Earnings Call Transcript
NatWest Group plc (NWG)
Earnings Call Transcript - NWG Q4 2023
Operator, Operator
Good morning and welcome to the NatWest Group Annual Results 2023 Management Presentation. Today's presentation will be hosted by Chairman Howard Davies, CEO Paul Thwaite and CFO Katie Murray. After the presentation, we'll take questions.
Howard Davies, Chairman
Good morning, everyone, and thank you for joining Paul, Katie and me for our full year results call. This will be the last set of results the bank publishes before I stand down as Chairman. In addition to our full year results this morning, we've also announced the appointment of Paul Thwaite as our permanent Group CEO. As you will know, Rick Haythornthwaite was announced as my successor in September last year. He joined the group board formally as a non-executive director at the start of last month and will take over from me as Chair on the 15th of April. He led the process to appoint our new CEO. The bank this new leadership team inherits is very different from the one I joined in 2015. The group has returned to profitability, is more customer-focused and is fundamentally stronger. In my first year, we declared a loss of over GBP 2 billion. Last year, we reported a profit of over GBP 6 billion. So as I prepare to leave, there’s a lot to be positive about. The strong returns delivered in 2023 enabled us to make further significant capital distributions to our shareholders through dividends and buybacks. And as you would expect, we're working closely with UKGI as they explore a potential retail share offer, which would further help in returning the bank to private ownership. I'm personally pleased the succession process has been completed, and we can look forward with an incoming Chair and a new CEO who have proven skills to support the group's continued progress and who I know care deeply about this business and its customers. So, I'll now hand over to Paul and Katie for an update on the bank's performance. Thank you.
Paul Thwaite, CEO
Good morning, everyone. Naturally, I'm delighted to have been confirmed as the CEO of NatWest Group today and look forward to driving the very best performance we can for the benefit of our customers and shareholders. Our customers' needs and expectations are changing at pace, as they engage with technology, adapt to new social trends and build ever more resilience in a fast-evolving world. Our priority is to deliver more value for customers, which in turn creates more value for shareholders. Over the last six months, the focus for me and my team has been on supporting customers as they manage the impact of inflation and a rapid rise in interest rates. This gives us an opportunity to be a trusted partner to customers at a time of ongoing change. And by doing so, we are shaping the future of NatWest to deliver its full potential. So, I'll start with the business update this morning. Katie will take you through the full year numbers. And then we'll open it up for questions. Since our performance is grounded in supporting our customers, I'd like to begin by putting the financial headlines in that context. In 2023, we increased our lending to customers by GBP 9 billion. We opened over 100,000 new start-up accounts for entrepreneurs and more than 1 million current accounts for individuals. We helped customers to save, with GBP 21 billion more fixed-term savings at the year-end as well as to invest, growing assets under management and administration by GBP 7 billion. And we helped over 6 million customers manage their finances better with support such as financial health checks, understanding their credit scores and encouragement to save. We provided GBP 29 billion of climate and sustainable funding and financing, bringing the total to GBP 62 billion since July 2021, so we are well on our way to achieving our GBP 100 billion target by the end of 2025. And we continue to support the growing renewable sector, where we have been a leading lender in the U.K. over the last ten years. This customer activity underpins our strong financial performance. We delivered operating profit before tax of GBP 6.2 billion, with attributable profit of GBP 4.4 billion. Income was up 10% at GBP 14.3 billion, with cost growth of 5% to GBP 7.6 billion. Taken together, this resulted in a return on tangible equity of 17.8%. We remain committed to generating capital in order to reinvest in the business and make shareholder distributions. Today, we're announcing a final dividend of 11.5 pence, bringing the total to 17 pence. This is in addition to a directed buyback of GBP 1.3 billion last May and the GBP 500 million on-market buyback announced in July, which will complete this quarter. We are also announcing a new on-market buyback of GBP 300 million, which is included within our CET1 ratio of 13.4%. We expect this to complete by the end of July. This brings total distributions announced for the year to GBP 3.6 billion. These buybacks have supported a reduction in the government stake from 46% at the start of last year to under 35% today. You will also be aware of the government's intention to fully exit its NatWest Group shareholding by 2026, including a potential retail share offer. Our performance naturally reflects the rates environment in 2023, but our strong capital and risk management made an important contribution too. You can see this in the strength of our balance sheet. On the asset side, our personal lending is almost secure and our corporate book is well diversified. This disciplined approach is reflected in the low levels of impairment at 15 basis points of loans. On the liability side, our deposit base has remained broadly stable. Our loan-to-deposit ratio at the year-end was 84%. And our repayments due by 2025 on term funding for SMEs stand at just GBP 4 billion. This balance sheet strength and well-diversified funding underpins our ability to continue supporting customers through the economic cycle. As you know, we were operating in a rapidly changing environment last year as persistent inflation led to interest rate rises of 175 basis points. As a result, individuals moved balances from noninterest-bearing accounts to fixed-term products. They also drew on savings to pay down debt in the face of cost-of-living pressures. And in 2023, for the first time in at least 30 years, U.K. households repaid as much mortgage debt as they drew. This change in customer behavior clearly had an impact on our income and net interest margin as the year progressed. However, inflation has fallen and market expectations for interest rates have come down. So our plan assumes that rates will reduce materially this year and next. These expectations have flowed through to customer rates for both mortgages and fixed-rate savings, which have decreased by over 100 basis points from the peak. This means we are seeing early signs of improving mortgage demand and deposit migration to higher-rate savings accounts has slowed, yet mortgage payments are likely to remain elevated this year as customers pay down debt before refinancing onto a higher rate. Business confidence is also improving, and our net lending to large U.K. corporates grew in 2023. However, overall demand from personal and business customers is currently muted. And together with the impact of lower interest rates, this will impact our 2024 income. Household and corporate balance sheets remain strong and the resilience of our customers is evident from our low level of impairments in 2023. We expect this to continue in 2024, despite a slight increase in unemployment. Of course, I recognize that heightened geopolitical uncertainty has potential implications for global trade and supply chain security, so whilst we expect inflation and rates to reduce, the timing and quantum of this is difficult to predict and we remain vigilant. A significant benefit of the scale and breadth of our customer base is that it gives us access to large flows of data. We are using these insights to understand and react to customer behavior as the environment evolves. We believe the strength from our customer franchise positions us well for 2024 and beyond. We serve 19 million customers, meeting a wide range of needs in our three businesses: Retail Banking, Private Banking, Commercial & Institutional. We have leading market positions and we also have a track record of growing share in attractive segments. For example, we now serve around 20% of both the youth segment and new startup businesses. So we're winning new customers and building for the future. I also know that, from listening to existing customers, there is a clear opportunity to deepen these relationships by introducing more of our products and services alongside the expertise of our colleagues. By serving our customers well, we create value for all our stakeholders. We are targeting growth in areas with attractive returns, managing for value by striking a balance between volume and margin. There is also more we can do to improve productivity and cost efficiency. We have a strong record on cost reduction, and we'll direct our investment spend to areas that deliver savings to mitigate ongoing inflation. We're also actively shaping our balance sheet and deploying capital thoughtfully, which is helping to manage regulatory change. This discipline on both costs and capital will allow us to continue investing in the business and making attractive distributions to shareholders. Between 2021 and 2023, returns to shareholders totaled GBP 12.5 billion and a 28% reduction in share count led to higher earnings per share. Against this backdrop, we have three key priorities all focused on driving returns. Our first priority is to continue growing our three customer businesses in a disciplined way, building on our strong market positions, so let me share some examples. We brought commercial and institutional banking together to deliver greater value for customers and the bank. And we are now able to serve the needs of a much wider range of customers in foreign exchange rates and capital markets. Over 1,500 of our mid-market commercial customers have now signed up for our foreign exchange services. Our leading mid-market business has an extensive network of specialist relationship managers across the U.K., which gives us a significant competitive advantage of scale and reach. This segment delivers attractive returns and we see this as an area of further growth. In retail banking, we have grown our share to become the second largest mortgage provider in the U.K. Our mortgage business is well positioned, following significant multiyear investment with strong through-the-cycle returns. It is highly digitized and scalable, and a driver of efficient growth when market demand and pricing are right. Our second priority is to drive bank-wide simplification. There is a lot more we can do to make it easier for our customers to do business with us, to improve engagement and productivity for our colleagues and to drive significant efficiencies and operating leverage. Since 2021, we have delivered run rate savings of around GBP 250 million a year through digitizing customer journeys, so we continue to simplify journeys across the bank in order to improve customer experience and deliver further savings. We are streamlining systems and processes. For example, in our retail bank, we are integrating five legacy front-office systems into one digital platform to give us a single view of the customer. This has enabled us to spend more time with our customers and improve the quality of our interactions. We are also using artificial intelligence and data to improve productivity, and we have seen some very encouraging results from recent pilots. We've reduced scam losses; freed up time to focus on customer relationships; and identified ways to reduce our complaints resolution time. This is a significant opportunity as we roll it out across the bank. Our third key priority is to deploy capital efficiently and maintain strong risk management in order to drive capital generation. Our exit from the Republic of Ireland is now largely complete, and we received a further EUR 300 million dividend in the fourth quarter. 2023 was also the year we delivered on our CET1 ratio target of 13% to 14%, but we can do more to optimize capital allocation. This means working dynamically to capture attractive growth opportunities and being very disciplined at origination. We will also address RWA efficiency on the back book, for example, through greater use of insurance or risk transfer, where we are less active than some of our peers. So as you can see, we are very focused on the levers that we can control, but the macroeconomic environment, coupled with an expected reduction in interest rates and changes in customer behavior, means that we are adjusting our target for return on tangible equity. We now expect to deliver greater than 13% in 2026 whilst operating with a CET1 ratio of 13% to 14%. We are committed to delivering value for shareholders, so we maintain our payout ratio of around 40% for ordinary dividends, with the capacity for buybacks. And with that, I'll hand over to Katie to take you through the full year numbers in more detail.
Katie Murray, CFO
Thank you, Paul. I'll start with discussing our strong performance for the year. Income excluding all notable items was GBP 14.3 billion, up 9.8% and in line with the guidance we gave last quarter. Operating expenses rose 4% to GBP 8 billion, including GBP 7.6 billion of other operating expenses. Together, this contributed to a cost-to-income ratio below 52%. The impairment charge was GBP 578 million or 15 basis points of loans. Taking all of this together, we delivered operating profit before tax of GBP 6.2 billion. And profit attributable to ordinary shareholders was GBP 4.4 billion. And return on tangible equity was 17.8%, ahead of guidance, in part due to the recognition of historic tax losses. Turning now to fourth quarter compared to the third. Income excluding all notable items was GBP 3.4 billion, down 2%. Operating expenses were GBP 2.2 billion, including the annual U.K. bank levy. The impairment charge decreased to GBP 126 million or 13 basis points of loans, bringing operating profit before tax to GBP 1.3 billion. Profit attributable to ordinary shareholders was GBP 1.2 billion, including a deferred tax asset recognition. And return on tangible equity was 20.1%. I'd like to now talk about key performance trends across our three businesses. We have delivered strong returns across our three businesses in both 2022 and 2023. Retail Banking continued to be our highest-returning business in 2023 with good income growth. However, this was offset by higher costs and an increase in impairments, which impacted the return on equity, reducing it to 23.8%. Private Banking return on equity was 14.8% and was affected by lower deposit balances and mix changes as well as cost inflation. Our Commercial & Institutional business delivered the strongest year-on-year improvement, growing income by 16% and operating profit by 27%. It is now the largest profit engine of the group, delivering GBP 3.2 billion or 52% of group operating profit, equivalent to a return on equity of 15.4%. Our business diversification enabled us to deliver a strong group performance whilst responding to a broad range of customer behaviors and market dynamics. Turning now to our 2023 income performance. Full year income excluding notable items was GBP 14.3 billion. And bank net interest margin was 304 basis points. Net interest income was 12.1% higher, benefiting from favorable yield curve movements, partially offset by the change in deposit volume and mix. Non-interest income excluding notable items grew 2.5%, supported by increased customer activity and higher income from the markets business. Turning to the fourth quarter, underlying net interest income was GBP 2.7 billion, broadly stable versus the third quarter. Non-interest income fell 6.9%, reflecting seasonally lower trading and other income. Bank net interest margin reduced by 8 basis points to 286 which includes a 3 basis point drag from notable items. As expected, the rate of margin compression was slower than in the third quarter. Going forward, we will report group net interest margin which presents statutory group net interest income as a proportion of all average interest-earning assets. We see this as the most useful measure of how we are managing spreads between our interest-earning assets, including the liquid asset buffer, and our interest-bearing liabilities. Bank NIM is a less-relevant measure now that interest rates are above zero. Full year group net interest margin increased 31 basis points year-on-year to 212 as a result of higher deposit margins, net of pass-through and mix changes and lower mortgage margins. Group NIM in the fourth quarter was 199 basis points, reflecting a gross yield on interest-earning assets of 450 basis points and 251 basis points cost of funding. I'd like to move on now to our disciplined approach to lending growth. We are pleased to have delivered another year of balanced lending growth across the group. Gross loans to customers across our three businesses increased 2.6% or GBP 9.1 billion to GBP 359 billion. During the first half, we delivered strong mortgage growth, whereas in the second half, we delivered strong corporate loan growth as we took a disciplined approach to capital allocation in a competitive and dynamic market. During the fourth quarter, customer loans across our three businesses increased by GBP 1.1 billion. Taking retail banking together with private banking, mortgage balances reduced by GBP 500 million, as customer repayments offset new lending. Mortgage flow share for the full year was 14% or GBP 31.2 billion. However, this flow share reduced to 10.5% in the fourth quarter, as we managed the balance sheet in a smaller, more competitive market. Our stock share increased from 12.3% at the start of the year to 12.7% at the end. Unsecured balances increased by a further GBP 300 million in the quarter to GBP 15.8 billion, reflecting strong demand for credit cards. In commercial and institutional, gross customer loans increased by GBP 1.4 billion in the fourth quarter. Within this, loans to corporate and institutions increased by GBP 2.2 billion, including higher revolving credit facility drawdowns, where utilization was close to pre-COVID levels at 25%. This growth was partly offset by companies continuing to pay down government scheme borrowing. Across 2023, our Commercial and Institutional customers have accessed bank loans for house building, acquiring vehicles and managing working capital. I'll turn now to deposits. Customer deposits across our three businesses were GBP 419 billion at the year-end, broadly in line with the first quarter as expected. A reduction in the fourth quarter was primarily driven by our larger corporate and institutional customers as we managed down low-value deposits and as a result of normal year-end balance sheet management. Across retail and private banking, deposits grew by GBP 4 billion in the quarter, mainly in term savings. The migration from non-interest-bearing to interest-bearing deposits slowed during the fourth quarter. Non-interest-bearing balances were 34% of the total, down from 35% at the end of the third quarter and 40% at the start of the year. However, customers did continue to move balances to term accounts, which now represent 16% of our total deposit mix. This was slightly lower than our expectations as a result of active management in December yet up from 15% at the end of the third quarter and 6% at the start of the year. I'd like to turn to the drivers of deposit income. Deposit income was the key driver of group income in 2023, so it's important to consider how the component parts of our deposit base may evolve and impact income in 2024. During 2023, deposits across our three businesses reduced by GBP 14 billion, the majority of which was in the first quarter. Our noninterest-bearing deposits reduced to GBP 142 billion. And term deposits increased to GBP 68 million. As the deposit mix changed, so did the proportion of hedged and unhedged deposits. Starting with term deposits, where we lock in the margin at origination. Given the strong growth in a competitive market, these are some of our tightest deposit margins. Overall, we expect term deposit income to grow moderately in 2024 due to higher average balances. Our unhedged deposits reduced to around GBP 166 billion at the year-end, and they earned the widest margins. These are managed rate deposits and this is where we expect to see the most significant income reduction as the base rate reduces. Turning now to the product structural hedge. The notional balance at the end of 2023 was GBP 185 billion, down GBP 23 billion from the start of the year. We expect this to reduce further in 2024, reflecting the reduction in eligible balances during 2023. We expect the yield to increase from 152 basis points in the fourth quarter through reinvestment of maturities at the prevailing 5-year swap rate. This will more than compensate for the notional reduction, supporting higher structural hedge income in 2024, with more meaningful growth in 2025 and 2026 as eligible balances stabilize. Let me explain how this feeds into our rate sensitivity disclosures. The change in deposit mix contributed to a significant increase in the costs of our deposit funding from 0.5% in the fourth quarter of 2022 to 2% in the fourth quarter of 2023. This moderated in the fourth quarter with an increase of 20 basis points compared to 60 basis points in the third as customer rates stabilized and migration to higher-interest-paying accounts slowed. Lower deposit balances, mix changes, and our 12-month look-back approach to the structural hedge means our balance sheet has become less rate sensitive in absolute terms. The chart on the right is our illustrative interest rate sensitivity disclosure. It shows the year 1 impact on net interest earnings for a 25 basis point downward shift in the yield curve. This illustrative disclosure naturally has limitations, not least because it assumes a static balance sheet and a parallel shift in the yield curve, but it helps explain how our income is affected by changes in interest rates both in relation to the structural hedge and the managed margin. The managed margin is the most relevant sensitivity for changes in the base rate and deposit pass-through. Based on our year-end balance sheet, a 25 basis point downward shift would reduce annual income by GBP 125 million. This is mainly driven by our unhedged deposit balances of GBP 166 billion at the year-end. It assumes a pass-through of around 60% on our instant-access savings of GBP 209 billion at the year-end, with minimal timing lag. As you think about our income progression through 2024, you should consider, first, the quantum of pass-through to customer deposit rates; and second, the associated timing lags, including the contractual notice periods. We continue to actively manage our deposits, aware that there is uncertainty on both the timing of rate cuts, competition, and how our customers will behave. Turning to Slide 18. As you have heard, interest rate changes associated pass-through and the second-order impacts on customer behavior are the key considerations when we think about income in 2024; and they remain difficult to predict. So to summarize, the four key income drivers today are: First, our plan assumes the Bank of England will start to reduce rates from May, reaching 4% by the end of 2024. We assume this will be reasonably spread out and in 25 basis point increments, though the actual outcome will be different. We expect to pass through changes in interest rates to our customers' deposit rates, but the quantum and timing are subject to competition as well as contractual terms and conditions. The second driver is deposit volumes and mix. Overall, we expect deposit balances to follow a similar pattern to 2023, reducing in the first quarter due to annual tax payments and then some recovery after that subject to market dynamics. We anticipate less change in deposit mix than we experienced in 2023. Third, we expect the hedge to deliver a tailwind in 2024 despite a reducing hedge notional and for the strength of this tailwind to increase into '25 and '26 as volumes stabilize. And then finally, on the asset side, we experienced significant mortgage margin pressure in 2023 as our mortgage customers refinanced onto higher rates at a tighter margin. This headwind continues to moderate. And we expect the mortgage book margin to stabilize around the middle of 2024, although this is dependent on market dynamics. Taking all of this together, we expect 2024 income excluding notable items to be in the range of GBP 13 billion to GBP 13.5 billion. Turning now to costs. Other operating expenses were GBP 7.6 billion for 2023, in line with our guidance. That's up 4.6% on the prior year, mainly due to staff costs, which are almost half of our cost base. This includes the average annual wage increase of 6.4% and a one-off payment in January last year to support colleagues with the rising cost of living. We also faced cost inflation on utilities and other contracts. Our ongoing investment in technology is reflected in higher depreciation and amortization costs. In 2024, we expect to hold other operating expenses broadly stable. You'll see that our fourth quarter costs, excluding Ulster and the bank levy, are annualizing at around GBP 7.5 billion, including the inflation embedded into our cost base during the year. We expect to incur around GBP 100 million of Ulster direct costs and around GBP 100 million for the bank levy, which brings annual run rate costs to around GBP 7.7 billion. In order to keep costs broadly stable from here, we will continue our strong track record of mitigating inflation by making cost savings. I'd like to turn now to our well-diversified prime loan book that is performing well. Over half of our group lending consists of mortgages, with an average loan-to-value of 55%; and around 70% on new business. Our customers continue to take advantage of the best possible rate in the six-month window before roll-off. And recent behavior has shown an increased preference for two-year deals. We monitor the impact of higher rates on customers closely after they refinance, and whilst arrears have increased slightly, they still remain low. Our personal unsecured lending is less than 4% of group lending and is performing in line with expectations and good-quality new business. Across our wholesale portfolios, our corporate book and other exposures such as commercial real estate remain well diversified and are still performing well. And we are not in scope for the FCA review into motor finance. Let's move to impairments and our economic scenarios. We have reviewed and updated our economic scenarios, both forecasts and relative weightings. Our weighted average expectations for GDP are slightly improved in 2024 but with a small decline in 2025. We also anticipate a slight deterioration in levels of employment in both '24 and '25. Our balance sheet provision for expected credit loss includes GBP 429 million of post-model adjustments for economic uncertainty. We remain comfortable with a 93 basis points coverage of the book, which continues to perform well. We reported a net impairment charge of GBP 578 million for the full year, equivalent to 15 basis points of loans. The current performance of the book, combined with our updated economic outlook, means we are expecting a low impairment rate below 20 basis points in 2024. Turning now to look at capital and risk-weighted assets. We ended the fourth quarter with a common equity Tier 1 ratio of 13.4%. In 2023, we generated 154 basis points of capital before the impact of non-recurring notable items and RWA model updates totaling 43 basis points. This net capital generation was offset by distributions to shareholders equivalent to 195 basis points. RWAs increased by GBP 6.9 billion in the year to GBP 183 billion. This includes a GBP 7.9 billion increase from business movements, and a further GBP 3 billion of model updates, which includes the CRD IV regulatory inflation we discussed in Q3. This was partly offset by a GBP 4 billion reduction as a result of our phased withdrawal from the Republic of Ireland. We continue to expect RWAs to be around GBP 200 billion at the end of 2025, including the impact of Basel 3.1 and further CRD IV model development. This is subject to final rules on credit and output floors that we expect later this year, as well as, of course, regulatory approval. As is our practice, we will continue to update you on the development of RWAs. Turning now to our track record on delivering for shareholders. Our capital generation has enabled us to support our customers in difficult times as well as invest for growth and shareholder distributions of almost GBP 12.5 billion over the last three years. Our improving profitability has supported increases in the total ordinary dividend in 2023. Combined with our multi-year buyback programs, this has delivered a significant improvement in the dividend per share of 17 pence, up 3.5 pence year-on-year. Our share count has reduced by 28% since the end of 2020 or 30% pro-forma for the GBP 300 million buyback we announced today. We remain committed to returning surplus capital to shareholders, as demonstrated by our strong track record. Turning to guidance on my final slide. In 2024, we expect income excluding notable items to be in the range of GBP 13 billion to GBP 13.5 billion; group operating costs, excluding litigation and conduct to be broadly stable versus 2023; and the loan impairment rate to be below 20 basis points, delivering a return on tangible equity of around 12%. And with that, I'll hand back to Paul.
Paul Thwaite, CEO
Thank you, Katie. So to conclude. Our priority is to continue supporting our customers in an uncertain macroeconomic environment. We are pursuing opportunities for targeted growth across our businesses, with a focus on returns as we strike a balance between volume and margin. By combining this disciplined approach to growth with tight cost control and efficient capital allocation, we plan to drive strong capital generation so that we can both reinvest in the business and continue making attractive distributions to shareholders. With a payout ratio of around 40% and capacity for buybacks, we remain fully committed to creating sustainable long-term value for shareholders. Thank you. I will now hand back to the operator.
Operator, Operator
Our first question comes from Aman Rakkar of Barclays.
Aman Rakkar, Analyst
First of all, congratulations, Paul on your appointment. I also want to pay my respects to Howard for your time at the firm. I have a couple of questions. One main question I’m hearing this morning is regarding your revenue guidance for '24. At first glance, it seems there's a significant drop in the revenue run rate for '24, which appears to be below consensus. However, it’s not entirely surprising to see such a low revenue number given the current uncertainties surrounding rate cuts, competition, and other factors. Can you elaborate on the various components influencing this and whether you acknowledge the cautious approach here? I know you might not answer this, but I will ask anyway. The current spot rate market suggests a base rate closer to 4.4% at year-end, rather than the 4% you are using for your guidance. I recognize that these rates can be volatile, but it seems unlikely we will see rate cuts based on the current forward curve, making your revenue guidance for '24 appear quite conservative. I'd be interested in your thoughts on this. Should I ask my second question now or later?
Paul Thwaite, CEO
Keep going, Aman.
Aman Rakkar, Analyst
I would like to discuss distributions. I think it's great to see the GBP 300 million open-market buyback. I'm curious about how the retail share offering that the government plans to execute this summer will affect your thinking. It seems you haven't budgeted for a directed buyback in May, which suggests you might be confident in capital generation for the upcoming quarters. However, the retail share offering could reduce the chances of a directed buyback. Do you feel that this would allow for more regular execution of open-market buybacks? Any insights you can share about your updated approach to distributions would be greatly appreciated.
Paul Thwaite, CEO
I’ll address the second and third questions. Then Katie will discuss the revenue guidance. Regarding the directed buyback, it's part of our plans and budget. We have accounted for it and can execute after the annual anniversary. Concerning the challenge with conservatism and the interest rate outlook, I acknowledge where the curve stands. It's important to consider the overall economic consensus, which has fluctuated recently. We have a set of assumptions featuring five rate cuts in 2024, four in 2025, with the first cut expected in May. We’ve provided detailed disclosures about the sensitivities, so those with differing views on volatility can easily adjust their expectations based on our information. Now, Katie, would you like to discuss the revenue guidance?
Katie Murray, CFO
As I see it, there are several variables at play. You might already be aware of the answer I’m about to provide, but these variables are affecting the income range. Customer behavior has been quite unpredictable, and we might observe varying competitive dynamics. I believe it’s important to consider four key aspects as you build your model. First, base rate cuts, which Paul has mentioned, with five cuts anticipated for May and four later on. The timing of these cuts will influence income, starting in May, although it could vary. As Paul noted, there are sensitivities to consider. The second aspect is deposit volumes and their mix. We anticipate a slight decline in deposit balances during Q1 due to tax payments, after which they should align more closely with market trends. We foresee continued deposit migration into 2024 but at a slower pace than previously observed. As mentioned in Q3, this slowdown is already evident, but we don’t expect it to be linear. The third point is the structural hedge, which will be a tailwind in 2024 as higher yields compensate for lower volumes. Lastly, we will discuss mortgage volume and margin in more detail as the call progresses. Overall, we are focused on managing both sides of the balance sheet to ensure we meet our income and return guidance. We expect the income shape to improve throughout the year, with the second half being slightly stronger than the first. I also want to clarify that the retail share offering will not affect our buyback plans. The board has a separate strategy in place for what needs to be done.
Paul Thwaite, CEO
Yes, that’s a key point, Katie. It’s in the plan.
Benjamin Toms, Analyst
You know your guidance on your income, ex notable items, of GBP 13 billion to GBP 13.5 billion, but could you provide us with an estimate for NIM for the full year, I guess, based on your new measure; and how the shape of NIM might change as we go through the year? And then secondly, just a clarification question on your sensitivities to rate cuts, where you assume a 60% pass-through assumption. Can you just clarify what that 60% means? Is it measured from the first rate rise in the cycle or from the first rate cut? If it’s the latter, is 60% a fairly conservative assumption? I think I’ve heard peers of yours talk about deposit pass-through being much higher on the way down than it is on the way up.
Katie Murray, CFO
Yes, absolutely. Regarding net interest margin, we are providing total income guidance today of GBP 13 billion to GBP 13.5 billion. As you know, we have managed margins on both sides of the balance sheet, which is a major focus for our management team. It's one of the factors we consider for overall returns. You also need to take into account the cost of risk, capital needs, and operational expenses. This is why return on tangible equity is our main financial metric, as it drives capital generation and our ability to invest and distribute to shareholders. The key income drivers for 2024, which I mentioned earlier, are also our main margin drivers, so you can expect margins to follow a similar trend to income throughout the year. Now, regarding sensitivity, we provided an illustrative example of a single 25 basis point cut, which shows the incremental pass-through associated with that. The pass-through will largely depend on competitive dynamics. As we did previously when rates were rising, we didn't disclose our next pass-through expectations, as those emerged based on competition and market conditions. While I won't disclose specifics right now, our analysis assumes a 60% pass-through of the rate, keeping in mind there may be a delay due to regulatory requirements for notifying our customers. How we implement this and the timing will depend on customer needs and market conditions.
Paul Thwaite, CEO
Yes. What I’d add on that, Ben, is I would see it as a sensitivity and an example, not a statement of our pricing strategies. Our pricing strategy will be influenced by as and when the rate changes happen, what the competitor responses are, what our funding and liquidity needs are at that time as well.
Rahul Sinha, Analyst
I’ve got two, please. The first one is just around the confidence in your new RoTE targets, just interested in the moving parts from the sort of 12% that you guide for '24 to above 13% for 2026. I guess the simple question is, is it all just driven by the hedge? Or are there other sort of material drivers that you would point to as well? And I guess, related to that, the second question, just on the mortgage business. The book didn’t grow in Q4. Obviously, your flow share was 10.5%. I think you’ve done 14% share through the year. I’m just trying to understand if this more disciplined approach to mortgage growth means that we should expect lower growth in the loan book driven by mortgages going forward given competitiveness in this market is probably not going to change. And just an addendum to that, if you could give us a bit more color on the mortgage refinancing churn, the back book to front book; how it phases through the quarters in 2024 that would be really helpful.
Paul Thwaite, CEO
Thanks, Rahul. Katie, I'll begin with a few points regarding RoTE, and then you can discuss the bridge. I am sure we can both address mortgages as well. Rahul, concerning the general guidance for RoTE, we have indicated around 12% for '24 and more than 13% for '26. This has been considered thoughtfully, and the economic assumptions we analyzed are visible. As I mentioned in my response to Aman, you can form your own opinion on those. The key factor driving this is the trajectory of the peak, from 5.25 to 3 over the next two years. To answer your core question about what drives the improvement, it certainly involves more than just the hedge. While Katie pointed out the favorable aspect of the hedge, my main focus is on enhancing various P&L lines. We will be managing costs and capital with great discipline, carefully considering capital allocation while also fostering growth in our core businesses, whether that involves fees or lending growth, including mortgages or corporate loans. So, while we benefit from the positive impact of the hedge, we are also actively utilizing other strategies to advance the business.
Katie Murray, CFO
I will focus on mortgages now. In terms of the mortgage business, the churn appears more stable in the first quarter, showing a consistent flow. We expect this stability to continue into the second quarter. Recently, we managed the application flows based on the shape of the balance sheet, which we believe was a sensible approach. A 14% growth over the year makes us comfortable, as it exceeds our expectations. We view this area as crucial for growth. While we don't expect growth every quarter, we anticipate growth over time. Pricing dynamics and fluctuations in the swap curve are vital to ensure we are managing for value and maximizing our return on tangible equity in this sector. We are confident in this process, and one quarter should not be seen as indicative of future performance. We still consider this book significant for us, providing strong returns and being essential for our growth moving forward, and we are investing significantly to scale and benefit from the digitization of this business.
Andrew Coombs, Analyst
I have two questions. The first is regarding the structural hedge. The previous guidance projected it would finish the year at GBP 190 billion, but it has come in at GBP 185 billion. This is despite the deposit mix shift being generally in line with your guidance for Q3. Could you clarify what led to the additional GBP 5 billion decline in the nominal amount? Additionally, could you share your thoughts on the anticipated direction and magnitude for 2024? My second question concerns the impairments. Given the confident guidance for this year under 20 basis points, I noticed on Slide 21 that you still report through-the-cycle figures as being 20 bps to 30 bps, and you expect to perform better than that this year. Is there any factor included in that for the release of the GBP 429 million adjustment for economic uncertainty, or is it simply due to improved IFRS 9 assumptions and lower Stage 3 migration?
Katie Murray, CFO
Yes, perfect, absolutely. So as I look at the hedge, what we’d sort of talked about was around a GBP 190 billion base on a static balance sheet. We know that the balance sheet obviously is not static. In terms of the direction of travel is a few things I would probably mention on that. The average product yield for the hedge was 142 basis points. It’s important to understand in the fourth quarter that increased to 152 basis points for the quarter. When I look at the kind of sizing of the hedge as we go into next year, we would expect the shrinkage to be less than we saw in 2023, in line with that conversation we’ve had around deposit movements kind of stabilizing in the middle of the year. If you were to look at the year-end notional balances and the mix remains static, you could see that number would recalibrate to about GBP 170 billion. I think what’s important, though, as you look at the hedge is also the level of reinvestment. So Andrew, it matures over 2.5 years. You take the GBP 185 billion today. One-fifth of it will mature every year, so therefore, it’s GBP 37 billion when you look at that kind of average life of the book. We are assuming that it gets reinvested at around 310 over the course of the year. You can see that rates are slightly better than that today, but on average, we think that’s an appropriate number to look at. And we’ve talked in the past around the fact that the roll-off yield is so much lower than what the reinvested real. So we do see this as a positive tailwind as you see that stabilization coming through in the first half of the year and moving forward from there. And Paul, do you want to take impairments?
Paul Thwaite, CEO
Yes, I’ll take impairments. Andrew, your hypothesis or as you outlined is pretty much spot on. The book is performing better than we’d anticipated. Customers have adapted resiliently to the higher rate environment, so arrears levels remain low across most of the asset books. So loan impairment, 15 bps for '23, obviously below our through-the-cycle range. You’ve seen the guide for '24, below 20. So assuming no sign of significant macro deterioration. You also astutely point out we do have post-model adjustments of GBP 0.5 billion, GBP 400 million for economic uncertainty, GBP 0.5 billion overall, but we will be very prudent about them in terms of the release. So your thesis is right in terms of what’s happening.
Andrew Coombs, Analyst
Can I just clarify one thing with Katie? Roll-off yields. I think previously you said 80 bps for this year and 50 bps for '25, presuming that guidance is unchanged.
Katie Murray, CFO
It's unchanged. There are some technical details I'll avoid going into, but as we manage the process of reducing the notional and we fixed swaps to decrease that, the roll-off yield actually decreases. So it's actually a bit lower than that due to the mechanics we implement. However, if you consider the differences, the pay fixed swap as we manage the notional does have a slight impact. But those figures are good for you to reference.
Alvaro Serrano, Analyst
I have a follow-up regarding the margin and future expectations. Setting aside the conservative rate assumption, how much of the 80 basis points on mortgage product spread is attributable to mortgages? What additional headwinds should we anticipate in the first half of 2024? Additionally, we have observed that sector data indicates very stable deposit movement in November and December, so should we expect significant pressure on deposit margins as well? Furthermore, when I consider your projected return on tangible equity of over 13% in 2026 compared to 12% this year, and relate that to the nine rate cuts you have planned, it seems that your revenues may not grow until those rate cuts conclude. Is that the reasoning behind the expected improvement in 2026, suggesting that growth will pick up post-rate cuts in 2025? Apologies for the lengthy question. Paul, in your introductory remarks, you mentioned enhancing your share in targeted segments. Reflecting on the past few years, which have predominantly emphasized mortgage growth, what key areas do you intend to focus on for growth over the next three years?
Katie Murray, CFO
I’ll address the first question. Looking at the mortgage margin, we discussed last year how it would stabilize around 80 basis points, which is where we ended up. The rate of churn we experienced has slowed down. Currently, we’re writing around 70 basis points. The refinancing headwinds from the mortgage book will be less significant in 2024 compared to 2023, although there may still be some fluctuations. We anticipate some stabilization by mid-2024. Due to the volatility in swap rates, some of our business was written below 80, but we are comfortable with our current writing level and managing our flow share effectively. Regarding deposits, based on both Bank of England data and our own experiences, we are still seeing some migration, increasing from 15% to 16.4% at the end of the year. We expect this trend to continue for a couple more quarters, likely stabilizing around the summer. In terms of revenue through 2026, I want to clarify that we do not anticipate flat revenues during that period. We’ve discussed this frequently throughout last year. With deposit stabilization and mortgage stabilization, along with the structural hedge taking effect, we expect income in the latter half of 2024 to exceed that of the first half, continuing into 2025 and 2026. Now, Paul, I’ll pass it over to you for the second question.
Paul Thwaite, CEO
Thank you, Katie. Alvaro, I am considering the various growth opportunities in the business. As mentioned in my presentation, there are several key areas. When looking at our different customer segments, mortgages are positioned well for growth. If the market conditions, demand, and pricing align, we are currently the second largest lender and expect continued growth in this area, as long as margins and returns remain favorable. We have also made significant progress in the unsecured segment of retail, where we are pleased with both our returns and credit quality. Moreover, we acknowledge that we are underweight compared to some competitors, presenting an opportunity that our retail team is keenly targeting. In the commercial and institutional sectors, we have observed solid growth in our project finance, infrastructure, and funds business, which we believe will provide substantial upside over the next few years. Our strategy is not just focused on the short term; we are also capturing market share in areas like startups and youth, where we now exceed 20%. I view this as a way to build a pipeline for future revenue and returns. While we are dedicated to growth, we prioritize disciplined growth, which is a key focus for me and the team. We see numerous opportunities within NatWest’s core businesses to achieve this.
Jason Napier, Analyst
Paul, there has been considerable focus from you on cost efficiency within the business. Can you provide more details on 2023 regarding expenditures on restructuring, the key changes, and the performance from last year? Some feedback suggests that a flat performance may be acceptable for one year, but in the current operating climate, the organization may struggle to maintain that over time. Could you elaborate on what you achieved last year and your thoughts on the expected cost growth rate for NatWest moving forward? Additionally, for both Katie and Paul, there were mentions in the prepared remarks about a more proactive approach to capital management, securitization, and risk transfer. It appears there hasn't been a change in the outlook for RWAs in 2025 and that it remains linear. Could you discuss what this means for NatWest? Specifically, this year there seems to be a need for share buybacks in the market. Can you explain whether this active balance sheet management will significantly impact the availability of excess capital in the near term?
Paul Thwaite, CEO
I’ll take costs, Katie. And then maybe come back to Basel 3.1 and RWA trajectory. So Jason, on costs, we're only guiding for '24, which is broadly stable. Within that we have restructuring costs built in, so then I guess it's pretty easy to conclude that to stay broadly flat, we're going to work pretty hard to mitigate the impacts of both wage inflation and general contract inflation. So we're very focused on mitigating any cost increases. I’d like to take those costs in year, so no broader restructuring charge. So we’ve built in a higher level of restructuring charges in '24 than we used in '23, just to directionally give you a sense of that. Overall, I do see big opportunities in respect of bank-wide simplification within the bank. You’ll have seen that in the slides. I think there’s a lot to do, a lot that we can do to make our bank easier for customers to do business with us but also improve productivity for our colleagues. I talked in October how I’d reshape the investment spend around some key projects to deliver more digitization and automation. That obviously plays through in terms of efficiency. We also have opportunities in terms of consolidation of some of our tech platforms as well. So we’re gripping cost as a management team. We want to take the charges in year. That’s what we’ve done in '23. That’s what we’ll do in '24. We are very focused on the glide path and mitigating any of the natural inflationary aspects that there are.
Katie Murray, CFO
Basel 3.1 and RWA. You’re absolutely right, Jason. I want to emphasize the GBP 200 billion guidance we've provided until the end of 2025, which should be viewed as linear from this point, keeping in mind it may vary. In RWAs, there are numerous factors at play. We are very disciplined in how we allow the businesses to utilize them and how we manage them over time. We will monitor aspects like SRTs and the lending origination we have at any point to ensure we're achieving the right returns on our RWA investments. If you project linearly from here, you will reach the correct figures as we progress.
Operator, Operator
That concludes the Q&A section. I will now hand back to Paul for closing comments.
Paul Thwaite, CEO
Thank you, everybody. Thank you for joining. Katie, Howard and myself appreciate it. I hope you’ll agree we’ve laid out a good strong performance for 2023. I’m delighted to be confirmed in role today. And hopefully, you’ve got the sense I’m very focused on driving the performance and returns of NatWest, but before we sign off, I do also want to thank Howard for his commitment at NatWest and his invaluable contributions as Chair. I know this will be the last time you join the analyst call. I know many of you on the call know Howard very well and have spent a lot of time with him over the course of his tenure, so I guess I’ll take the liberty of thanking him on your behalf for that. And we’ll build on these strong foundations to deliver the very best we can for our customers and our shareholders moving forward. So have a good Friday, everybody. Thank you.
Operator, Operator
Thank you, Paul. That concludes today's presentation. You may now disconnect.