilizing, and then this very material structural hedge benefit still to come through. I think I asked you a similar question on the Q1 call, but if I could invite you to talk about that again based on sort of stable-ish base rates or something close to your trajectory into '24. Is that the right way to think about it, that actually, the structural hedge benefits should be outweighing the mortgage pressures and the deposit forces, at least in the short-term deposit forces around beta catching up to a more sensible level sort of a bait? Thank you.

Katie Murray, CFO

Yes. If I look at deposits, I can say that Q3 is performing as we anticipated. We're seeing good results in fixed-term accounts, which is encouraging. We have also recently launched an instant access product under our Ulster Bank Northern Ireland brand, and we expect it to contribute positively as we move forward. This launch just occurred in the last few days, and we will provide more details on its performance in Q3, but it has been consistent with what I've been stating. Chris, I’ll likely give you a response similar to what I shared in Q1; I prefer not to comment on our Q4 NIM forecasts. We need to consider factors like base rates and their timing, whether our assumption of 5.5 is accurate, and whether it will rise and impact customer deposit rates if we are indeed at peak levels. The mix and balances that will emerge are also important. I think the alignment of the hedge with mortgage market margins is beneficial for us. Let’s discuss more about 2024 when the time comes. I'm not going to share any opinions on that right now. Thank you, Chris.

Operator, Operator

Thanks. Our next question comes from Robin Down of HSBC.

Robin Down, Analyst

Just one really quick question. I would have asked this on Monday, but I've got to be wall crossed on HSBC. So I can't ask them. The mortgage bank book spread, you've given us that number in the past, and this is quite useful to compare with kind of new business spreads. I can't see it.

Katie Murray, CFO

I mean, let me give it to you. It says the Bank Group margin is 102%, down from 115 in Q1.

Robin Down, Analyst

Great. And regarding the new business, I believe you mentioned you were somewhat unclear.

Katie Murray, CFO

I'm not going to give you that exact number. We can try to manage over time, and given this is a multiyear product, I can get too obsessed by kind of quarterly moves. So managing to AT, I said we were a bit lower in the beginning of the quarter; we're a bit better at the end. You can also, 102 I've given you; you can also calculate it on the fence up if you want. But that's what the bank book is at the moment.

Operator, Operator

Our next question comes from Ed Firth of KBW.

Ed Firth, Analyst

I have two questions. First, I want to discuss the 50% deposit beta you mentioned. Your largest pool of savings is in instant access accounts, with the majority being under £25,000, which currently earns 1.4%. This implies a spread of about 3.6%, which seems unusually high for customer savings historically. Assuming rates stay flat or that you maintain a 100% beta moving forward, do you believe that 1.4% is a sustainable rate, especially considering that the largest bank is offering 3.8%? Do you think this is a reasonable reflection of customer expectations, or might there need to be adjustments even without changes in rates? The second question concerns the Farage situation, which has been largely avoided in discussions. I've seen reports of around 10,000 subject access requests, with many people closing their accounts. Could there be potential costs to manage this in the second half, particularly due to the administrative load similar to past experiences like PPI? Any insights on this would be appreciated. Thank you.

Katie Murray, CFO

Thank you for your question. I would advise caution in believing everything reported in the media. While we have seen an increase in access requests, they remain manageable, and we will allocate more resources to handle them. I'm not concerned about this situation as we have assessed the numbers and currently, with the volume in the manageable range, we anticipate seeing more requests come in. Regarding deposits, I want to clarify that most of our balances exceed £25,000. There are substantial amounts in the £25,000 to £100,000 range, as well as significant balances above £250,000, with amounts ranging from £210,000 to £310,000. It's crucial to acknowledge that different rates are available, and part of these balances are hedged, meaning the benefits from changes in what we pay versus what we receive will accrue over time. The current deposit balances may appear low, but we cannot simply subtract one figure from another due to our hedging strategies. We are committed to informing our customers about the various rates available, as encouraged by our regulator.

Operator, Operator

Thank you very much. I will now like to hand back to Katie for any closing comments.

Katie Murray, CFO

Thank you very much, and thanks to everyone for your questions and participation this morning; it is greatly appreciated. We have had a strong performance in the first half, which shows that our strategy is effective. We have a solid balance sheet and are increasing lending to support our customers. We are on track to meet our cost guidance for 2023. We distributed £2.5 billion to shareholders in the first half, and we continue to aim for a sustainable medium-term royalty of 14% to 16%. With that, I appreciate your ongoing support, and I look forward to speaking with many of you in the coming weeks. Take care, and thank you. Goodbye.

Operator, Operator

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