Earnings Call Transcript
NatWest Group plc (NWG)
Earnings Call Transcript - NWG Q2 2024
Paul Thwaite, Chief Executive Officer
Good morning, and thank you for joining us today. I'll start with a business update. Katie will take you through the financial performance, and then we'll open it up for questions. You all have seen that it's been a busy first half. We announced our acquisition of a mortgage portfolio from Metro Bank today, our transaction with Sainsbury's last month, and we've also grown our customer base organically by over 200,000. We are closing our hub in Poland as we continue to simplify the business, and our directed buyback in May further reduced the government shareholding, which is almost half to less than 20%. These are good examples of our progress that I'll come back to later. At the same time, we've been working hard to support our customers, and this activity underpins our strong financial performance. So let me start with the headlines. We have had a strong first half, with significant growth quarter-on-quarter. Income was £7 billion, and costs were £4 billion resulting in operating profit before tax of £3 billion, with attributable profit of £2.1 billion. Our return on tangible equity was 16.4%. Given the strength of our performance, together with our updated economic forecast, we are upgrading our 2024 guidance, which Katie will talk about later. Improving consumer and business confidence is reflected in good customer activity across both sides of the balance sheet. Customers are increasing their savings, with deposit growth across our three businesses of more than £6 billion, whilst we attracted record flows to ISRE accounts, the overall mix of term deposits was stable. We see good activity in Commercial & Institutional banking, where lending grew by £3 billion, excluding government schemes. We provided £16 billion of climate and sustainable funding and financing, bringing the total to £78 billion since July 2021. Our target is to reach £100 billion by the end of 2025. Customers are also absorbing the impact of higher interest rates, and arrears remain low. Our disciplined approach to lending is reflected in an impairment charge equivalent to 3 basis points of loans. We remain focused on generating capital in order to reinvest in the business and make shareholder distributions. Our CET1 ratio is within our target range at 13.6%. And we increased capital through earnings as well as active management of risk-weighted assets, which added 140 basis points during the first half. As a result, we're announcing an interim dividend of 6p today, up 9% on last year. This is in addition to the £300 million on-market buyback announced in February, which completed this week, and a directed buyback of £1.24 billion in May. I'd now like to outline our approach to creating long-term shareholder value. We serve 19 million customers meeting a wide range of needs across our three businesses: Retail Banking, Private Banking, Commercial & Institutional. By putting customers at the heart of our business, we create value for all our stakeholders. We are targeting disciplined growth by focusing on areas with attractive returns and by striking a careful balance between volume and margin. This growth, together with managing costs and capital, allows us to invest in the business and make attractive distributions to shareholders. We announced £1.7 billion of distributions during the first half, and the lower share count from buybacks has resulted in higher dividends per share. You can see on the right how the dividend has grown, while a number of ordinary shares is reduced from 8.9 billion to 8.3 billion year-on-year. This has supported a 16% improvement in tangible net asset value per share to 304p, and we expect continued growth into 2025 and '26. Turning now to our three strategic priorities: disciplined growth, bank-wide simplification, and active balance sheet and risk management. I'll talk about each one in turn. We have continued to build on our strong market positions through both organic and inorganic activity. The growth in new customers of over 200,000 has contributed to growth across the bank. Lending in commercial banking to mid-market customers grew by £1.8 billion. Assets under management and administration are up 11% to over £45 billion, and our share in credit cards grew 0.5 percentage point to 9% due to our investment in technology to make us more competitive on price comparison websites. We are accelerating this organic growth by making acquisitions where we have opportunities to add scale in our target areas at attractive returns. We announced today that we are acquiring a £2.5 billion portfolio of prime UK residential mortgages from Metro Bank, and we expect the deal to close in the second half of this year. Our Sainsbury's transaction is expected to complete in the first half next year, adding around 1 million new customer accounts with about £2.5 billion of unsecured loans and £2.6 billion of savings. On completion, this transaction should increase unsecured balances in Retail Banking by 17% and grow our credit card share from 9% to 10.6% on a pro forma basis. We continue to simplify the bank to increase efficiency and improve customer experience. For example, we have three strategic hubs in the UK, India and Poland, which we are reducing to two by closing our operations in Poland. And the number of telephony systems we use across the bank has come down from 20 to 5 since the year-end. We are also accelerating our digital transformation. I'll share just a few examples from many across the bank. We continue to digitize customer journeys to make it easier and simpler to interact with us. This year, we have transformed 11 customer journeys on our digital channel for commercial customers bank line. This includes the management and tracking of international payments online, which should free up our colleagues from thousands of inbound calls each year. We have also reduced onboarding times for clients who want to carry out foreign exchange transactions from 7 days to 1 day. As a result, our foreign exchange business serves an additional 300 customers from our commercial mid-market segments. To help both retail and business customers, we are enhancing our Chatbot, Cora, which handles over 10 million customer interactions a year by introducing generative AI. Our third priority is to allocate capital dynamically and maintain strong risk management. We reduced our flow share in mortgages at the end of last year in a competitive market with considerable pricing pressure. But we deployed additional capital in Commercial & Institutional banking, where first half lending grew by £3 billion, excluding government schemes. During the second quarter, we then increased the capital allocated to mortgages again following improved market conditions reflected in a growing share of applications. In addition to disciplined origination, we are actively managing our risk-weighted assets and have delivered a £4.3 billion reduction in the first half using a range of means, including significant risk transfers and credit risk insurance. By focusing on disciplined growth, improving efficiency, and managing our capital dynamically, we are driving capital generation in order to optimize shareholder returns. The positive momentum and progress made during the first half reflects the ambition across the bank to deliver its full potential, and we feel increasingly confident about the outlook. We continue to expect a return on tangible equity greater than 13% in 2026 whilst operating within a CET1 ratio of 13% to 14%. And we are targeting a payout ratio of around 40%, in line with our commitment to return surplus capital to shareholders. With that, I'll hand over to Katie to take you through our performance in the second quarter.
Katie Murray, Chief Financial Officer
Thank you, Paul. All my comments use the first quarter as a comparator. Income, excluding all notable items, increased 5.2% to £3.6 billion. Operating expenses were 2.3% lower at £2 billion. We made an impairment release of £45 million or 5 basis points of loans, which included post-model adjustment releases of £117 million. Together, this delivered operating profit before tax of £1.7 billion. Profit attributable to ordinary shareholders was £1.2 billion, and return on tangible equity was 18.5%. I'd like to talk now about our updated assumptions. Overall, the UK economy has performed better than we expected at the start of the year, and we are pleased to see consumer and business confidence returning. This means the Bank of England has not yet started to reduce interest rates. We initially assumed rates would start falling in May, reaching 4% by the end of the year and 3% by the end of 2025. We now assume rates will start to come down in the third quarter, reaching 4.75% by the end of the year, with a further five cuts in 2025 to 3.5%. Of course, the actual outcome may be different. The headline rate of inflation is now 2%, in line with Bank of England's targets, and we assume it will stay around this level. We continue to assume moderate real GDP growth and some increases in unemployment. I'll turn now to talk about our income performance. Income, excluding notable items, of £3.6 billion was up 5.2% on the first quarter, with growth in net interest income and non-interest income. Across the three businesses, income grew by £147 million, driven by higher deposit income and fees. All three businesses delivered higher deposit income as the tailwind from the structural hedge more than offset deposit mix changes. In Retail Banking, the pace of reduction in mortgage income slowed as the book has now largely repriced. Commercial & Institutional generated higher lending and financing fees as well as payment service fees. And Private Banking reported higher investment management fees following growth in assets under management of £2 billion or 4.6%. Group net interest margin was 210 basis points, up 5 basis points from the first quarter. Given this positive performance and our updated economic assumptions, we are raising our guidance for 2024 total income, excluding notable items, to around £14 billion. Moving now to lending. We continue to be disciplined in our approach and focus on deploying capital where returns are attractive. We are pleased to see ongoing demand from our commercial mid-market customers, together with an improvement in growth in mortgage lending. Gross loans to customers across our businesses decreased by £1.9 billion to £358.6 billion. Taking Retail Banking together with Private Banking, mortgage balances fell by £0.8 billion as customer redemptions more than offset new lending. The pace of reduction slowed in the second quarter, with gross new lending increasing over 20%, reflecting stronger market volumes and stable retention levels. We expect the book to return to net growth in the third quarter, given both stronger market volumes and an increase in our share of new applications during the second quarter. We have also announced the acquisition of a £2.5 billion prime mortgage portfolio from Metro Bank, which we expect to close in the second half. We continue to be disciplined in our approach to the mortgage market as we manage the business for returns. Unsecured balances increased by £0.3 billion to £16.1 billion, with growth in credit cards partially offset by lower personal lending. We continue to grow our share in unsecured lending, and the Sainsbury's Bank transaction supports this. Within Commercial & Institutional, lending to mid-market customers grew by £1 billion, driven by demand in social housing, asset financing, and invoice financing. Balances in Corporate & Institutions decreased by £1.9 billion, partly due to customers taking advantage of stronger capital markets, which is reflected in the performance of our markets business. I'll now talk about deposits. Across our three businesses, these were up £5.2 billion to £425 billion. Migration from non-interest-bearing to interest-bearing deposits continued at a slow pace as expected. Non-interest-bearing balances were 32% of the total compared to 33% at the end of the first quarter. And term accounts remained around 17%. In Retail Banking, there was strong growth in savings driven by record ISRE inflows. In Private Banking, there was good demand for instant access savings, including some short-term transitory inflows. In Commercial & Institutional, both non-interest-bearing balances and savings grew, driven by our commercial mid-market customers. Turning now to see how this has translated into the cost of our deposits. For the first time in 2 years, the average rate of interest we pay on our customer deposit funding has stabilized. It remained at 2.1%, in line with the first quarter. This stabilization reflects modest changes in mix and limited adjustments to deposit product rates. As UK base rates come down, we expect to pass through reductions on our customer deposit rates. But clearly, the quantum and timing of this is subject to competition as well as contractual terms and conditions. We have updated our illustrative interest rate sensitivity disclosure on the right of this slide. The managed margin is the more relevant sensitivity for changes in the base rate and deposit pass-through. Based on our first half balance sheet, a 25-basis-point downward parallel shift in the yield curve would reduce annual income by £125 million. This is mainly driven by our unhedged deposit balances and assumes a pass-through of around 60%. Turning now to the structural hedge. Many of you are familiar with our structural hedge and our mechanistic approach to managing it. It is an important driver of income, so I will recap a few points. £175 billion or 41% of our deposit base is part of the product structural hedge, where yields are depressed relative to current rates. The yield in the first half was 1.58%. Our product structural hedge has an average duration of 2.5 years, which means it takes a full 5 years to reprice, and we reinvest maturing balances at the prevailing 5-year swap rate. As we have shown in the chart, before further reinvestment is taken into account, more than 90% of income is already written for 2024, and product hedges already written will deliver income of £2.9 billion in both 2025 and 2026. The actual income from the structural hedge in coming years will reflect any changes in notional balances as well as differences between the redemption and the reinvestment yield. The product notional reduced by £10 billion during the first half, which reflects our 12-month look back at average eligible balances. We continue to expect around £170 billion by the end of this year, based on a static balance sheet. Overall, we expect the product structural hedge to deliver higher income in 2024 than 2023 and for this to deliver a more significant income benefit in 2025 and 2026. Turning now to costs. We remain on track for other operating expenses to be broadly stable compared to 2023, excluding the increase in bank levies of around £100 million and the costs associated with the potential retail share offering of £24 million. Other operating expenses of £1.9 billion for the second quarter were slightly lower than the first as a result of the Bank of England levy. Severance, branch, and property exit costs increased in the first half as we accelerated our work on simplification. The second quarter includes costs relating to our announced exit from Poland. I'd like to remind you that our investment spend and cost savings are not evenly spread across the year, and you should not make run rate assumptions based on a single quarter. Turning now to impairments. Our diversified prime loan book continues to perform well. We are reporting a net impairment release of £45 million for the second quarter, taking the first half charge to £48 million, equivalent to 3 basis points of loans. In Retail Banking, a charge of 12 basis points reflects broadly stable Stage 3 inflows, partially offset by a further post-model adjustment release. Commercial & Institutional reported a release of 28 basis points, driven by post-model adjustment releases as well as a reduction in statutory impairments. Our balance sheet provision for expected credit loss still includes £302 million of PMAs for economic uncertainty. We have also reviewed and updated our economic scenarios, which drove a £17 million release. We have included the economic forecast and weightings in our appendices. Stage 3 charges have remained low in the first half. And as our economic scenarios are relatively stable with little sign of deterioration, we now expect a loan impairment rate below 15 basis points for the full year. And turning now to capital. We ended the second quarter with a Common Equity Tier 1 ratio of 13.6%, up 10 basis points. Capital generation was especially strong given our impairment release and active RWA management. We generated 63 basis points of capital from earnings and 41 basis points from lower RWAs. RWAs decreased by £5.5 billion to £180.8 billion. Active capital management accounted for £3.9 billion of this reduction. This activity is in line with plan and with a number of actions successfully completed in the second quarter. And while it is an important capital management tool, it should not be considered the run rate. We currently expect around £200 billion of RWAs by the end of 2025, but the journey will not be linear. You need to bear three things in mind. First, the continued disciplined growth, including the Metro Bank and Sainsbury's Bank transactions; secondly, further RWA management; and finally, ongoing regulatory headwinds. We are awaiting the PRA publication of the Basel 3.1 rules. We are also liaising with the regulator on CRD IV model changes, where we expect some further inflation in the second half and through 2025, though timing and quantum remains uncertain. Overall, we believe around £200 billion by the end of 2025 is an appropriate basis for planning. We will continue to operate with a CET1 ratio in the range of 13% to 14%. And finally, turning to guidance. For the full year, we now expect income, excluding notable items, to be around £14 billion; other operating costs to be broadly stable with 2023, excluding additional bank levies of around £100 million, and the retail offer costs of £24 million; and our loan impairment rate to be below 15 basis points. Together, this will deliver an expected return on tangible equity of greater than 14%. And with that, I'll hand back to the operator for questions.
Operator, Operator
Our first question comes from Raul Sinha, JPMorgan.
Raul Sinha, Analyst
Can I have two questions, please? The first one is about the deposit margin, which has increased by 6 basis points this quarter. I’m curious about the overall deposit performance of the franchise and how much of that growth might be sustainable as we enter the second half, especially with the potential for increased rate volatility. The second question is regarding capital management, which I thought was a pleasant surprise today with £3.9 billion achieved through RWA management. That’s a strong result. I understand you've gained some advantages from SRTs. Can you explain how you manage this and what we might expect in terms of future opportunities? Additionally, does this impact how the government might consider exiting its stake, given that you have a larger buyback authorization for next year? How does this relate to the government's plans for phasing its exits?
Paul Thwaite, Chief Executive Officer
There's a few in there. Katie, I'll start with kind of deposit piece, and then maybe you can follow up on some of the margin specifics. And then maybe it makes sense for you to talk about the RWAs and the SRTs. So Raul, on deposits, as you say, it's a strong quarter and a strong half year. You'll probably recall I spoke last October around managing deposits for income and liquidity value. So it's pleasing, this quarter, to see the deposits up by just over £5 billion. And when you dig down into the details, I'm sure you've done, you can see that we've got growth in all of our three customer businesses. So £1.5 billion in retail, £2 billion in C&I and £1.7 billion in private. So good broad balanced growth from the three businesses. I guess, the other part of your question really was around the outlook there. Obviously, we don't give specific guidance on deposits, but pleased with the positive growth in half 1 and probably encourage you to think about it that we'd expect our deposit balances to trend pretty much in line with the sector. And you can also see that the term deposits have stabilized at 17%. We indicated, we thought that would be the customer behavior as we came through the half of this year. But quarter-on-quarter, we're stable at 17%. So that's a nice mix effect, which has obviously supported the performance. And obviously, we're working hard to retain those deposits, but in a way that manages the liquidity value and income. So Katie, do you want to talk specifically about that?
Katie Murray, Chief Financial Officer
I'll add a little bit on margins, okay? Raul, the way I would think about the deposit margin in H2 is clearly there's going to be an ongoing benefit from the hedge, which we expect to continue to offset deposit mix changes, which as Paul says, are slowing. Then you need to consider the base rate cuts, one in Q3 and one in Q4, which will slow the pace of growth that we saw in Q2. But overall, I would say both of these things are factored into our full year '24 income guidance of around the £14 billion. And then, if I just go on to SRTs, it's something we've talked about over time, and it's good to see them coming through. So £3.9 billion in the quarter, £4.3 billion in the half. There's probably three different things I would highlight there. I mean, Raul, you probably haven't got to Page 11 or Pillar 3 this morning. If you have, I'd be terribly impressed. But what you can see within there that when we look at that RWA management, of that £4.3 billion, £1.2 billion of it is SRT transactions. We then have a portion, which is in relation to credit issuance. And then we have probably a bit more or less about half of the balance, which is actually RWA kind of management actions. Now there's a raft of different things. I'm not going to go into huge detail as to how they all might work. But we've done a little bit of debt sales. We do quite a lot of credit limit management. And all of those things together for this half have brought us to £4.3 billion. We did talk about an area we were particularly focusing on, so it's good to see them kind of coming onto the ticket. I wouldn't take that £4.3 billion as a kind of half rate run rate. They will continue to move as we do different transactions and different management actions. But what it does do is it supports our capital generation, particularly so in this quarter, and obviously, our distribution capacity over time. And I would say you asked about the government, there's no direct link of that at all to the government sell down. This is really about managing the capital to make sure we're getting the best return for our shareholders.
Operator, Operator
Our next question comes from Alvaro Serrano from Morgan Stanley.
Alvaro Serrano, Analyst
Hopefully, I've unmuted correctly, and you can hear me?
Paul Thwaite, Chief Executive Officer
We can.
Alvaro Serrano, Analyst
I have a quick question about the hedge and the guidance. Regarding the hedge, I believe the redemption yield is lower than what Katie mentioned in previous results. I would like to understand what is causing this and if we can expect any changes in the future—what should we keep an eye on? As for the guidance, I understand from your earlier comments that NII is expected to grow in Q3 and Q4, although the cuts will limit that growth. Considering our growth, the £14 billion target seems quite conservative following a strong performance. Am I missing something regarding your comments on non-interest banking and non-interest income, or is there anything else I should consider? Also, regarding the 2016 guidance, is it not the right time to update it, or do you believe it is still relevant?
Paul Thwaite, Chief Executive Officer
I'll address the 2026 guidance targets. We shared those targets in February, and it's still quite a while until then. I want to emphasize that we are increasingly confident about the outlook for 2026. We are reaffirming our return target for that year, which has always been and remains greater than 13%. However, it feels too early to make any changes to that. Now, Katie, please discuss the hedge.
Katie Murray, Chief Financial Officer
Yes, absolutely. So if I take the hedge first in terms of the specific point on the redemption yield. So overall, we operate a very mechanistic approach, and we take to the managing of that product hedge. And what that does result in the execution of pay fixed swaps, which reduces the nominal of the hedge, while maintaining the average duration of 2.5 years. So that has the impact of reducing the net income and the applicable redemption periods, and hence, they respect the yield when expressed as a percentage of the normal hedge goes out selling. So we always talked about 80 basis points previously. What we've seen is we've been reducing that hedge down to the 175 at the end. At the moment that, that takes you to 40, the impact of it into 2025. It takes the 50 we historically talked about down to 0 and then in 2026, which clearly, there's been a lot less feathering happening at this stage in 2026 as much further out. At the moment, that's still sitting up at 40. So hopefully, that helps. But I think these are good redemption yields to use for your modeling at this stage. If I then look at the £14 billion of income, so H1, £7 billion strong start, really supported by customer activity on both sides of the balance sheet. And obviously, the absence of rate cuts as well. We were pleased to see the margin expansion across the three businesses. When I think about the income outlook into H2, it does imply a broadly stable versus H1. And there's four things that are probably in my mind as I look at it. The first one, base rate cuts, we've got two base rate cuts of 25 basis points, one in Q3 and one in Q4. So you know that, that will bring some pressure in those quarters, particularly in the period as we're waiting to kind of pass that cut through. I think the second thing is customer behavior. Volumes have been positive in H1. But I think we still don't quite know how customers might react as you see those rates fall and importantly, how the market might react. So that's something to think about in the second quarter. There's always some seasonality in C&I. I think we've been very pleased with the performance of our markets business in this first half, but we do expect some seasonality there. And I guess, the last thing to kind of end on a bit more positive is that we have seen the mortgage book and margin stabilization. The book is now around 70 basis points. We're writing at around 70 basis points. So that drag has kind of gone. But overall, I think strong guidance as we go into the second half, really reflecting the strong activity of our customers.
Operator, Operator
Our next question comes from Andrew Coombs of Citi.
Andrew Coombs, Analyst
I have a couple of questions. First, could you discuss standard variable rate mortgages and what trends you're observing in terms of repayment as we see stability in the base rate? Secondly, regarding capital management, I understand you mentioned not to extrapolate the capital management related to RWAs this quarter. However, you're still confirming the RWA guidance for the end of '25, despite the acquisitions of Metro Bank and Sainsbury's Bank portfolios. My question is, as you consider capital return or usage going forward, why haven't you announced another ordinary buyback today, given the stronger core Tier 1 ratio and these two portfolio acquisitions? How do you view the balance between inorganic growth potential and ordinary or directed buyback opportunities?
Paul Thwaite, Chief Executive Officer
I'll cover the capital aspect. Katie, could you follow up on the SVR mortgage aspect? You're correct, Andrew. While we are pleased with our active capital management activities and the benefits we've seen in the first half of the year, particularly in the second quarter, we are still targeting around £200 billion by the end of 2025. As you mentioned, we've announced two inorganic transactions, which we expect to contribute approximately £3 billion of RWA. We remain confident in our existing guidance, which remains unchanged from that perspective. There are several factors we are considering, including awaiting the final PRA publication of the Basel 3.1 rules and clarity on the implementation of CRD IV. We still have some model changes pending, which we expect will impact the second half. The timing and extent of that are still uncertain. Regarding the broader question of distributions, our approach remains unchanged, Andrew. We prioritize the ordinary dividend, aiming to distribute about 40% of our profits. We are pleased to announce a 6p interim dividend today, reflecting a 9% increase over the previous year. Next, we'll prioritize the directed buyback we initiated this May. We just completed the £300 million on-market buyback this week. We'll review future distributions at the end of the year in consultation with the Board. Katie, about the SVR?
Katie Murray, Chief Financial Officer
Yes, certainly. Andrew, SVR is not a significant portion of our business, accounting for about 3%, and it has remained around that level. You can find more detailed information on Slide 33 in the appendix slides. We typically do not have long-term SVR customers, and we have put in a lot of effort over the years to address this. As we move forward, it's really not a concern for us. There's nothing particularly noteworthy to mention regarding SVR. Thank you, Andrew.
Operator, Operator
Our next question comes from Jason Napier of UBS.
Jason Napier, Analyst
I have a straightforward question about the hedge. Paul, could you discuss the decline in redemption yields on the hedge, which is certainly a positive sign and indicates a favorable outlook for next year, even though some of that benefit might be countered by the five rate cuts we've seen? Could you elaborate on the size of this tailwind for this year, next year, and the following year, and how it accumulates or not? Additionally, Paul, the capital beat today seems to have been well received in the market, along with the growth from the Metro acquisition and, to a lesser extent, Sainsbury's, which is also projected to positively impact EPS and RoTE. However, it doesn't change the revenue mix between NII and RoTE. NII is performing well right now, but could you address whether the current mix aligns with your expectations? If it doesn’t, what steps does the bank need to take to achieve the desired mix on a through-the-cycle basis? While acquiring loan books is beneficial, it doesn't alter the profit mix for the firm, and some of those assets may be in decline anyway. It would be helpful if you could discuss the ideal revenue mix for a bank like NatWest.
Paul Thwaite, Chief Executive Officer
Katie, do you want to go with the hedge?
Katie Murray, Chief Financial Officer
Yes, sure. I'll go with the hedge first of all. So I mean, Slide 14, what we've tried to do here is to set out for you is, how much of the hedge is already locked in, and then you can see obviously '24, 90%, 70% and then 50% in 2026. I've talked previously already on the call about what happens to that redemption yield and why it's moving and you would expect as we manage the size of it. So we're expecting the hedge today is 175. We're expecting it to get to 170. We have talked about things that deposit levels kind of stabilizing. So that would make you say, well actually relatively stable as we go forward. It's a kind of 5-year hedge. So it matures kind of every year as we move forward from here. So, I think the way that I think about it as you model it, if you're looking into '25 and '26, obviously, you get full year benefits of the previous year and then the averaging effect, but when I look at '24 and '25, I would think that it will enhance my income over where we end the end of this year by about £800 million, and then it will continue to grow from there into 2026. So clearly, a strong growth coming through from the hedge piece, and we're very comfortable with the levels that we've got locked into that as well. Thanks, Jason. Hopefully, that answers your question. I'll hand back to Paul.
Paul Thwaite, Chief Executive Officer
That's great. Thanks, Katie. It's a broad question, Jason, regarding strategy, so let me share my thoughts. We're pleased with the two acquisitions, as they are beneficial for both earnings per share and return on tangible equity in the first year. They are attractive moves to build scale and provide immediate returns for shareholders. In terms of our financial goals, I am primarily focused on managing the business for return on tangible equity, which I hope is expected. Beyond that, we also consider net interest income and non-net interest income. It's important to note that the size and position of our commercial bank and deposit base are advantageous for income and returns, making us more reliant on net interest income compared to some of our competitors. Nonetheless, we have seen growth in our non-net interest income this quarter, which is up 9%, and the underlying growth is closer to 4.5% to 5%, which we are pleased with. We observe growth in payments, lending fees, foreign exchange, and assets under management. Strategically, we want to continue growing our fee income, which is a key focus for us. The areas that are growing this year represent strategic opportunities. I believe that if we're to expand in this area, it must be done organically, which we are currently doing. However, if we consider inorganic opportunities, they tend to be relatively expensive. From a shareholder value perspective, any initiative around fee income must be strategically sound as well as beneficial for shareholders. At this point, considering the relative valuations, we are focused on growing that line through organic efforts, and I am pleased with the quarter-on-quarter momentum. In summary, for any acquisitions, they must be earnings per share and return on tangible equity accretive. Return on tangible equity is our North Star. While we focus on net interest income, it should not come at the expense of value. Thanks, Jason.
Operator, Operator
Our next question comes from Aman Rakkar of Barclays.
Aman Rakkar, Analyst
Yes, I have two questions. First, I've noticed that your forward-looking guidance lacks details on the organic growth we can expect from your business. It's a bit frustrating because this information seems embedded in your £200 billion RWA guidance that you've provided for some time. It’s challenging to distinguish what's due to regulation and what is the inorganic growth you've already mentioned. However, I know you have a medium-term outlook on your underlying organic growth, whether it’s loan or deposit growth. Could you share what we might expect in terms of low single-digit growth in average interest-earning assets over the next few years and what factors might contribute to that? I believe this is crucial as the market looks to evaluate NatWest beyond just the immediate effects of rate hikes. Any insights you can provide regarding anticipated volume growth and your assumptions leading to 2025 would be very helpful. Secondly, I’d like to ask about the structural hedge. Your updated disclosures are excellent, and I appreciate them. The reinvestment potential looks promising. However, I have a question about Slide 14. You've mentioned locking in £2.9 billion of income from the structural hedge over the three-year period, which surprises me since I expected this amount to decrease due to the amortizing nature of the structural hedge. Is this possibly due to the offsetting swaps you've implemented? I’d appreciate your help in clarifying the support for the structural hedge income from the already established hedges. I assume we will be adding significantly to this with the new hedges maturing, so any additional context on that would be very beneficial.
Katie Murray, Chief Financial Officer
Can I start with the hedge? Thanks very much. If we look at it, it's £2.9 billion in each year. I would say don't be distracted by the fact that it's rounding to the same number. If you looked at decimal places, you would see the rounding. What's happening is that although the hedge has shrunk in size, the differential in yield from the rates we've set is basically compensating for that. As we mention that one-fifth of it matures each year, we’ve seen a slight decrease in the last couple of years, but we believe it's stabilizing. What we've done recently is adjust those numbers based on the prevailing five-year rate at the time. Back in February, I indicated expecting the average to be 3.1 for that rate. Today, we're expecting around 3.7 for the year. If we were setting it today, which some team members are doing, it would be about 3.9. We've observed a significant increase where the roll-off will be minimal. Even though the absolute size of the hedge has decreased, the differential in yield more than compensates for that. That's really what’s happening. The Fed rate has little significance this year, but it’s not affecting that £2.9 billion due in 2026, which is two years away. It’s all about the flow-through of the hedge and the strength of our systematic approach. We’ve already locked in £2.9 billion for this year, and we will add more as we progress through the year. We are only halfway to that number, and I mentioned earlier that we expect our year-end result this year to grow year-on-year by about 800, and continue to grow year-on-year leading into 2026. This really benefits from the systematic approach we've implemented over the years.
Paul Thwaite, Chief Executive Officer
Aman, regarding your question about organic growth, I understand your concerns, so I'll address that. Firstly, we don't provide guidance on individual lines, as you know. However, I have been clear since February about our three priorities. The first is to pursue growth, but in a disciplined manner. You can see from the half-year results that our growth is broad-based, particularly in deposits, and our market shares are relatively stable or increasing. In our lending business, we are also being disciplined and focusing on returns. For instance, we've seen £1.8 billion growth in our commercial mid-market sector, which we are pleased about. Additionally, there's been growth in our unsecured lending, especially in our card business, where we gained significant market share towards the end of last year. We're satisfied with the risk-return profile and the credit quality there. Growth will also stem from our acquisitions, including the Metro mortgage portfolio, which will enhance our unsecured borrowing by about 19% and add over 1.5% to our pro forma market share. Overall, when considering our bank and the mix on the deposit side, it's reasonable to anticipate growth in line with the market. However, on the lending side, we have demonstrated that we can outperform the market. This is how we approach growth, with discipline, and by dynamically allocating capital to various products and asset classes to ensure we achieve satisfactory returns, enabling us to generate return on tangible equity and capital for all stakeholders. Thank you, Aman.
Operator, Operator
Our next question comes from Benjamin Toms of RBC.
Benjamin Toms, Analyst
One of your peers spoke yesterday about some mortgage spread compression for the rest of this year. Does it sound like you're expecting to see the same dynamic? Is that a correct way to think about the half 2? And then secondly, we saw some news for yesterday around that the government is now looking at the institutional sale of shares rather than a retail sale. Just from your perspective, are you relatively agnostic to those two different approaches? Presumably, the only difference is you don't incur costs in relation to an institutional sale.
Paul Thwaite, Chief Executive Officer
I think, we can knock them both off pretty quickly. On the mortgage one, it's very simple. The book margin will kind of hit at and around the inflection point. The book margin, 70 basis points on new business flow is around 70 basis points. So we feel very good about that. And obviously, it's something that we trailed last quarter. On the, I guess, government shareholding, we're very pleased with the momentum so far in '24. You know it's come down from 38% to just above 19%. So we're pleased with the momentum. Ultimately, any further sales or decisions for the government, as you say, we're relatively agnostic. What I'm clear about is returning the bank to private ownership is in the interest of all stakeholders. So we're very focused on that. But ultimately, it's a decision for them, which the timing of that, the mechanic of it, and the structure. Cheers, Ben.
Operator, Operator
Our next question comes from Chris Cant of Autonomous.
Paul Thwaite, Chief Executive Officer
Chris, can you hear us?
Operator, Operator
Chris, please unmute and go ahead.
Chris Cant, Analyst
Can you hear me? Sorry, the unmute option seems to lag in the Zoom app. Could I come back, please, on the £14 billion? And then I also have a question on your hedge slide. So the £14 billion implies sort of a leveling off of total income into the second half. And I guess if I think about what you're telling us on NII dynamics, particularly the last comment about the mortgage book reaching an inflection point in terms of that source of asset spread pressure and the fact that you're expecting to roll, I guess, a bit more of your structural hedge implicitly in the second half given £170 billion sort of year-end expectation. What else is going on within the revenue dynamic to sort of offset the upwards trend that you're otherwise seeing? Is it literally just the rate cuts and you're expecting big negative pricing lags around the impact of those in terms of that £14 billion? I mean, I have had one investor comment this morning that your guidance looks stale even though you've already given it. So just to give you some context on how people are thinking about that. That will be the first question, please. And the second one is on that hedge slide. Am I interpreting it correctly that when you say £2.9 billion in full year '26, it's 50% of income? Does that mean we just doubled £2.9 billion to get to the correct answer for the hedge income? Are you expecting £5.8 billion of gross hedge income in 2026, up from something like £3 billion in 2024, and so it's about £2.8 billion headwind? Is that the right way to interpret what you're presenting to us there? I mean, I know that your reinvestment yields for '25 and '26 still look quite low relative to forward swaps. But in terms of your assumptions, is that what you're trying to tell us?
Paul Thwaite, Chief Executive Officer
Katie, do you want to take that? Yes, okay.
Katie Murray, Chief Financial Officer
Sure, absolutely. Thanks, Paul. To start with the hedge, it's a bit simplistic to just double it. When we mention the 50%, our hedge has a 5-year duration, and we aim for a 2.5-year rollover. Considering that 2026 is roughly 2.5 years away, about 50% is currently written. We'll see maturities this year, next year, and again in 2026, so simply doubling it doesn't capture the timing of reinvestment, which is key as it often gets overlooked in such calculations. Regarding guidance, we expect to see a bit more this year, exceeding £2.9 million, and anticipate an increase of around £800 million next year, with further strength into 2026. If you were to double the figure, it might lead to disappointment with the final outcomes, so I wouldn't go that far. Still, we expect strong growth ahead.
Paul Thwaite, Chief Executive Officer
When you mention the percentage of income already written, should we understand that as the percentage of the total portfolio of swaps currently written, considering the churn by then? Is that a more accurate interpretation, given your reference to the percentage of income?
Katie Murray, Chief Financial Officer
That's the best way to think about it, Chris, yes. Yes, I think that could be a good end our slide, Chris. Thank you for the build on that real time. So very, very happy on that piece. Thank you. So then if I go back to kind of income, we're talking about income of around £14 billion. We're comfortable with that number. I guess, it really is story, we've got two base rates coming. We know that will bring a little bit of pressure into it. We do have a lag effect as we price those base rates through. It's a bit shorter in retail. But in some of them, we have in commercial, we have a 60-day contractual notice period for most of our commercial savings accounts. So that does have an impact as the rate kind of comes through. So that's kind of what we're considering within there. And then obviously, I talked about customer behavior already and seasonality in C&I mortgage book, I think we spoke about a lot on the call already. But overall, that around £14 billion, I would say, it's a really good guidance to use from here, and we're very comfortable and confident around that number. Thanks, Chris. Thanks for the edits as well.
Operator, Operator
Our next question comes from Guy Stebbings from BNP Paribas.
Guy Stebbings, Analyst
I had a question about the hedge and another regarding costs. First, I appreciate the detailed disclosure on the hedge; it’s extremely helpful. Much of the detail pertains to the product hedge, which is understandable since it makes up the majority. However, I would like to know if we should also pay attention to the equity hedge component, especially regarding maturation and reinvestment rates. Could that significantly affect our situation, or is it better to concentrate on the product hedge? Any additional insights on the hedge would be appreciated. Now, about costs, I see them in relation to a very encouraging revenue trajectory. The £14 billion projected for this year is clearly much stronger than what was initially expected. I realize you're not ready to revise targets right now, but the foundation looks solid, and you're highlighting supportive factors as you move forward. I was wondering if this situation influences your perspective on investment capacity. Does this allow for more investment in the business than you had previously considered? I'm trying to understand whether the improved revenue will flow through the P&L or provide you with more capacity to invest beyond the inorganic actions you've discussed.
Paul Thwaite, Chief Executive Officer
Thanks, Guy. Katie, do you want to take the equity hedge?
Katie Murray, Chief Financial Officer
Yes, sure, absolutely. So I think, Guy, probably the best place to look is we've given you our sensitivity on Page 28 in the pack. So it is important. It's now increasing in yield. It's at 195 in H1 versus 187 for the full year 2023. The size is not as large, obviously, but it's definitely a contributor to that income tailwind. And I guess we talk more of the product hedge because that is the one that is more impactful as we go through from here. But it's definitely one you shouldn't ignore as part of the income tailwind.
Paul Thwaite, Chief Executive Officer
And then on the cost piece, Guy, so the guidance for '24 is unchanged on costs, but broadly stable, excluding the one-offs. You'll probably remember, I spoke in, I think, in March of the quarter 1 about we're front-loaded some of the kind of property cost, branch closures, severance, et cetera, into half 1. And the philosophy is I'd like to fill that restructuring from the kind of the core cost base. So that's how we're thinking about it. I'm very keen to create capacity for investment, but to do that from the existing cost base. So that's the philosophy that we're working to. Thanks, Guy.
Operator, Operator
Our next question comes from Edward Firth of KBW.
Edward Firth, Analyst
I believe I have covered most of my questions, but could I clarify some of the numbers? I apologize for bringing up the hedge again, but your disclosure is intriguing. You mentioned a £800 million annual tailwind from the hedge, but I seem to be misunderstanding your chart on Slide 14. The math appears straightforward. It looks like there's a portion of the hedge rolling off, which is £35 billion, and you're rolling off £0 while putting on £3.1 billion, leading to approximately £1.1 billion of tailwinds. Am I overlooking something, or is that an oversimplification? That's my first question. My second question is, is there a way to quantify the short-term impact of a rate cut? I recall that when rates increased, we saw a temporary boost to the margin, which then diminished as deposit pricing adjusted that quarter. I assume the same might occur on the way down. Regarding the £125 million year 1 impact in the first two months, do we have any insight into how much of that will be realized upfront before we can reprice the deposits? What kind of volatility might we expect in Q3 or Q4?
Paul Thwaite, Chief Executive Officer
Actually, I think we can quite simply. Katie, go for it.
Katie Murray, Chief Financial Officer
Yes, we can. Regarding the hedge, it's a bit more complex than it appears. Timing is important since it doesn't all mature on the first day of the year. Managing a £35 billion differential isn't straightforward. To clarify, the difference in our end position income for 2024 will result in an increase of about £800 million into 2025, which should help with your calculations. Looking at the repricing, I've mentioned before that the structural hedge indicates a 25 basis point reduction with a 60% pass-through, which would impact our annual income by £125 million. Therefore, considering August or September, we will experience 4 to 5 months of that income. This assumes a time lag and a 60% pass-through, but our actual pass-through could vary, and the timing might be slightly different. This should give you a solid idea of the overall impact from a rate cut and how it will flow through. Thanks, Ed.
Operator, Operator
We're now going to take our final question from Amit Goel of Mediobanca.
Amit Goel, Analyst
So apologies, I can't actually hear for this one. I have my colleague, probably can. Just two follow-up questions. One, just in response to the previous questions, I think you said it's a bit too early, obviously, to update on the '26 targets. So I was just curious when you think it could potentially make a bit more sense, would that be full year '24? And is it really realistic to see 2026 profitability below 2024 especially given some of these product hedge tailwinds that we've spoken about? And then my second question, you saw another 2 bps NIM benefit from funding and other. A peer called out yesterday that they may continue to see these kind of tailwinds this year. Would you also expect to continue to see those tailwinds?
Paul Thwaite, Chief Executive Officer
Katie, I'll let you pick up the NIM piece. On '26 targets, Amit, we're not going to update today on when we will update, but I would reiterate we're reaffirming the return target for '26. And as I stressed earlier in the call, I guess, which is part of your question, I'll remind you, it's greater than 13%. So we're confident we can deliver both the strengthened '24 guidance that we've shared today and the 2026 targets. But we're not preannouncing any date change or anything similar. Katie, on NIM?
Katie Murray, Chief Financial Officer
Yes, absolutely. Regarding that funding and other aspects, I wouldn't consider them to be fixed or recurring figures. As you can see from our quarterly updates, there may or may not be a number in any given quarter. This will vary based on some of our treasury activities. It’s not something I would commit to definitively. What we are confident about, and as discussed during this call, is that we have the benefit of the improved guidance we provided today. We do anticipate continued NIM expansion, which is driven by our businesses, and that's very important. While the rate cuts may slightly temper that expansion, we do expect it to continue from this point onward.
Operator, Operator
I'd now like to hand back to Paul for closing comments.
Paul Thwaite, Chief Executive Officer
Thanks, Matt, and thank you, everybody, for the questions. We appreciate you joining and asking them. As you all have heard, we're pleased with the performance and the positive momentum during the first half. It reflects my and the management team's ambition for the business, and it does give us increased confidence about the outlook which is obviously reflected in the upgraded guidance for the year. So we look forward to speaking to you all soon, and I wish you all a very good weekend. Thank you.