Good morning, and thank you for joining the Virgin Money UK PLC 2022 Interim Financial Results Fixed Income call. There will be an opportunity to ask questions at the end of the call following a brief presentation. If you would like to ask a question, please press star followed by one on your telephone keypad. I'll now hand you over to Justin to commence the call.
Good morning, everyone. Thank you for taking the time to join us today. Hope you're all well and have had a good weekend. As mentioned, I'm Justin Fox, I'm Group Treasurer, and I'm joined by Richard Smith, our Head of Investor Relations, Matthew Harrison, our Head of Treasury Debt Capital Markets, and Gareth McCrorie, our Debt Investor Relations and ESG Manager. If you haven't already done so, please take a look at the financial results section of our website where you will find today's fixed income slides which Richard and I will go through. As always, we hope these sessions cover the right topics and the right level of detail. As ever, we are grateful for any feedback. Today's slides will take you through a brief overview of our first half financial performance.
We'll walk you through the key elements of our capital funding and liquidity position and update you on our issuance progress and plans, and a few other key themes emerging that we feel are worth sharing. At the end, we'll open up for Q&A as normal. I'll now hand over to Richard to talk you through our interim results. Richard.
Thanks, Justin, and good morning, everyone. Starting on slide 4. Over the first half of the year, we've made good initial progress delivering against the accelerated digital strategy, which we announced in November 2021. We are happy to report a continued improvement in our financial performance. This has been supported by the strategic momentum in the business, combined with an improved operating environment. Our statutory profit before tax of GBP 315 million was significantly higher than H1 2021, with stronger underlying profits of GBP 388 million. We have also delivered a strong CET1 with a 9.1% statutory rating. Total income improved 16% year-on-year, with a stronger contribution from both net interest income and other income, driven by a positive rate environment and a continued improvement in customer activity levels.
We are particularly pleased with our net interest margin performance, which has significantly strengthened to 183 basis points for the half year, and we now expect a stronger outlook for FY 2022 NIM of between 180 and 185 basis points. Other income of GBP 83 million also reflects an improvement in customer activity across both business and personal customers. Underlying costs of GBP 466 million were broadly stable year-on-year, and despite the higher inflationary backdrop, we continue to be well placed to achieve our broadly stable guidance for FY 2022 and our objective of GBP 175 million of gross cost savings by FY 2024. Asset quality remains robust with a low impairment charge of GBP 21 million or 6 basis points cost of risk.
Notwithstanding the post-COVID recovery, we remain cautious going forward given the combination of the Ukraine conflict, rising interest rates, inflation and cost of living. Having returned to paying a dividend alongside our FY 2021 results and following the group's successful participation in its annual stress test last year, we were pleased to update the market on our capital framework and returns policy, which Justin will go through in more detail shortly. Given our strong capital position and robust H1 performance, the board has also announced an interim dividend of GBP 0.025 per share. Let me now turn to our view of the economy on slide 5. This slide details the outlook, the economic outlook from our third-party provider, Oxford Economics, which has informed our IFRS 9 model. The biggest change in the backdrop since we updated our full year results is the increase in inflationary pressures.
This has led to a further large increase in energy and other commodity prices, including food, with the Bank of England increasing rates and a significant steepening of the yield curve in response. The latest outlook for GDP currently remains resilient despite slowing growth in Q1, and the base case suggests that the economy has broadly recovered back to pre-pandemic levels. Consumer activity levels remain strong across our credit card book, with spending now back above pre-pandemic levels across all categories, including travel. There is some potential that we could see slower growth in certain segments such as the mortgage market as rates rise further, but to date, that's been limited. Expectations for peak unemployment continue to reduce in the most recent outlook, with levels predicted to remain below 4% in the base case.
Our early warning indicators continue to be benign, and while the outlook is more uncertain, we are tracking these inflationary pressures carefully for any impacts that they might have, including cost of living for individuals and also for our business customers. However, overall, our book is performing well, and we'll be monitoring closely. Moving on to slide 6. You'll see here that we have managed overall volume broadly flat across the period, with strong growth in unsecured offset by modest reductions across mortgages and total business. In mortgages, we've been selective on new business volumes given the competitive backdrop. At the full year, we mentioned that we were seeing spreads below the back book level and this trend has continued through the first half. We are comfortable with our defensive performance, and we will look to regrow the mortgage book with the market when pricing is more attractive.
Business lending has reduced 2.5%, reflecting reductions in government guaranteed lending schemes as expected. In the BAU business book, we saw a growth in balances in the second quarter, and we are building a strong pipeline into the second half of the year, and we expect to see those balances continue to grow. We're happy with our performance in unsecured, where we've grown balances by 7%, led by cards where we continue to take market share. In March, we saw the highest ever amount of monthly retail spend, and we continue to expect strong levels of growth for the remainder of the year, supported by the strength of our digital propositions. Moving on to asset quality on slide 7. We're pleased with the quality of our lending book and are well-placed to manage the current risks and uncertainties.
We are, of course, keeping a close eye on the war in the Ukraine, though would note that we have no meaningful direct exposures to either Russia or Ukraine as a UK-focused lender. Overall, our final ECL provision of GBP 479 million reflects a reduction of GBP 25 million from FY 2021 set out on the left. That performance reflects our solid credit quality, which has remained resilient throughout the year with low arrears and default levels and refreshed economic scenarios. We reduced total TMAs by around GBP 30 million, despite including an additional TMA of GBP 25 million to take into account possible impacts of affordability stresses on existing customers. Despite the reduction in provisions, we've maintained a strong coverage ratio of 66 basis points, which remains well above pre-pandemic levels.
This resulted in a modest income statement impairment charge of GBP 21 million, equivalent to a cost risk of 6 basis points. Looking ahead, we expect the group's cost of risk to rise through FY 2022 towards three cycle levels. We are conscious that the outlook remains uncertain, especially with high rates of inflation increasing the cost of living. We have yet to identify any material concerns across lending portfolios, but are monitoring the situation very closely, and have taken action on additional underwriting measures to reflect affordability stresses for new customers. Moving on to our progress on sustainability on slide 8. Our ESG agenda continues to gain momentum and progress has been made across all of our ESG goals.
Sustainability implies over a long period of time, and we remain focused on embedding ESG throughout the organization to support our 2030 aspirations and ultimately a more sustainable future. It is worth taking the time to reflect on some of our here and now achievements. These include our continued focus on defining a national measure for the poverty premium in partnership with Smart Data Foundry. Promoting the Turn2Us benefits calculator to help over 65s claim entitlements with over 1,000 calculations now completed, something incredibly relevant against today's cost of living squeeze. We have the sustainable business coach available in the App Store, enabling businesses to identify their high priority ESG goals, their progress score, and actionable guidance to enhance their business.
From a product perspective, we've launched greener mortgages, incentivizing customers to own a more energy efficient home and launched our sustainability linked business loans, waiving arrangement fees for customers who meet the threshold set out by the sustainable business coach, and we'll soon be launching our agriculture specific initiatives. Finally, in terms of our green funding plans, it is something that we continue to look at, but for the time being, we are focused on improving our data further. We are working on a data project to track EPC data across our mortgage book, and this will improve our capability, supplement our reporting, and help provide the infrastructure to support a green funding framework. We must also demonstrate lending against our new ESG products, as this will drive the funding we need and enable us to develop a truly customer-driven ESG funding solution.
Finally, I'll finish with our guidance and outlook on slide 9. The left-hand side sets out the FY 2022 KPIs and guidance. We're tracking well against this, and we've given upgraded guidance for FY 2022 NIM, and are now looking for 180-185 basis points as I mentioned. We've also updated our capital framework and dividends as promised. We are maintaining our medium-term outlook, repeated here on the right, and in particular our double-digit statutory RoTE, and also including the updated capital framework. I'll now hand back to Justin to talk through the capital funding and liquidity position of the group in more detail. Justin.
Thanks, Richard. If you could turn to slide 11. We are happy with our current capital position of 14.7% CET1 ratio, which represents a 35 basis points increase from the full year. Looking through the benefit of software and tangible now removed. Strong capital generation in the first half reflects 103 basis points of underlying profit, offset by 6 basis points from modestly higher RWAs, 10 basis points from AT1 distributions, 25 basis points for the dividend accrual at 30%, and 27 basis points of other items, primarily restructuring charges and acquisition accounting unwind. Looking to the remainder of the year, we expect CET1 to remain broadly stable, reflecting continued capital generation from ongoing statutory profit, offset partly by RWA growth as the group targets growth from higher risk weighted unsecured business lending and further dividend accrual.
Our FY 2022 RWA expectation does not include any benefits from the move to IRB for our credit card portfolio or the adoption of hybrid mortgage models, both of which await regulatory approval. We expect the mortgage hybrid models to take effect from FY 2023 and the cards IRB transition at some point after that. Moving to slide 12. As you can see, our capital position remains robust across all measures. As noted at our full year presentation, our Pillar 2A CET1 requirements reduced by 50 basis points to 1.7%. A lower Pillar 2A means a lower MDA hurdle at 8.7%, giving us a meaningful GBP 1.5 billion CET1 management buffer on top of the GBP 0.5 billion of on-balance sheet provisions.
Total capital of 21.8% and the UK leverage ratio of 5.1% both remain strong. At 31.7%, we remain comfortably ahead of our MREL end state requirement of 24.7%. Turning now to the breakdown of our capital stack on slide 13. Compared to others in the market, we have a very straightforward capital structure. All the group's regulatory capital and MREL is issued by our holding company, Virgin Money UK PLC, and it's fully eligible from a CRD IV perspective. There are no issues around grandfathering. There's also no FX exposure in the capital structure, providing stability during periods of market volatility. We have an excess total capital of 8.3% over our regulatory minimum.
As I've mentioned before, we don't have a target level for AT1 or Tier 2 per se, but what we're looking for is a balance between maintaining a regulatory efficient buffer while supporting our targeted growth aspirations, which as we've explained before, include a higher allocation in unsecured and business lending. Over the medium term then, our AT1 and Tier 2 stacks will evolve as we manage buffers within the parameters I've just mentioned, primarily through redemptions and refinancing activity. As a reminder, our core policy remains unchanged. Future capital call decisions will be assessed on a broad economic basis, so balancing factors including balance sheet movement, our funding costs, current and future regulatory capital and MREL value, rating agency treatment, and wider wholesale funding needs. Of course, all calls are subject to PRA approval with whom we have an active dialogue.
Turning to our MREL position. As I've already mentioned, our MREL ratio of 31.7% comfortably exceeds our end state MREL plus buffers requirement of 24.7% of our RWAs. Again, we do maintain a suitable buffer over our end state requirements to help better manage maturity risk. Our view on issuance guidance hasn't changed since the full year. That is, we don't see a need for incremental capital issuance over and above refinancing, and the timing of refinancing will reflect the broad spectrum of factors, not least having stable market conditions. As we have no senior holdco issuance plans this year, again, given our comfortable MREL position, you know, we don't have any holdco senior redemptions until 2023. Turning to slide 14.
What I have just said makes a lot of sense in the context of the updated guidance on our capital framework. Now this reflects a refinement to our internal risk appetite, which has been informed by the conclusion of our inaugural solvency stress test exercise, which I'll come to in a minute. As a result, we think a CET1 target of 13%-13.5% is a sensible target level for us to be operating at, particularly when set against our expected regulatory minimum as set out on the left-hand side. Given the current heightened macroeconomic and uncertainty, we expect to operate above this range for the time being. We're also pleased to return to paying dividends sustainably and are committing to a full year dividend payout ratio of 30%.
This payout supports our expected growth plans and allows for at least some net capital generation. This first year, we're paying a 2.5p dividend at the interim, and going forward, we expect to pay around a third of the prior year's total dividend alongside our interim results, with the remainder as a final. We will supplement the ongoing dividend with buyback, subject to ongoing assessment of surplus capital, market conditions, and regulatory approval. In terms of timing, we expect that any buybacks will be aligned to our May interim results from full year 2023, not alongside our November full year results. This timing reflects the conclusion of the Bank of England stress testing process and subsequent buffer determination, which is generally at the end of the calendar year. We've not ruled out buybacks for the current financial year.
However, we would need to take into full consideration the current uncertain environment, and any buyback would be subject to regulatory approval. It's worth noting that our total capital MREL buffers will remain comfortable even at our target operating CET1 range, and fully optimized AT1, Tier 2 buffers allow for a sensible buffer over MDA, particularly when compared to larger domestic peers. Moving on to funding on slide 15. We delivered further growth in customer relationship balances, which were up 4.5%, thanks to strong performance in new current accounts, supported by a compelling new Brighter Money Bundles. Adding product features such as the launch of debit card cashback and improved customer experience, supported by further rollout of digital onboarding.
Relationship deposits now comprise 50% of total customer deposits, which together with a further reduction in more expensive term retail deposits during the period, meant we further improved our funding mix, which drove an overall reduction in cost of deposits despite higher base rates. On TFSME, when the scheme closed in October 2021, we had drawn our full initial allowance of GBP 7.2 billion while repaying all of our TFS drawings. GBP 7.2 billion TFSME represents 8% of total assets, which feels like the right balance between supporting additional lending to the real economy while not increasing refinancing rates. As with FLS and TFS, we plan to repay TFSME about one year ahead of contractual maturity, and having almost a GBP 1 billion tenor extension to 6 years-10 years helps reduce the cliff edge risk further.
The incremental TFSME drawings, along with a successful GBP 600 million 5-year covered bond transaction during the period meant wholesale funding increased to GBP 15.5 billion as at the first half, offsetting the reduction in term deposits. We continue to expect GBP 2 billion-GBP 3 billion of issuance this year and have made good progress in the first half of the successful GBP 600 million covered bond trade in February, followed up with a GBP 700 million RMBS issuance in late April, achieving solid outcomes despite what has been a challenging market. Wholesale funding costs have clearly widened since the low point at the start of the year for reasons we all know and understand. Those increased costs are in line with our funding plan assumptions, largely because our financial planning process happens much more earlier than other banks, given the timing of our year-end.
Our overall strategy remains the same. We compare wholesale funding costs, liquidity costs against the franchise benefits and wider strategic goals associated with our deposit strategy, to ensure we optimize the overall funding costs for the bank. Quickly on liquidity. LCR was 139% because we opted to manage liquidity slightly lower as more term deposits matured away. However, it continues to comfortably exceed both regulatory requirements and more prudent internal risk appetite metrics, ensuring a substantial buffer in the event of any outflows due to the cost of living squeeze. Moving to slide 16.
We are pleased with our performance in our inaugural solvency stress test, and as you can see from the left-hand side of the slide, performed well relative to peers in what was a test designed to simulate a severe path for the UK economy in 2021 to 2025 on top of the economic shock associated with the COVID pandemic. On a pre-management actions basis, our CET1 draw down of 5.1% was among the lowest in the peer group and shows resilience to outcomes for the UK economy, which are much more severe than current forecasts.
With access to published reference rates on both transitional and non-transitional basis, no requirement to take any additional capital actions, this was a solid first time performance and supported our update to the market on our go forward capital framework and distribution policy that I discussed earlier. On top of the regulatory deliverables, just as a quick reminder, along with the other larger U.K. banks, we submitted our first resolvability self-assessment earlier this year. In case you're not familiar with the Bank of England's resolvability assessment framework, certain firms are required to perform an assessment of their preparations for resolution, in which they identify any risks to successful resolution and have plans in place to address them, submit a report of that assessment, and publish a summary of their most recent report.
This is designed to make resolution more transparent, better understood and more successful, should it ever happen. Bank of England said that it intends to make a public statement concerning the resolvability of each firm in scope in June 2022. We will also be required to publish our own assessment alongside the larger peers. We believe that the inherent merits of our simpler and more manageable scale helps position us well against larger and more complex firms. Moving to slide 17. I'll update you on our structural hedge first and then move on to our rate sensitivity. On the left, you can see at the first half, the group had GBP 32 billion of balances in the structural hedge, having increased the size of the hedge in October last year, reflecting one of the benefits of our deposit strategy.
The average yield has increased from 45 basis points in the first quarter to 52 basis points in the second, reflecting the higher rate earned on reinvested balances. You'll also recall we have a legacy hedge position that was previously unwound in full year 2020. The full year 2021 contribution was around GBP 150 million, and the full year 2022 contribution is expected to be slightly lower at around GBP 120 million. Overall, strong and increasing contribution from our structural hedge going forward. On the right-hand side, we have set out what this means for interest rate sensitivity. You can see our interest rate sensitivity is pretty low in year one, given the scale of our structural hedge and using our standard pass-through assumptions. In practice, we have benefited significantly from rate rises recently as deposit pass-through has been low.
We've also now disclosed our interest rate sensitivity in years two and three, with the benefit in those years relating to the rollover of the structural hedge, which builds up meaningfully over time in the rising rate environment. Moving finally to slide 18. In concluding, I would like to reflect on the progress we have made in the last couple of years. Many of you will have heard me say this before, but we sit in the category of one between the large O-SII banks and the challenger or larger mutuals. I still think that is fair, but I also think it comes with more advantages than disadvantages, but you'd expect me to say that. We're managing the transition to being a Tier 1 bank reasonably well. Stress test outcome really demonstrates that. That transition has been quite intense, and there's a good reason why.
Overall, I think we don't fit into that challenger bank category. Integration is done and we are fully engaged now on our transformation, which is delivering results. Our balance sheet resilience is coming through, and that's a positive for investors up and down the stack. Capital has improved, in part because the balance sheet is lower risk than the market perceived, and performance over the last couple of years has shown that. We also have prudent risk appetite, which is reflected in solid asset quality with robust coverage that sits above pre-pandemic levels. I see our announced capital framework as being creditor supportive. Funding and liquidity are robust at a time when we have been transitioning the composition of our funding mix. That transition is helping being able to lower deposit margins, but also help build up the structural hedge, all of which supports NIM.
Overall, we've delivered strong financial momentum in the first half of the year. Our balance sheet is conservative and well-positioned to manage an uncertain outlook. When it comes to thinking about our debts, our debt stack, our view has evolved. Initially, it was about managing down that overall difference to larger peers. A lot of that has already happened, and therefore, you know, it will work its way through the stacks as and when we refinance it. Going forward, though, what we think and talk about internally is where the fair value point is relative to those larger peers. There's an inherent strength to being a simpler, less complex bank that has enough scale to operate competitively in the market. It lacks the risk appetite it is comfortable with. We think that means that there's further room to go in our relative performance to peers.
What our differential should be is something for us to work out with all of you. In my mind, that all makes a pretty compelling investment proposition and supports further spread compression to peers. We will now open up the line for questions. Operator, please go ahead.
Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. If you'd like to remove your question, please press star followed by two. When preparing to ask your question, please ensure your line is unmuted locally. We take our first question from Corinne Cunningham from Autonomous. Please go ahead.
Good morning, everyone. Thank you for the call. I wonder if you could give us a bit more detail on, your liquidity position and your funding plans. For example, what would the LCR look like if you excluded the TFSME, and a bit more detail perhaps on how you intend to replace that? Thank you.
Well, I'll have to come back to you as to what it would look like ex the TFSME, Corinne. Let me follow up on that afterwards. The way I think about it is we have seen elevated liquidity across all banks over the last couple of years, largely because of that sort of excess deposit build-up during the COVID pandemic. We have been managing some of that down principally because we've been building up the relationship deposits and seen term deposits come down as a result. Therefore, we haven't necessarily had to go out and/or look to maintain, let's say, an LCR of about 150%. On a go-forward basis, I think somewhere between 135% and 140% is about the right level.
What that means is the way we've been thinking about it recently is clearly we mark up in terms of the increased cost of wholesale funding, certainly relative to the back end of last year and certainly through January. As I said, that is less of a concern for us because when our plan was effectively last summer because of the timing of our year-end, and clearly, you know, the cost of funding wasn't at very low levels at that point. The way we think about it is we have spread the drawdowns of our TFSME over the period, and what we'll be looking to do is effectively refinance those maturities up to one year in advance.
That's what points us towards GBP 2 billion-GBP 3 billion of increased issuance, primarily through cover bonds, but also with support through the RMBS programs. I think the couple of the things that we did last year in terms of simplifying some of our funding programs helps that. Certainly, the integration of the two cover bonds into a single cover bond program is helpful. It's been, I think, the two transactions that we've done this year have been helpful exercises for us in terms of name recognition, because that was the first time post-integration. The market got to see the sort of benefits of, you know, the integrated platform. Matt, have I missed anything else off that you would like to point out?
No, I don't think so, Justin. We can follow up on the LCR point. Christine, we do on page 61 of the interim financial results, which we published last week, we do give the breakdown, but let us come back to you on that.
Thank you.
As a reminder, if you would like to ask a question, please press star followed by one on your telephone keypad now. Okay, we take our next question from Daniel David from Autonomous. Please go ahead, Daniel.
Morning all, and thanks for taking my question. Just a couple, just based on what you said, I guess you talked about the catalyst to your bigger peers, regards to where your debt trades. I'm just wondering, is there anything that we should be looking out for? Is it likely to be a ratings upgrade that could see you tighten in? Or is there anything else that you call out that you're looking for in the short term to maybe close that gap or is there anything else you call out? And then just a bit more of a broader one. Obviously, we had the Bank of England's update last week. Is there any update to your...w ell, does that change your view kind of on the macro outlook?
Any thoughts with regard to their points on how that could impact your planning going forward? That'd be great. Thanks.
Yeah, sure. Let me take the first point, and then I'll bring in Richard for the second point.
Sure.
There isn't a specific catalyst that we're looking towards as being an event driven exercise that would change our perception. I think it's something that we continue to work on over time. You know, we have an active dialogue with all of the agencies. You know, we've been talking to them very actively about our plans and the execution of those plans. I think they'd like to see more evidence coming through in terms of delivery, or in terms of those progress against those plans. But I don't think it's a specific event that would cause us to say, "Okay, job done." I think, I mean, if I look back over the last couple of years, Daniel, what we started off was, you know, what is that absolute level of difference?
Over time, you know, that has improved. When we talk to the Street, when we talk to investors, I think it's a question of improving that perception around our ability to deliver on the strategic agenda, and look at the sort of benefits of being our size and scale, and being able to operate meaningfully in the markets we choose. Richard, is there anything more from your perspective? Because I think clearly, you know, you look at the broader IR side of things.
No, not specifically to that. I mean, I have to sort of talk to the macro as well. I mean, I think-
Yeah.
Daniel, your sort of point around, you know, does the Bank of England change our view of anything? I think we'd already started to incorporate quite a lot of the themes that they talked to. I mean, when we look at the sort of inflationary backdrop that we've seen, we've already been building into our underwriting some of the sort of cost of living stresses that people are seeing. If we put that in context, you know, on the personal side, we've been building in additional affordability checks that have higher energy costs associated with those. We've also been factoring that into our review of how we think about business lending as well, and the sort of roll off of customer fixed energy contracts within that.
On the sort of existing book that we have, we added an affordability stress PMA. So a sort of additional buffer on top of that, around GBP 25 million in the half, which provides, you know, a bit of conviction just around sort of the back book as well as the new underwriting that we're doing. I think, you know, we continue to monitor very closely the early warning signs that we're seeing. We're not seeing anything currently, but, you know, we do stand ready if there were to be any areas of emerging issue to support customers through that. But at the moment, there's nothing presenting. I think the other point I should make as well is just around the, you know, the sort of rate environment that we're operating in.
We are, you know, again, stressing customers already to a level above the current rate environment. If we continue to see rate rises coming through, that is already baked into our underwriting assessment as well. There isn't anything that's really changed our view. It seems that obviously we've been observing anyway, and they're already being baked into how we're operating as well.
I think the only other point I would say is that we've also been reflecting that on the liability side. Clearly with the benefit of rate rises coming through and a steeper swap curve we've been having. Away from that, you know, the widening of costs within the wholesale side, we have been, you know, having very active discussions with our deposit teams in terms of the relative value of where pricing is in deposit market. I can certainly see it becoming, you know, slightly more competitive going forward, given those factors.
Thank you. Maybe just one quick one, just following up on kind of size and scale. I think when we've talked in the past, you've mentioned that you were still digesting previous deals. Maybe any comments on M&A? I realize the market is maybe a bit more difficult than in the past, but just anything you can say on M&A or your outlook, that'd be interesting. Thanks.
Richard, did you want to take that one?
Yeah, sure. I mean, nothing really changed in terms of our thinking. I mean, we continue to have a compelling organic strategy, and that remains our primary focus. You know, we updated Q1 to say that, you know, if there were to be any sort of M&A activity, it would be focused much more towards smaller bolt-ons and not so much the larger scale M&A piece. There isn't anything specific. As I say, our kind of overall focus remains very much the organic strategy that we laid out at the full year in delivering that.
Thank you.
We take our next question from Robert Montague from Allspring Global Investments. Please go ahead, Robert.
Yeah. Good morning. Thanks very much for the call. Just one very quick question. On capital ratios, you referred to various internal model changes coming down the line. Can you quantify the impact on your ratio from those model changes?
Richard, have we offered guidance on what we expect that impact to be?
We haven't for some time. We did quantify the impacts of hybrids a while ago, but things have moved on a little bit, so I would steer away from that at the moment. There are two sort of qualitative comments that I can maybe give that might be helpful. The model changes that we refer to, there are two sets. There is mortgage hybrid models which are anticipated could be an FY 2023 event. We do expect those to be beneficial to us based on what we know today. We weren't caught by the average LGD as a portfolio risk weight threshold of 10%, given that our average LGD density is about 16%.
The only comment that we've made around hybrid is the direction we would expect it to be positive, but we'll wait and see sort of how things crystallize as we get closer before quantifying that. The cards IRB model changes are anticipated now to be an FY 2024 event, and much sort of smaller in terms of quantum. They're not really sort of, you know, we'll work through the plans with PRA, but in terms of timing of updates. As we see things at the moment, they're not a sort of significant RWA change in that sense. We've also got worth just calling out a sort of Basel 3.1 consultation expected in Q4.
We'll see if there are any implications from that around, you know, the sort of mortgage hybrid interaction that we've got at the moment. Latest view would be positive FY 2023 for mortgage hybrid. Cards IRB, limited change FY 2024.
Thanks.
As another reminder, if you would like to ask a question, please press star followed by one on your telephone keypad. We take our next question from Guillaume Desqueyroux from Sanlam. Please go ahead.
Hi. Good morning. Thanks for the call. I just have, I think maybe a couple. Can you indicate which kind of you think level of the Bank of England rate will you know will really trigger further the competition that you mentioned? Like, if you think about like some kind of a 75% pass-through to your customer deposits, that would be kind of where I see the competition. If you can give a range where you think that it will get intense, more intense, that would be quite helpful. I guess, well, you covered the other subject, but my maybe another question from me would be just on the regulatory front, what are the current operational review from the regulator? What are the key topic they engage you with?
In particular I wonder on the credit card activity, if yeah they keep maybe investigating or collecting information on the rate that can be disclosed to customers and what is actually really happening on the back end. Is there like any kind of topic that the regulator spend some time on would be quite helpful? Thanks.
I can take the second part of the question. Richard, do you have a view on the first? Because I think our internal view of where Bank of England gets to is probably not in line with the market. We, you know we talk about this a lot internally, but I think the market expectations as to where the terminal rate will be is much higher than we have in our sort of plan. How that feeds through in terms of the overall competitive dynamic, particularly in, let's say, the mortgage market, I'm not sure, Richard, if we've got a view there. I mean.
Yeah. I mean, maybe if I kind of give a couple of comments, and we can frame it in that way. I think at the moment what you've seen has been a very sharp steepening of the swap curve, which is yet to fully translate through into, you know, customer pricing on the asset side of things. Certainly in mortgages you're seeing that particularly. I think there's a couple of dynamics there. I mean, we are seeing customer pricing starting to improve and you're seeing, you know, the sector as a whole start to pass on the pickup in swap curve into customer rate, but it hasn't yet kept pace with the increase that we've seen in terms of swap rates.
Now, clearly swaps have been more volatile the last week or so, but overall I think, you know, there is always a lag in a rising rate environment where you see that start to get passed through more, as you progress further on. We've seen some pickup there. On the liability side of things, I think, you know, we flagged as part of the results that we were anticipating some normalization in terms of savings market, and really there's a couple of factors to that, which is partially some increase in terms of level of competition. The sector as a whole, for us as well, we've been carrying additional balances related to COVID.
We do expect some unwind of those balances start to come through as people spend those deposits that they built up. You know, we will see sort of how the pass-through evolves, but we have assumed that you don't get the same sort of level of pass-through benefit as we've seen in the early rate rises coming through where, you know, pass-through levels were near zero. I think, you know, in terms of sort of competitive dynamics, at the moment what we baked into the NIM guidance for the 180-185 range is assuming that there is limited further mortgage spread benefit coming through over the remainder of the year, and that you still continue to see a pretty competitive backdrop.
You know, the normalization in terms of the savings market, and I mean that in the sense of those sort of three drivers I mentioned. Continued benefit of the role of the structural hedges Justin talked to, and continued growth in terms of some higher yielding segments. Those are really the drivers that we're thinking about there.
On the regulatory side of things, I mean, let's bifurcate between the PRA and the FCA. I think with the PRA, there has been a rather intense period of late for us. It was, you know, last year was pretty much consumed with the whole stress testing process and outcomes, particularly as, you know, it's the first year we've actually done it. At the same time for us, it was completing and submitting the resolvability assessment. So, the way I sort of think about it is we've got ICAAP and ILAAP. They help inform stress testing and the stress testing regulatory cycle, which in turn helps us think about resolvability and recovery planning. So, we're held to the same timetable that the larger banks need to complete these exercises in, and that's been quite transition for us.
I think the key things for us are really about, okay, having gone through these exercises, what do they mean for us in terms of how we think about our risk, internal risk appetite framework, and how we're sort of using the outcomes from those exercises. You know, that helped inform the capital framework. Again, there's been a pretty active dialogue with the PRA around, what that looks like, what it means in terms of how we manage, excess capital over and above. Specifically, on FCA sort of driven activity around the insights in our underlying lending portfolios. I'm not aware of anything off the top of my head, Richard, that there's anything specifically going on there that we, you know, we've sort of mentioned to the market. I don't think there is anything in particular.
No. There isn't. I mean, there's always a sort of, you know, it's a very ongoing dialogue. You do have lots of conversations around things that, you know, they are very focused around ensuring fair treatment of customers across all things. That's not to call anything out specifically, but just as a BAU basis, you get a lot of dialogue around that. We haven't sort of called anything out specifically in terms of that dialogue. It's obviously typically bilateral anyway, so we don't sort of tend to talk too much in detail about it, unfortunately.
Yeah. I think the other area that there is a really active side with the regulators right now is really on the sustainability agenda. I mean, clearly all regulators have stepped up in that space. One of the things, again, when, you know, we think about how we apply and implement our sustainability agenda is clearly very focused on the customer proposition, what that looks like. Also at the same time we know that the requirements for regulators are stepping up in this space. A lot of that's why we make the point about data management and acquisition so that we can then inform, you know, our approach and looking, you know, are we cross-purposing the data smartly in terms of what's required for future regulatory exercises.
While we didn't participate in the CBES process, we were asked to basically go off and sort of do the shadow work so that in future iterations we would participate in that. That's been a very useful learning exercise for us. That sustainability agenda I think is an area where there is increasing focus from regulators. A lot of change going on there.
All right. Thank you.
We have no further questions. I'll hand it back to Justin for any closing remarks.
Well, listen, thank you very much for everybody for dialing in today. Appreciate your time, your support. Hopefully, this was useful for all of you. You know where we are if you have further follow-up questions. We appreciate your ongoing support. Have a good rest of the day.
Thank you for joining. This now concludes the call. You may now disconnect your lines.