At this time, all participants are in a listen only mode. There will be a presentation by William Chalmers followed by a question and answer session. At which time, if you wish to ask a question, you will need to press star one on your telephone. Please note this call is scheduled for one hour. I must advise you that this call is being recorded today. I will now hand over to William Chalmers. Please go ahead, sir.
Thank you, Operator, and good morning, everybody. Thanks for joining our Q1 interim management call. As usual, I'll run through the group's financial performance in the first quarter of 2022, before we then open the line for Q&A. It is only nine weeks since Charlie and I outlined the group's new strategy alongside the full- year results. I do not intend to go through our strategic plans again today. I will nonetheless provide comments on this at the half year. Suffice to say, the group has embarked upon implementation of the plans we set out in February. Indeed, you may have seen the recent announcement on our new management structure, which has aligned with the new strategy and positions the group for delivery. Now let me turn to the results presentation, starting with an overview of the financials on Slide 2.
The group delivered a solid financial performance in Q1. Net income of GBP 4.1 billion is up 12% from the prior year, supported by a stronger net interest margin of 268 basis points, other income of GBP 1.3 billion, and a continued low operating lease depreciation charge. We remain committed to efficiency in retaining our market leading cost position. Operating costs of GBP 2.1 billion are up 3% year-on-year, reflecting stable BAU costs and planned higher investment. We remain on track for the circa GBP 8.8 billion operating cost guidance for the full- year. Asset quality remains strong. GBP 177 million net impairment charge reflects a low incurred charge, with new arrears remaining very benign and below pre-pandemic levels. It also reflects our updated economic outlook, which I'll talk more about later on in the presentation.
Given this solid performance, statutory profit after tax is GBP 1.2 billion. Return on tangible equity is 10.8%. Underlying this outcome, we've seen continued franchise and balance sheet growth. Capital build of 50 basis points in the quarter after the 230 basis points of regulatory headwinds on January was strong. This has enabled the group to make significant accelerated contributions to the defined benefit pension schemes. As of Q1, we made the full GBP 800 million annual fixed deficit contribution, plus around half of the expected variable contributions relating to our year-end plan distributions. Finally, risk-weighted assets closed the quarter at GBP 210 billion, following the regulatory inflation of GBP 16 billion, which we outlined at the full- year. Moving on to Slide 3 and the continued recovery in customer activity and franchise growth seen in Q1.
We continue to see good levels of activity in the UK mortgage market. Balances were up GBP 1.2 billion in the quarter, given continued open mortgage book growth of GBP 1.7 billion. Credit card balances were flat in the quarter. That is a reasonable performance given the normal seasonal repayments that we see in Q1. Added to this, we're seeing improving travel spend given lifting restrictions, which is an important component, as you know, of overall card spend. Elsewhere in consumer finance, motor finance is up GBP 0.1 billion in the context of supply chain issues across the motor industry. Commercial banking balances, meanwhile, were up GBP 2.6 billion, led by the growth of GBP 2.9 billion in corporate and institutional, particularly higher financial institutions balances.
Taken together, average interest earning assets of GBP 448 billion are up GBP 8.6 billion on the prior year. AIEAs are down GBP 1.4 billion on Q4, driven by lower trade and average term lending balances in commercial banking. However, for 2022 as a whole, we continue to expect low single-digit % growth in AIEAs. Now looking briefly at the other side of the balance sheet. We continued to see deposit growth in Q1. Retail deposits were up GBP 2.5 billion, reflecting resilient customer inflows across current accounts and relationship savings products. This further highlights the strength of our customer franchise. Commercial deposits were up GBP 2.8 billion, driven by higher balances from SMEs and corporate institutional clients. I'll now look at the group's strong revenue performance on Slide 4.
Net interest income of GBP 2.9 billion is up 10% year-on-year and up 2% in the quarter. This was significantly driven by the stronger net interest margin of 268 basis points on average interest earning assets of GBP 448 billion. Q1 margin is up 19 basis points on Q1 2021 and up 11 basis points on Q4. This is the result of base rate changes, increased deposit volumes, and benefits from the structural hedge, more than offsetting the dilutive impact on mortgage margins. As mentioned, we continue to see a competitive mortgage market with average completion margins in Q1 around 85 basis points. Application margins are below this level in the context of both pricing and swaps continuing to move upwards.
We'll continue to monitor closely how this develops, recognizing that we probably need to see a period of sort of stability to see where margins ultimately settle. Turning to the hedge. Structural hedge now has a nominal balance of GBP 245 billion. We have approved capacity of GBP 250 billion, up GBP 10 billion in the quarter, including a little more of the substantial deposit growth that we've experienced through the pandemic. We continue to be cautious on hedge eligibility with buffers of roughly 3x pre-pandemic levels. In this context, gross income from hedge balances was GBP 0.6 billion in the quarter. Given rising swap rates, we continue to expect 2022 hedge income to be higher than 2021 and then to increase modestly again in 2023 and 2024. We remain positively exposed to rising interest rates.
We currently expect a 25 basis points parallel shift in the yield curve, the associated base rate rise, to benefit interest income by around GBP 175 million in year one. As you know, this is illustrative and based on the same assumptions as we have outlined previously, including the 50% pass-through. Clearly, in practice, the pass-through could differ from this assumption, as indeed we saw in Q1. The group's interest rate sensitivity is lower than reported at the full- year, given the increase in the size of the hedge. Higher rates over the last few weeks and a larger hedge means that we've locked in more interest income through the P&L rather than reporting a theoretical sensitivity. It's also worth noting that sensitivity, as always, does not consider potential asset spread compression, particularly in mortgages as a result of swap movements.
Again, as we've seen here in the first quarter. In practice, what we're seeing is base rate changes benefit income today, and this is expected to persist through 2022, providing a net tailwind to the margin. The impact of mortgage repricing, if spreads remain low, will continue to build into the margin in the second half and indeed over the longer term. For 2022, the base rate changes we have seen so far this year and the very significant interest rate moves in the market in recent weeks, combined with our new year-end base rate assumptions, are resulting in an improved interest income outlook. We therefore now expect the group margin to be above 270 basis points in 2022. Now looking briefly at other income. OOI continues to show signs of recovery.
GBP 1.26 billion in the quarter is up 11% on prior year and in line with the last three quarters. As mentioned, we're seeing improving activity levels in retail and insurance, while market performance has also improved in Q1 over Q4. We saw an adverse impact of around GBP 30 million in the quarter relating to the winter storms, although this was offset by a positive insurance methodology change. If you remove both of these items, the underlying run rate quarter was just over GBP 1.2 billion. Operating lease appreciation at GBP 94 million in the quarter remains low in the context of the reduced lease fleet size and continuing strength in used car prices. Now let me turn to Slide 5 and the group's continued focus on efficiency. Operating costs of GBP 2.1 billion are up 3% from prior year.
As mentioned, this includes stable BAU costs combined with planned higher investment. We outlined the group's new cost reporting basis at the full- year. The restructuring costs and fraud charges that are now included within BAU operating costs are broadly in line with the prior year charges. Our cost income ratio of 52.3% remains market-leading. As you can see on the slide, the cost income ratio, excluding remediation, is 51%, consistent with previous quarters. The remediation charge of GBP 52 million in Q1 reflects a continuation of existing programs and no further charge in respect of HBOS Reading. Q1 charge is in line with our expectation of an ongoing cost of GBP 200 million-GBP 300 million per year. In sum, we're maintaining our focus on efficiency and our market-leading cost position even after increased investment.
We remain on track for the circa GBP 8.8 billion operating cost guidance for 2022. Turning to Slide 6 on the group's asset quality. Asset quality remains strong and mortgage arrears remain very benign with underlying charges below pre-pandemic levels. The net impairment charge of GBP 177 million for the first quarter reflects an underlying charge of GBP 150 million plus GBP 27 million in respect of our updated economic scenarios. We revised our base case economic assumptions at the quarter end. We now include a slightly weaker GDP forecast, but given performance in the year to date, slightly stronger house price and unemployment outturns. Alongside this, we now also expect higher inflation. For 2022, we forecast CPI inflation of 7.5%, peaking in Q4 with 4.3% thereafter in 2023.
We focused on the potential impact of higher inflation on our customers and the potential risks to asset quality. Our low risk model means we have limited direct exposure to customer segments which are most likely to experience near term payment difficulties from cost of living pressures. However, we are proactively contacting customers where we feel they may need assistance, and we'll continue to help with financial health checks and other support measures. While discussing asset quality, it's worth noting that we have no direct exposure to Russia or Ukraine. We are actively investigating and monitoring any indirect exposures and have not yet found anything of significant concern.
Our clear UK focused business model is helpful in this regard. Overall, absent a material change, the main effects on us of the current Ukraine crisis and attendant inflationary impact are likely to be second and third order, for example, on overall levels of economic activity. We expect those to be captured by our macroeconomic forecasts, but of course, we remain vigilant. Based on this outlook, the stock of ECLs remains stable at GBP 4.5 billion at the end of Q1. This remains about GBP 0.3 billion higher than at the end of 2019 before the onset of the pandemic. Within that ECL, we continue to hold just under GBP 800 million COVID related management judgments, including the central adjustment. We have also now added a further judgmental ECL provision of about GBP 100 million to reflect potential affordability risks for our lower income customers.
Touching briefly on our IFRS 9 staging. As we've discussed before, in Q1, we updated our models to reflect CRD4 regulatory requirements. Notably, this includes changing the definition of default for mortgages from 180 to 90 days and updating our approach to past term interest-only mortgages. Together, this has resulted in an increase in mortgage assets in stage 2 and stage 3. This change is presentational. It does not change the economics, and it has an immaterial impact on ECLs. Indeed, excluding this regulatory change, the underlying movement in mortgage asset staging in the quarter has actually seen further improvements. In summary, and looking forward, given our performance to date and macroeconomic scenarios, we continue to expect the net asset quality ratio to be around 20 basis points in 2022. Moving on to look below the line on Slide 7.
Following the change in cost reporting that we outlined at the full- year, there's now very little difference between underlying and statutory profit. As you can see, restructuring costs of GBP 24 million reflect only the remaining M&A and integration related costs. The volatility line shows a charge of GBP 138 million and includes negative insurance and banking volatility, in addition to the usual fair value unwind and amortization of purchased intangibles. After these items, statutory profit before tax of GBP 1.6 billion and profit after tax of GBP 1.2 billion both represent a solid financial performance. The return on tangible equity of 10.8% in the quarter above our cost of capital reflects this performance. Based largely on the stronger income outlook that I outlined earlier, we now expect the ROTE for 2022 will be greater than 11%.
Tangible net assets per share were GBP 0.565 for Q1, up GBP 0.041 from the prior year, but down GBP 0.01 on Q4. The quarter-on-quarter movement largely reflects strength in the income contribution, offset by movements in the cash flow hedge reserve, given how rates moved during the quarter. Looking forward, you should remember that the 2021 final dividend will come out of TNAV in Q2, while the buyback impacts as the program is conducted through the year. I'll now turn to slide eight and consider the group's capital position. Risk-weighted assets of GBP 210 billion are up GBP 14 billion in the quarter, but down GBP 2 billion excluding the regulatory inflation of the first of January that we set out in the full- year results.
Lending growth has been offset by optimization, and we've seen limited impact from credit migration given our strong portfolio. Strong business-led contributions augmented by effective RWA management supported strong capital build of 50 basis points in the quarter. A closing CET1 ratio of 14.2%, both after the headwinds on the first of January. Importantly, and as previously mentioned, the healthy capital build has enabled the group to make significant accelerated pension contributions. We've already made the full annual GBP 800 million fixed contribution, and this is included in the 50 basis points build. In addition, we've made around half of the variable contributions relating to our planned year-end 2021 distributions equivalent to GBP 500 million. This is reflected in our 14.2% CET1 quarter end position.
It's an efficient use of capital, and it means the group will have greater free capital through the rest of 2022. In line with the guidance previously, continue to expect 2022 closing RWAs to be around GBP 210 billion. This is driven by the expected balance sheet growth offset by optimization activity through the rest of 2022. Based on our performance to date, our business model and the outlook, we expect capital build to continue to be strong through the rest of this year. Finally, turning to Slide 9. In summary, the group has delivered a solid financial performance in Q1, with strong revenue growth supported by an increased margin and continued recovery in customer activity. At the same time, we've maintained our focus on costs, while asset quality remains robust.
Capital build of 50 basis points in the quarter supports the group's strong capital position and has enabled significant pension contributions. As mentioned, uncertainties persist in the current environment, most notably concerning the potential impact of inflation on our customers. In this context, we'll provide effective support for our customers wherever we can. The group's business model is resilient. Together with our new strategy positions the organization well. This confidence is reflected in our updated guidance for 2022. As you've heard, we now expect the net interest margin to be greater than 270 basis points and the return on tangible equity to be greater than 11%. All other guidance statements, including those for 2022 and the longer term, are reaffirmed.
Outside of the financials, and as mentioned at the start of the call, the group has recently implemented a new management structure, so it's fully aligned with our new strategy and it helps position the group to deliver higher, more sustainable returns and capital generation. That concludes my remarks this morning. Thank you very much for listening. Let me now turn the call back to the operator for Q&A. Operator, over to you.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. Thank you. We take our first question from Omar Keenan with Credit Suisse. Please go ahead. Your line is open.
Good morning, everybody. Thank you for taking the questions. I had just some questions on net interest income, please. I wanted to ask on the revised NIM guidance, which is now above 270 basis points. I understand that's a floor rather than a target, but I wanted to understand what the minimum assumption changes that were there so we can make our judgments of how far above 270 basis points it will be. Presumably, at least it's the deposit beta experience from the December hike, and maybe including an extra Bank of England rate hike. If you can clarify what those minimum conditions are, that'll be very helpful.
Just secondly, on the structural hedge, I can see that the duration has shortened a bit from three point five years to between three and three point five. I guess the shape of the yield curve lets you do that without giving up any yield. What are the various debates that you're having at the moment, in terms of how to position the structural hedge given what's going on in the fixed income markets? It looks like you think it's worth shortening a bit and say, increasing your year two to four rate sensitivity, if you think the bias to yields is ultimately higher. Thank you.
Yeah. Thank you for the questions, Omar. Just to deal with each of them sequentially. In terms of the guidance on net interest margin, as you say, we have increased it from greater than 260 to greater than 270 in the context of significantly increasing rates, and of course the effect of bank base rate changes to date, applied to substantially increased deposit volumes over the course of the pandemic, including some of the growth that we've seen in the last quarter. Now, as you point out, the language is greater than 270, and so in that sense it's a floor. But what are we looking for in terms of the basis on which we have undertaken those judgments? I think first of all, I'd draw your attention to our slightly revised economic forecasts.
We have one more base rate rise in the context of that. That's a base rate rise that is expected to take place before the end of this year. One in May and one in the later part of the year take the base rate to 1.25%. We see one further base rate rise before flattening out thereafter. The second is the rise in interest rates generally that we have seen over the course of this quarter. Since the 24th of February, spot one-year is up around 50% or so. Term rates are up around 35% or so, and so that has been a factor too.
Finally a third area that you might look at there is around the deposit beta assumptions that we've made, which are very much in line with the guidance that we've given you before, which is as we progress into the rising interest rate environment, the rising base rates associated with that, then I think we'll see the pass on assumptions start to converge towards the 50% that we model on a continuing basis. Those are the types of judgments that we put into our expectations around the interest rate. I think they're around the margin, I should say. There are clearly some moving pieces in there. What will happen to interest rates, for example? How will the bank base rate environment play out, for example?
Indeed, ultimately, what will the deposit beta be, for example, our three points in question. Those are the basis on which we perform the interest margin guidance. The structural hedge, as you know, is managed both for continuity and stability in earnings and also for shareholder value. We manage the hedge dynamically. We are very much aware of and debating interest rate movements as we see them on an ongoing basis. Now, underneath that, as said, this is about hedging interest rate risk and therefore contributing earnings stability through the P&L. That is the objective, and that is why we generally manage around the weighted average life that we manage to. We don't tend to deviate too much from it. As we look forward, Omar, we will debate where rates are today.
We'll look at obviously the inflationary outlook and how we expect both the Bank of England and the markets to adjust to that over time, and we'll deploy the hedge accordingly. That will all be within pretty tight risk management standards that in the end are about ensuring earnings stability in the context of shareholder value.
That's wonderful. Can I just ask a quick follow-up question on the deposit betas? At what point are you assuming that they converge to the 50%? I guess the deposit beta experience from the December, February, and maybe March rate hike you factored.
Yeah. Omar, we won't disclose precise details on that for, you know, obvious commercial reasons. Generally speaking, I think it is fair to say that in the context of the initial base rate rises, the liability margin has recovered somewhat. Therefore, the deposit beta has been lower than the 50% that we would typically describe it as. Looking forward, I suspect it will gradually converge to that level as interest rates increase. We're not disclosing more than that in terms of the path it will follow.
Okay, thank you very much.
Thanks, Omar.
Thank you. We take our next question from Rohith Chandra-Rajan with Bank of America. Please go ahead. Your line is open.
Hi, thank you very much. Good morning. Sorry, I'm gonna boringly stay on the margin. Thank you for the comments on the liability side, that's certainly very helpful. You mentioned earlier, William, that application spreads on mortgages were below the 85 basis points completion spread that you saw in Q1. I mean, I guess when we look across the market, you're seeing, you know, lenders continuing to raise mortgage rates, but really not keeping pace with the move in swap rates. I'm just wondering how far below the 85 basis points current application spreads are.
Do you still think the 75-100 basis points mortgage spread guidance or expectation that you gave at the full- year results is reasonable, particularly for this year and then also over the sort of period of the plan? That would be one question. Then just sticking on margin, just on the consumer credit side of the business, are you still confident in the recovery in demands for consumer credit given you know the concerns around inflation that you flagged? I have another one on capital, please.
Yeah, sure. Thank you, Rohith. On your first question on mortgage pricing, which is obviously a factor in the overall net interest margin as well as you point out. A couple of points there. First of all, completion margins, as I said, 85 basis points during the quarter, are consistent, I think, with what we said at the February 24th. But also, as you say, application margins, as per my script earlier on, have been below that, over the course of the quarter. That, of course, will feed through into our completion margins that we talk about in Q2. In terms of your question around how do we feel about the planning assumption of 75- 100 basis points, we don't generally mark our plans, our three-year, five-year plans to market every quarter.
I suppose you've seen two divergences over the course of this quarter. One is interest rates clearly significantly above our plans, which is a net positive from an earnings point of view. The other is application margins, which have probably been a touch below our plans of 75-100 actually in the course of the quarter, which is a net negative. Now, you add those two together, and it is a net positive to our expectations versus where they were on February 24th. The net effect of interest rates versus mortgage margins, both today and also as we project forward into 2023 and 2024, is a net positive versus where we were on 24th.
It's also worth saying that even if mortgage completion margins ultimately slip to the lower levels of our planning assumptions, even a touch below, it's pretty attractive business from an economic return point of view, Rohit. We consider that and we bear that in mind as we move forward. Consumer credit. We have seen increases in expenditure within consumer credit over the course of the quarter. If you look at Q1 credit card retail spend now versus what it was in Q1 of 2019, it is up 7%. That trajectory has been gradually improving through the three months. For example, March 2022 credit card spend is up 13% versus where it was in March 2019. Aligned to that, Rohit, we also see travel spend recovering quite fast. I think I mentioned it in my comments.
As you know, that's responsible for around a third of our overall credit card expenditures. Now to be clear, there's a balance in there which is typically more weighted towards transactors today versus revolvers, and that needs to be accounted for in terms of the pace at which balances might expand within consumer credit. Those spending patterns are broadly supportive of consumer credit gradually, and I would, you know, make the point gradually, expanding more or less in line with our expectations, not hugely different to where we were on February 24th.
Thank you. Just on the mortgage spreads, would you be able to comment on where the application spreads are currently?
No, Rohit. I don't typically comment on the application margins. They vary quite a lot in any period of time. What I would say, Rohit, around the margin question in mortgages in general is that we've seen a period of rapidly rising swap rates, and as you pointed out in your question, we've also seen alongside that rising pricing. Now, you know, a lot of people pre-hedge, and therefore pricing generally will lag swap rates. That I think is what we've seen in Q1. I think what we have to see to get a good impression of what the overall margin is gonna be on a stable look-forward basis, Rohit, is a period of swap stability. At that point, pricing can catch up with a period of swap stability.
At that point, you'll get a sense as to what the true mortgage margin is. Indeed, in the context of our 75-100 basis points planning assumption for 2024, I think we feel comfortable with that. Let's wait for that period of swap stability. Let's see how prices react, and let's see where ultimately the mortgage margins settle as a consequence of that.
Okay. Thank you, thank you very much. Then I just had a quick one on capital please, and particularly around the pension contributions. You mentioned that you'd taken all of the fixed contribution and half of the variable. In terms of how we think about the phasing of the variable contribution, I mean, is the sort of the Q4 and the Q2 distributions, the contributions related to those, should we think that the way that they're evenly split over the subsequent two quarters?
Yeah. Thanks, Rohit. First of all, in terms of the fixed contribution, as you know, the fixed contribution is around GBP 800 million per year. We've taken all of that in the context of our Q1 capital numbers. In total, that's about 31 basis points of capital consumed by that, which is before you get to the 50 basis points capital generation. The accelerated component of that is obviously three quarters. Around 23 basis points of capital is consumed by that accelerated proportion of the fixed capital, of the fixed pension contributions, which gives you some idea around the underlying capital generation of the business. For phasing of the variable, there's no predetermined schedule for that, Rohit. It is reasonable to think about it as spread through the course of the year.
We've taken a view that we had, frankly, strong capital generation in Q1, and therefore we felt it appropriate to accelerate variable contributions ahead of what we might otherwise do. That's what we've done. You know, we'll see how capital generation fares for the remainder of the year, which as I said, we expect to be strong. In that context, you know, we'll look to get the variable contributions behind us, probably reasonably promptly. I think, you know, overall there, Rohith, no particular schedule for that variable contribution, but we'll deal with it probably relatively rapidly, I suspect.
Okay. Thank you very much.
Thanks, Rohith.
Thank you. Thank you. We take our next question from Raul Sinha with JP Morgan. Please go ahead. Your line is open.
Morning, William. Thanks very much for taking my questions. Maybe just want to follow up on the discussion previously. I was just wondering, at a high level, you know, what do you think is the utility of purely focusing on the mortgage margin, when swap rates and rates in general are moving up so rapidly? Just given the timing differences you know, you've talked about because there's a lot of focus I think, from investors and analysts on just your mortgage spread and using the mortgage spread as a proxy for the Lloyds' overall margin. Clearly, it appears that the tailwinds on the deposit side are obviously much stronger and realized much quicker than the feed through on the mortgage pricing side.
Just interested in sort of your broader thoughts on the utility of focusing on the application and the completion margin on a quarterly basis. That's the first question. The second question is around just to follow up to what Omar was asking in terms of deposit pass-through. What have you actually realized so far in terms of deposit pass-through rates? It looks very low from the outside. And my question really is it appears that the large banks aren't really passing on, you know, very material rate hikes so far, but there are clearly some very high interest rates in the market on savings products. Are you starting to see, and obviously you had very strong deposit inflows in Q1 as well.
Are you starting to expect, you know, this pricing environment to change on the deposit side, just given the amount of surplus capital or surplus deposits the industry seems to be sitting on? Thanks.
Yeah. Thank you. Thanks for the question, Raul. On the first question, I think you're absolutely right to point out the right way to look at the overall interest rate and mortgage margin environment is holistically. I think we've described that. Certainly I've tried to put forward that argument in the context of various calls in the past, where you need to look at interest rate movements and mortgage pricing movements in the same bucket, if you like. Look at them at the same time. Because as we have seen, where we see swap price movements, that is advantageous from an earnings point of view, particularly if the base rate rises come about shortly thereafter. That's advantageous to net interest income.
Of course, some element of that is likely to be offset in the context of narrowing mortgage spreads as those same swap price movements take place. There's a give and a take here. As I said, the business, our business both now and looking forward, is a net beneficiary from that overall move. It has been so far. We expect it to be going forward. That's one point. The second point per your comments there, Rahul, is from a timing perspective, the bank base rate changes and the associated liability margin widening that comes with that, alongside the reinvestment of the structural hedge as maturities become available, and as we consider the size of the structural hedge in the context of deposit increases.
Those benefits start to accrue pretty much from day one, particularly the bank base rate changes and then gradually to build into the hedge. The mortgage margin plays through as the mortgage book matures. You'll see the mortgage margin, it plays a role in the context of the NIM in quarter one for sure. It'll play a little bit more of a role in the context of the NIM in the second half of this year as the mortgage book rolls over, and it will play a stronger role in 2023 and 2024. Again, coming back to this point around looking at the whole, we are a net beneficiary of those interest rate changes, the swap moves, the base rate changes, and the mortgage margin compression. That is a net benefit, a net positive for our P&L, for our interest income line.
Moving on to the second of your questions, the deposit pass-through question. The way that we look at deposit pass-through is a function of three main parameters. One is about offering, frankly, value and service to our customers. That's very important to us. Our customers come first. At the end of the day, they are what the business is, and we're building a strategy based upon our customers. We are very observant of that, and it's an absolute priority for us. The second is the overall balance sheet need of the business. What are the funding needs of the business look like? At the moment, as you know, we have a loans to deposit ratio of 94%, which is a very liquid balance sheet. We've seen deposit inflows now of GBP 70 billion.
GBP 70 billion since the start of the pandemic, which is what sustains the loan-to-deposit ratio. That's a factor in determining how we look at the deposit environment going forward against asset growth needs that we have. Thirdly, we have to look at what the competition does, as your comments indicated, Rahul. You know, we keep a close eye on that. We aim to remain competitive in the customer services and products that we offer, and we believe we do. I think you will see headline rates from time to time, and you will see increases on certain products from time to time. It's always worth looking behind the headline, if you like, as to how broad that pricing change might be, and therefore what the overall competitive implications of it might be.
As we look forward and we adjust deposit pricing, I think it's inevitable, and, you know, history would suggest that at very low interest rates, there tends to be relatively modest pass on of interest or base rate changes simply because what you're doing is essentially allowing the liability margin to recover to something more like what it looked like before we came into these very, very low interest rate environments. It is also inevitable that as those bank base rate changes and go up, that, so institutions like us are likely to respond to that in terms of passing a little bit more on over time. Precisely how fast that development happens depends upon those three factors that I mentioned just a second ago.
Thank you. That's really helpful. I guess just one unrelated follow-up. Is there any kind of capital headwind that we should be thinking about for the remaining quarters of the year apart from the pension contribution, just in context of, you know, the fact that the capital generation target was not updated given your strong performance in Q1? Thanks.
Yeah, sure. Couple of points on capital generation. First of all, Rahul, as you know, we don't offer guidance so much on capital generation. I think we talk about an average of 150 basis points over the course of 2022-2024 in our February 24th results presentation. That was an average over a period of time with inevitably years differing in their makeup in that respect. Having said that, what we have seen is, as said, strong capital generation in the first quarter of this year. Looking forward, looking at the components of that, I'd expect to continue to see strong core banking build within that capital build for the remaining quarters. We'll get some tailwinds and some headwinds within that, Rahul.
Headwinds will be we had RWA benefits in the first quarter, likely to be less in quarters coming forward. Tailwinds, we are likely to see reduced pension contributions clearly in the context of us having accelerated into Q1. We're also in Q1 we didn't have an insurance component to the overall capital build. Adding all of those together, two comments really. One is I think we'll continue to see pretty strong capital build through the course of the year. I don't think you're necessarily missing any big items, none that I would call out as such. Overall, I think we're likely to be, you know, well ahead of that 150 that was mentioned on the 24th of February.
Thanks very much.
Thank you. We take the next question from Jonathan Pierce with Numis. Please go ahead, your line is open.
Hello there. I've got two questions. Actually they're on exactly the same topics as the last set of questions. Sorry about that. Coming at it slightly differently, I do wonder, William, whether you're still being slightly cautious on this mortgage margin point by lumping together the benefits of the managed margin and the hedge income and saying that will, you know, more than offset the mortgage margin decline in recent months. Because if I just think about the hedge alone, we've seen 100 basis points increase in the reinvestment rate on the hedge since the start of the year, whereas maybe mortgage spreads are down, I don't know, 20, 30 basis points.
Even though you put a lot more mortgages through the pipes every quarter than the structural hedge reinvestment, it sort of feels to me like the hedge is providing a pretty much complete offset incrementally versus, you know, the extra pressure that's coming through on new business mortgage margins. And therefore what you are seeing is really just a pure flow through of the benefits of the managed margin. Am I missing something there? Because I really can't get too worried about the movement in mortgage margins that we've seen since the start of the year for that very reason.
Thanks. Thanks for the question, Jonathan. I'm not sure you're necessarily missing anything, no. I mean, I guess a couple of points. One is, as said, in the context of the rising rates, we see benefits from that in the hedge, as you pointed out. We see benefits from that in the context of bank base rate changes that should follow. We're forecasting two more bank base rate changes this year, one more than we expected on February 24th to bring it to 1.25 at the end of the year. We also see benefits from the overall volumes that we have in deposits, as mentioned. Those are benefits that we see. I don't think you're missing anything in that respect.
I think on the mortgage side, we are seeing, as I said, application margins that are below completion margins of 85. I mentioned in answer to Rahul's question earlier on that actually the application margins in Q1 have been outside of our 75-100 basis points too, and we'll see that flow through. As you know, Jonathan, we have about GBP 90 billion of mortgages maturing in any given year on a roughly GBP 300 billion book.
Mm-hmm.
The rates at which we had written those mortgages in the course of recent years, particularly high rates in 2020 and 2021, that provides quite a significant step down for those mortgage maturities as they mature in remainder of 2022, but particularly going into 2023 and 2024. There's, you know, there is a step down from that, and we've given some indication of that previously. That element, you know, ought not to be underestimated, Jonathan, in the context of the rising rate and spread compression market that we're seeing. As said, I would call out that we are a net beneficiary versus where we were on February 24.
Yeah. I mean, I absolutely accept the mortgage refinancing headwind that's coming later this year, next year on those sort of mid-pandemic two-year fixes. I was really just talking about the separate issue of the movement in mortgage margins that we've seen, you know, on new business since the start of the year. That's helpful. Thanks, William. Can I ask a second one on deposit beta?
Yeah.
We can sort of back out from your slides showing that 10 basis points of the margin improvement was from base rate, in the course of, probably each 25 basis point rate hike so far has helped the managed margin by, I don't know, probably GBP 350 million. Whereas I think, you know, your guidance at the end of the year on the 50% pass-through assumption was GBP 200, including the hedges, so maybe GBP 150 managed margin. Am I in the right ballpark there? Because I'm thinking about how we roll through the full period benefit into Q2, because the sort of base rate average in Q2 versus Q1, about 30 basis points, which is not dissimilar actually to what Q1 was versus Q4.
In other words, are we looking at the moment at about GBP 350 million per 25 basis point hike? Should we see even absent any further base rate increases in Q2, another high single-digit improvement in the margin from the flow through of the February and the March rate hikes into Q2? Thanks.
Yeah. Thanks, Jonathan. Couple of comments to make for you. One is just to reiterate the point around the base rate changes that we have put into the economic forecast for the remainder of this year, which you'll have noted. Second is, as your comment really alludes to, Jonathan, we have seen relatively modest pass-ons in the course of the late part of last year and beginning of this year. Indeed, we've seen these relatively accelerated base rate changes, certainly versus our expectations from December onwards. That combination has led to some of the outperformance that you've seen in Q1.
That leads to the third point, which is to say these base rate changes and the effects of them on the liability margin, they stay with us for this year and they stay with us for next year and beyond. You know, it's not transitional. It stays in the interest income, provided, of course, that we don't kind of compete it away insofar as that margin has been widened to date. That stays with us. Fourth point is our sensitivity that we've given is 175, rather than the numbers that you've given, Jonathan. As you say, your numbers were based off of slightly different assumptions.
175, as you know, is based on the 50% pass-on assumption, and indeed a full asset side pass-on, in the context of mortgage balances and spreads. What I would say, and perhaps this is helpful, is that it's roughly linear. That is to say, you know, when we look at the overall component of our sensitivity, that component which relates to liability margin management is roughly linear in terms of the relationship that it has 50% versus zero versus 100%.
Okay, great. Thank you for that.
Thanks, Jonathan.
Thank you. We take our next question from Joseph Dickerson with Jefferies. Please go ahead. Your line is open.
Hi. Good morning. Most of my questions have been answered, could you just discuss on the GBP 800 million COVID overlay that's sitting on the balance sheet. What are the hurdles that need to be met before you look to release that? Do you just plan to bleed it out as credit starts to normalize on an underlying basis? Thanks.
Thanks, Joe. It's an important question. As you say, we have COVID-related judgments within our overall ECL now, just shy of GBP 800 million. That's composed of two main blocks. One is the GBP 400 million group overlay, that is essentially an insurance, if you like, against changes in the conditioning assumptions on which our economic forecasts are built. The second is a further amount of just shy of GBP 400 million, which is essentially such that we would have experienced higher levels of default, but for various forms of government support programs that were in place. That second block is in order to compensate for temporarily lower default ratios.
Commenting on each of those, Joe, which will go to inform how we look at them going forward, for the GBP 400 million release, what we would need to see in order to reconsider that is low and sustained low levels of infections, number one. And number two, a period of no new emergence of vaccine-resistant viruses. Now, it's worth remembering today that it's only a matter of weeks ago, let's say eight weeks ago or thereabout, that we were at the height of the Omicron induced virus, and nobody quite knew where that was gonna go. Although it seems like a long time ago, in fact it wasn't.
There's no doubt, Joe, that as we go through this year, we will take a look at that environment and see whether or not we indeed have a sustained low level of infections and indeed whether or not there is an emergence of any new viruses and whether they're vaccine-resistant. Off the back of that, be able to reexamine the GBP 400 million that is the group central judgment. On the second piece, Joe, it's a question of how asset quality performs off the back of the withdrawal of government support programs. So far, Joe, the performance has been very benign as I mentioned in my comments.
The underlying performance of our portfolios, retail and commercial, has been very strong, which gives you confidence that actually of that amount of slightly less than GBP 400 million that is there for the potential increase in default as these support programs withdraw. It so far has not been much used up, let's say. We just have to see how asset quality performs in the context of the weeks ahead of us before taking another look at that. Hopefully that gives you some idea as to how we're looking at it.
That's very helpful. Thank you very much, William.
Thanks, Joe.
Thank you. We take the next question from Chris Cant with Autonomous. Please go ahead.
Good morning. Thank you for taking my questions. If I could just come back on the deposit beta point, and then we can all do the same math on your slides with the 10 basis point improvement in the quarter. You talked about it being fairly linear in terms of how the deposit beta assumption materializes into the actual NII movement we're seeing. What we've seen in the first quarter is about double your disclosed full- year sensitivity. Implicitly, the pass-through wasn't kind of very limited. It's virtually nothing. Is that a fair inference, or is there also a variance in the first quarter in terms of the quantum of managed margin deposits that you thought you had versus what you now actually think you have? That would be the first question, please.
Second on the cost of living point, I thought your comments around the GBP 100 million sort of add on within the mix of your macroeconomic variable change was quite interesting. What do you expect to see here in terms of customer behavior? You know, there's a few data points kicking around. I think there was a data point from Centrica recently about the number of customers now in arrears on their gas bills has gone up by some multiple versus where they were a year ago. Is your take that it's just about your customer profile and you don't overlap in the Venn diagram, which I sort of struggle with given your size in the U.K. market.
Is it that you think the people who are gonna get into real difficulty as a consequence of that cost of living are not part of your cohort, and where others are maybe struggling, you know, they go into arrears on their gas bill first, but they're not gonna stop paying that credit card. Is that how you're thinking about it? I'm just curious if you could add a little bit more color on that cost of living comment, please. Thank you.
Sure. Thanks, Chris. In terms of the performance in the first quarter on net interest income, the relationship of that to the sensitivity. You know, as said before, I think it is fair to say that the bank base rate changes have made more of a difference than the sensitivity would suggest, and a lot of that comes down to the extent to which the liability margin has been restored in the context of slightly higher interest rates versus the near zero interest rates that we've experienced over the last few years. That is certainly a factor. I mentioned the linearity, and perhaps I should have been more precise in the answer to the question for John.
If you look at our overall 175 of sensitivity in year one, around half of that is related to effectively the 50% pass on assumption. That's where the linearity comes in for that half to which is related to the pass on assumption is around half of the overall 175, and that's where the linearity kicks in, which hopefully helps you with your numbers as we look forward. Literally what does that mean? Half of 175 therefore is related to pass on assumptions.
I think it is as we look forward, as said, it is likely that as rates go higher, we will seek to pass on more in the context of, as I say, making sure that we deliver customer value as well as service and interest and making sure that we remain competitive and at the forefront. Off the back of that, you know, we would see pass on assumptions that converge towards our 50% sensitivity that we show you in the illustrations that we've been giving. I would say that the underlying performance of the business in the deposit area has been very strong. When we look at the quality of the business on the liability side, we've seen a further GBP 4 billion or so of deposit inflows over the course of the first quarter.
That feels, as I say, very strong from a franchise point of view. Cost of living point, Chris, just to give you some thoughts on that really. We do obviously see quite a lot of data in terms of how our customers are responding to tougher conditions from a cost of living point of view and the inflationary environment. To give you one or two data points that we think are interesting. We think we've seen around 1.2 million subscription payments that have been stopped by our customers since summer of 2021. Those relate significantly to things like television streaming services. They also relate to more discretionary items of expenditures such as gym subscriptions and that sort of thing.
We've seen signs of customers somewhat tightening their belts with respect to discretionary expenditures, and we keep a close eye on those because they are also the data points that inform us as to whether or not we need to proactively reach out to customers and offer them support and financial planning help and so forth. In terms of our approach, a couple of points, Chris, about how we see the economic environment feeding through. One is that if you look at our economic assumptions, we still maintain GDP growth in 2022. Now admittedly, we don't see much occurring in the remaining three quarters of this year because most of it is already banked as of Q1, as it were. But nonetheless, it's a positive GDP environment, albeit less so than it was on February 24th when we talked about our Q4 assumptions.
Likewise, very importantly, we see unemployment remaining low, 4.1% for 2022, only gradually rising thereafter in 2023. Now those are very low levels of unemployment. As you know, Chris, unemployment has always been the leading indicator for asset quality default. As long as unemployment levels remain low, then I think the consequences of that for our portfolios will be measured by those low unemployment levels and therefore be manageable. Further point, we've seen over the pandemic savings cushions. I mentioned we've seen deposits increase by GBP 70 billion since December 2019, significant buildup in savings cushions.
Perhaps more importantly, when we look at the portfolios, we are careful about the extension of credit, and we try to make sure that we only extend credit where we believe the customer can afford to pay it back, predominantly for their interests. We also stress our portfolios. We stress secure portfolios, for example, to now well over 7% for affordability. Unsecured book, which is obviously most likely to be at risk potentially in this context, is a prime unsecured book, and you can see that testified to by some of the public securitization data, and credit scores that are available. It's not to say that we won't necessarily see some uptick in impairments if inflationary conditions persist and economic conditions worsen, but on the other hand, it's mitigated by these factors.
Moving on to commercial again, affordability checks, affordability criteria are key. Stressing likewise, we lend on cash flows, but 80% of the SME book is secured. We're very careful about early warning triggers to try to make sure that where defaults do occur, we offer customer assistance where we can, again, both in their interests and ultimately in the interest of lowering losses. I think, Chris, the data that we see in sum gives us some indications as to how customers are responding. Our view is that the economics are looking tougher. Cost of living is a big part of that. Overall, we see the unemployment rate staying low, which is an important data point. Finally, that we see the portfolio, both retail and commercial, as being well-positioned, if you like, for slightly more adverse economic circumstances.
Okay. That's really helpful. Thank you, Colin.
Thanks, Chris.
Thank you. We take our next question from Andrew Coombs with Citi. Please go ahead. Your line is open.
Good morning. One follow-up.
Andrew, are you still with us?
Can you hear me?
We can hear you now, Andrew. Yeah, that's better.
Okay, perfect. I was just saying I have one follow-up question, following on from Joseph's and Chris's questions, and then one on capital. On the follow-up, I'm interested in the point on the overlay because we've been talking about when you might release this for some time. I remember the discussion a year ago was really when you had more resilient data post CJRS, and we now have that resilient data. I'm interested that you're still attaching that overlay to very much COVID-based measures. You're talking about prolonged periods of lower levels of infection, vaccine success. Is it a case now that that overlay becomes fungible?
Even if we were to see lower levels of infection and success of the vaccines, that now you might rather wait and see how the cost of living crisis proceeds, how the Russia-Ukraine conflict proceeds from here before releasing that overlay. Any comments around that? And then the second question on capital. In your earlier commentary, you said you felt that you're going to surpass the 150 basis points guidance for this year. I see no reason why that couldn't be the case for future years as well, given the step up in your interest margins, even with the cost of risk normalization. As that 150 was baked into your plan and you now expect to exceed that, what do you plan to do with the extra organic capital generation? Would you accelerate the pension contributions even further?
Would you look at more RWA growth, or is there potential for even larger buybacks than you currently have plugged into your plan?
Thank you. Thank you for that, Andrew. On the first of the questions as to the overlay, it's worth saying that the provisioning assumptions as to COVID and the provisioning assumptions as to cost of living are not fungible. They're very much built up in and of their own justifications, separate pillars, as it were. When we look at the coronavirus related provisions there, as said, we have two blocks, the GBP 400 million and the just shy of GBP 400 million blocks. You know, hopefully the comments that I gave earlier on around the conditions to release the first of those are clear.
You know, in the great scheme of things, when you've only had an outbreak of coronavirus circa eight weeks ago, looking at it in the context of the second quarter doesn't seem to be awfully different to looking at it in context of the first quarter. You know, we'll look at it as the year goes on. As I say, in the great scheme of things, I'm not sure the timing difference is gonna make a lot of difference to our capital ratios to the business, to our stakeholders and so forth. We will get to it, and we'll look at it over the course of Q2, I'm sure.
Secondly, on the cost of living adjustment, the inflation adjustments, what we've done there is to look closely at potential probability of defaults in some of the lower income segments in unsecured, number one. Number two, to look at some of the segments within our commercial book that are more affected by inflationary pressures, particularly input pressures. We've looked at those sectors that we lend to. In each case, we've taken a view on how that might affect probability of default, and then collected up a provision as an inflation compensation, if you like, to compensate for that. Now that is based upon our economics forecast right now. Clearly if inflation takes off in a bigger way than we currently forecast, if the economy deteriorates more than we currently forecast, then we'll have to re-look at those.
That overlay of circa GBP 100 million is consistent with the economic forecasts that we have in place right now. It's also worth saying, Andrew, that it comes on top of an examination of the extreme stress severe stress scenario at the end of last year, which was also conducted with an inflationary watch, if you like. That contributed a GBP 60 million overlay for the severe ECL case or the severe scenario built into our ECL. The total inflation adjustments therefore are more like GBP 150 million or thereabout as again, post-model adjustments for the inflationary scenario. To return to the point, they're not fungible versus the COVID.
If COVID runs off because of a low level of infections and no new virus, then we'll look at that, and we'll consider whether or not we need to effectively release those provisions. Quite separately to that, we'll look at the economic environment, including the potential asset quality repercussions of higher inflation, and we'll determine how much ECL we need to set aside for those conditions. For the second of your questions on capital generation, Andrew, I've made comments around the strength of capital generation in Q1, and as I said, we expect that to remain pretty strong for the remainder of this year. I think as we look beyond this year, there's clearly a long way to go, number one. There's clearly many uncertainties that are out there, number two.
You know, the business remains relatively well-positioned, and so we feel comfortable with the overall development and progress that is being seen in the business. Therefore, I wouldn't really wanna get into too much speculation about what we might do with capital in the periods thereafter. Safe to say that we feel comfortable with where the business is today, and I've given you an outlook for 2022.
Indeed.
Thanks, Andrew.
Thank you. Ladies and gentlemen, as you know, this call is scheduled for one hour, and we have now reached the end of the allotted time. This was the last question we have had time to take this morning. If you have any further questions, please contact the Lloyds Investor Relations team. Mr. Chalmers, back to you for any closing remarks. Thank you.
Thank you, Operator. Just to say thank you very much indeed to everybody for taking the time to listen. Thanks very much indeed, and have a good day.