Okay, a very good morning, and welcome to Paragon's 2024 interim results presentation, covering the first six months of our financial year. We will, as normal, run through the financial and operational performance in detail and provide you with our view on the outlook, as well, of course, as leaving plenty of time for your questions. But before we get into the detail, let me spend a few minutes looking at the key highlights. The first six months of this year have again shown another strong financial and operational performance, and as you can imagine, we are delighted with these results, reflecting the growing specialist franchise of the group, the resilient nature of our business, and the continued strong progress in our purpose-driven strategy of supporting our customers in achieving their ambitions.
All our key metrics are either in line with or above expectations, and in many areas, we now expect to deliver full- year outturns at the top end of the ranges or above the guidance provided at the 2023 year end. Underlying profits for the first six months increased by over 13% to GBP 146.3 million, which delivered a return on tangible equity of 20.8%. There have clearly been some benefits arising from the transition to a higher rate environment, some of which are temporary, but some are permanent. Our guidance of achieving a return on tangible equity towards the top end of the 15%-20% range for 2024 is hereby reconfirmed. Earnings per share increased by over 17%, benefiting from the share buyback program.
Strong internal capital generation is a genuine strength of our business. 140 basis points in the first six months, as are our capital ratios, supporting our growth ambitions and the further buyback of up to GBP 50 million announced today, on top of the GBP 50 million completed in the first half of the financial year. The loan book growth was expected to be relatively dull this year due to the disruption in markets seen in 2023. However, we are running comfortably above our expectations set at the beginning of that year, and with pipelines rebuilding, we now expect this will give a healthy flow of new business in the second half. Indeed, pipelines for both buy-to-let and development finance have recovered well from their September 2023 position. Buy-to-let is up 47% and development finance, 21%.
With strong customer retention levels continuing, we are confident the loan book growth will be stronger than we had originally expected. The deposit book has seen outstanding growth year-on-year, strengthening our franchise in this space and enabling us to accelerate the repayment profile of our TF SME borrowings, which have reduced to GBP 1.45 billion currently from the GBP 2.75 billion in September, effectively nearly half repaid in eight months. NIM has expanded strongly in recent years to over 3% on the back of the rise in interest rates and the structural shift in income driven by our diversification strategy. We had expected NIM to plateau in 2024, which was reflected in the year-end guidance.
However, to date, we are outperforming with NIM for H1 at 319 basis points, and we now expect to come in above our guidance range for the year as a whole. In terms of operating costs, despite our ongoing technology transformation program and the new Bank of England levy, we still expect to deliver in line with our cost guidance and maintain our excellent cost-income ratio. The credit performance was again excellent, and notwithstanding the environment, we only required a charge of 14 basis points for the period, and we have still maintained a prudent, prudently positioned balance sheet provision of 51 basis points at the end of March. It is clear that 2024's first half performance is strong, but this isn't a one-year wonder.
This is a reflection of the disciplined strategic focus and the progress achieved over the 10 years since the bank's formation in 2014. As you can see from these charts, we have delivered great progress with a consistent track record over the last decade. Operating profits have increased by 153%, and with strong capital generation, including today's announcement, we have returned over GBP 1 billion to our shareholders through a combination of dividends and buybacks. Loan growth has been managed carefully, and the structural changes, due to our diversification strategy and interest rate normalization, have moved margins from 2% to 3%.
Our commitment to a high-quality customer base has resulted in an average impairment charge of 10 basis points across the decade, notwithstanding Brexit, COVID, interest rates climbing from 10 basis points to 525, together with the tough inflationary environment of the last few years. The 10-year image of strong, consistent growth and a robust financial and operational performance is clearly evident from these slides, as is the consequence of the long-term commitment to running our business prudently with an unswerving focus on specialist markets, seeking to optimize good risk-adjusted returns, backed by a high-quality loan book.... through the cycle experience and a deep understanding of the markets in which we operate and the customers we serve. I'll now hand back over to Richard to look at the period's performance in more detail.
Thank you, Nigel. I'll start with our income statement. You'll see that total income for H1 was up 12% on H1 last year. Pre-provision profits were up 14.8%, and operating profits were 13.5% higher. Our Fair Value Amortization was lower year- on- year, resulting in statutory profits being 138.4% higher than the first half of last year. Underlying earnings, which exclude fair values, raised by 17.4% to 49.9% per share. The growth in earnings exceeding the underlying profit growth, because of the impact of our share buybacks. When looking at the results segmentally, we've got a slightly more uneven picture, with continued strong, earnings performance in mortgages and further gains on excess liquidity in the central area.
However, we did see a small decline in earnings from the commercial segment in the six months. This latter point largely reflects lower asset side margins in this higher rate environment, and I'll touch on those shortly. Following the extremely strong margin performance in the second half of last year, we were anticipating a bigger reduction in H1 2024 than we've actually seen, with base rates stabilizing and the rate increases in the quarter to September driving higher deposit betas as the deposit beta developed. Instead, we've seen stronger performance than we expected, albeit the spread for the period was two basis points below the peak we saw in the second half of last year. We've now completed the GBP 1.2 billion net free reserve hedge that I flagged at the year-end.
This hedge carries an average term of four years, and is effectively delivered by not hedging a portion of the buy-to-let book that's equivalent in size to the net assets. Buy-to-let asset side spreads continue to be strong, but as I mentioned in the summary, spreads in our commercial business have been a little weaker at higher rates. We've also found that our development finance facilities have been taking a little longer to reach practical completion, so the in and out fees that we charge are now being spread over a longer period, effectively lowering the yield. Net deposit pricing relative to benchmarks, that is, after hedging costs on the fixed rate bonds and ISAs, has been better than anticipated. On my next slide gives a bit more color on the movements we've seen since the last year- end.
When compared to the spot position at September 2023, the funding spread to benchmark is reduced for both fixed-rate bonds and variable rate deposits. The former, after reflecting the hedging costs associated with those bonds. Fixed rate spreads have tightened by 11 basis points and the variable rates by 51 basis points as the deposit betas developed. However, after a very strong skew to fixed rate savings in 2023, the first half of 2024 has seen our deposit mix move back to a more variable rate focus. Overall, the spot deposit difference, spread to SONIA, has narrowed from an annualized 63 basis points in September to 45 basis points at the end of March. Moving on to costs.
In aggregate, these remain in line with expectations, even after absorbing the GBP 1.7 million pound, Bank of England, levy costs following the change in their approach in the period. Our change program continues apace, with an upgraded buy-to-let broker portal about to go live and other programs at different levels of development. This digitalization progress will be important in maintaining our tight focus on cost efficiency. This is evidenced by our 36.5% cost to income ratio as reported for the half year. As noted on the slide, we're maintaining our cost guidance for the year at below GBP 180 million, and this includes the levy. We continue to position ourselves at the conservative end of macro estimates for the scenarios that drive our impairment calculations.
Additionally, we've maintained the same scenario mix with 50% on the downside, 10% up, and the base case carrying a 40% weighting. It's worth noting that our base case for interest rates is that the rate cutting cycle starts later in the summer with rates trending down to 3.5% during our financial year 2026. The multiple economic scenarios summarized on the previous page drive both the probability of defaults and the loss on those projected defaults, together with expected losses on our currently defaulted loans. With a largely secured balance sheet, the different scenario weightings have a less pronounced effect on our impairment postings than they would for a lender with more unsecured exposures.
The main movement in the period relates to higher levels of arrears and accounts in receivership in our legacy variable rate buy-to-let portfolio. The old book now represents just 22% of the total buy-to-let loans. The combination of these provisions on the accounts and the economic modeling results in our impairments being GBP 2.8 million higher than those calculated for H1 2023. As Nigel mentioned, underlying capital generation for the first half remained strong and equates to 1.4% of CET1. Fair value movements on the near final IFRS 9 transitional unwind utilize 0.4% of this, loan book growth, 0.6%, dividends, 0.4, and the H1 buyback a further 0.7%.
The period end CET1 was 14.7%, and our GBP 150 million Tier 2 bond takes our total capital ratio to 16.6%, and we still have no AT1s in our capital stack. The capital position remains materially above our regulatory requirements, which supports both future growth and capital management. While our IRB progress, process with the PRA remains ongoing, and with the final Basel 3.1 rules yet to be finalized, we face quite a fan chart of potential, capital outcomes going forward, depending on the final calibration and timing of those various approaches. To be prudent, our capital planning currently assumes that Basel 3.1, as detailed in last year's CP, will be binding from, July 2025.
Within this, however, the dynamics of our own portfolio, both by asset class and through the mix effects within Buy-to-Let, have seen the potentially adverse impact from Basel 3.1 reduced to 2.1% of CET1, compared to the 2.3% I reported last summer. We'd expect this trend to continue as the mix develops. Our strong preference is to invest our surplus capital in growth, both organic and inorganic. But we've been running a strategy that incorporates both growth and capital management now since 2015, with our share buyback reducing the share count by around a third since that date.
Having completed the GBP 50 million buyback initially earmarked for FY 2024, we've announced that we expect to buy back up to an additional GBP 50 million worth of shares in the second half of this year. Thank you.
Okay, thank you, Richard. Let me turn our attention to how the business has progressed against our key strategic priorities and provide you with our view on the outlook for the period ahead. We have shared with you previously how we focus on these five priorities, and how they are interconnected and supported by our structural pillars of our strong customer-focused culture, our passionate and committed people who hold such incredible values, and our strong financial foundations with a high-quality customer base, strong capital, and significant liquidity. Turning now to how we have performed against these individual strategic priorities. As expected, new lending volumes were tempered this year due to the disruption in 2023, while prioritizing margin and risk over growth. However, we outperformed the market and delivered a loan book growth of 4.8% and a strong recovery in pipelines.
We are definitely seeing more confidence beginning to emerge from our customers and business partners, particularly in the Buy-to-Let and Development Finance divisions. These products typically have long lead times, so the growing pipelines bode well for H2 growth prospects and beyond. Furthermore, long term, we see more resilience in the specialist markets and believe they will continue to outperform the mainstream markets in the years to come. Our diversification strategy is an important ingredient in exploiting the operational leverage and broadening the sources of income. Banking has a high fixed cost operating model, which has risen over the years as regulation has increased. Consequently, broadening and growing the revenue base is important. Commercial lending now represents 48% of new lending, and its profit contribution is approaching GBP 51 million, up from GBP 14 million in 2020. Our technology transformation program has accelerated this year.
We now have over 90% of our core and support systems based in the cloud, and we are systematically transforming our customer-facing platforms across every part of the group, enhancing our customer experience and further improving cost efficiencies and operating leverage. We are increasingly turning our attention to focus on API connectivity, utilizing multiple data sources, building partnerships, and continuing the next level of our vision to be a technology-enabled specialist bank. 2024 will see the delivery of a number of new exciting platform changes, including a replatforming of our mortgage origination system, which will continue to strengthen our market position and better support our customers. This will make it quicker and simpler for our customers to progress from application to offer, streamlining the process and ensuring an improved customer experience.
We continue to run a number of generative AI pilots across the area, various areas of the group, and there are parts of the business where machine learning AI is already actively used and well-established. Whilst we are still in the early stages of the opportunities to utilize this technology, the future does look very exciting. Internal capital generation has continued to be strong in the first six months, where the group delivered a 1.4% accretion to CET1. This is a powerful and sustainable strength of the group and provides the ability to both support growth and enhance returns to shareholders. With today's announcement, we will, once complete, have returned a total of GBP 533 million via buybacks since 2015, whilst also delivering GBP 493 million by way of dividends.
As I mentioned earlier, including today's announcement, this brings a total of in excess of GBP 1 billion return to shareholders. Finally, we remain committed to doing the right thing as part of our sustainability strategy, and we're on course to achieve operational net zero by 2030. Since 2019, we have improved our operational emissions, reducing them by 42%. Our financed emissions, however, are based on our customers' assets, and therefore, much harder to reduce, particularly given the change in government stance earlier in the last year. This is an industry-wide challenge and will require government policy to help deliver the changes needed. However, we continue to take steps to help our customers, and EPCs rated A to C is a growing share of the mortgage book.
In our development finance business, we are seeing positive responses to the Green Homes Initiative, and to this end, we recently increased it from GBP 200 million to GBP 300 million. This scheme incentivizes developers to build EPC A-rated properties through reduced funding costs. We've been pleased with the take-up of the scheme, with a number of developments now complete and homeowners enjoying their energy-efficient properties. The general election may see a revised government strategy, but whatever happens, we will continue to provide, develop, and extend our products to support our customers' own sustainability objectives. So now let's turn to the performances, each of the business lines, starting with Buy- to- Let. 2023 witnessed a weak housing market, with activity off 29%, to levels last seen around the times of the financial crisis.
The Buy-to-Let market was not immune, with mortgage lending across the sector reducing by 49% year-on-year. But given lead times, this has affected H1 volumes, leaving new business levels lower than the equivalent period last year. However, after two years of negative sentiment, H1 has witnessed a more optimistic outlook, particularly from professional landlords, who themselves are taking an increase in share of this market. This is reflected in our own customer research, with 37% of portfolio landlords telling us that they plan to increase the size of their portfolios during 2024. Our Buy-to-Let pipeline has increased by 47% to GBP 874 million since the year- end, and has strengthened further since the 31st of March.
We have continued to see strong levels of customer retention, with over 80% of our customers with maturing fixed-rate mortgages going on to take a new product with us, enabling the Buy-to-Let market book to grow by 4.5%, with our post-financial-crisis book largely focused on professional landlords growing by over 10%. This result wasn't an accident. We reengineered a customer retention proposition two years ago, introduced a comprehensive customer communication program, and extended increased flexibility to allow our customers to plan their funding needs well ahead of time. There's clear evidence that amateur landlords, which are more likely to be focused in our legacy book, have been exiting the market, whereas professionals have been looking to invest and benefit from the excess of rental demand over supply.
Indeed, 40% of our new business flow is typically from a house purchase rather than a remortgage, and we see our landlord customers generating healthy rental yields, particularly in the specialist property segments, where we are market leaders, benefiting from the expertise that our unique in-house property valuation team provide. Population forecasts and demographic trends, such as the increase in single-person households, immigration, and the inadequate supply of alternative social housing, will continue to create a high and sustained demand for rental property. Our role here is to support landlords, to provide the homes for those who want or need a home to rent.
There is therefore a clear bifurcation in customer behavior that can be seen in the customer retention chart in the middle of this slide, resulting in strong growth in the so-called new book, up over 10%, whereas the legacy portfolio has contracted by nearly 12% year-on-year, down to GBP 2.9 billion. We have an award-winning, strong franchise in Buy-to-Let and continue to invest to strengthen this further. We've been working on a new proposition, a cloud-based digital platform, to support our new business activities, which we expect to go live in H2, and which we expect will deliver considerable benefits to our intermediary business partners and customers, while further improving our own efficiency.
Whilst volumes in H1 were weaker, as we expected, the pipeline is now stronger, and we expect our full-year mortgage lending to be towards the top end of the previous guidance range. We continue to use extensive data analytics to... in our Buy-to-Let business, supporting our comprehensive underwriting process in-life portfolio monitoring, as well as the IRB program, where the extent and depth of our data is unrivaled in the U.K., and which acts as a clear differentiator in our decision-making processes, including those for IRB. Mortgage arrears have ticked up over the last year, but from a very low base. Virtually all of this increase is located in the legacy book, which is largely variable rate, highly seasoned, largely amateur landlords, but with good LTVs.
The average LTV on the portfolio stands at 63.5%, and only 4.4% is greater than 80% loan-to-value. The flow rate into new arrears has now started receding as the interest rate cycle peaked, suggesting a plateau in arrears will emerge in the near future. We are conscious that affordability has been in the spotlight in this higher interest rate environment. We've always operated conservative stress testing in this area and have applied it rigorously throughout, including employing tests over and above the regulatory requirements. It is clear that although debt service costs are higher, rents have kept pace, leaving the current debt service ratio, the ICR in the pipeline, currently standing at over 200%. We will now look at our commercial business lines.
As I said earlier, commercial lending has been the means by which we have been able to diversify our business over a number of years in pursuit of our key strategic priorities. While commercial lending represents 14% of the loan book, it represents 48% of new business volumes and 27% of income. Additionally, commercial lending is not one homogenous product line, but a number of different businesses providing further diversification in itself. And within SME lending, there is a broad spectrum of customers, including SMEs, corporates, and even the U.K. government, covering a range of sectors from construction to logistics, from agriculture to education, manufacturing to transport, and many, many others. So let's now look at each lending line individually, starting with development finance.
As signaled previously, we expected that development finance division was likely to see weaker activity in 2023 due to the combination of supply chain disruption, cost growth, and the uncertainty of the environment, including the potential for softness in house prices. However, there are particularly long lead times in this sector due to extended planning processes, and that the facility drawdown phase is aligned to the actual construction of the underlying properties. However, although new drawings were weaker, the existing facilities continued to roll out their build programs, supporting robust cash drawings, leaving the loan book higher, approaching 11% year-on-year. Margins are tighter year-on-year in this division, not unusual at this stage of the cycle, although remain the widest in the group and underpinning excellent risk-adjusted returns.
The new business pipeline, similar to mortgages, has started to grow again, up 21% since the year- end, reflecting the change in sentiment I previously mentioned. Our product range has broadened recently, with new initiatives supporting house builders in the build to rent and purpose-built student accommodation sectors, both specialist pro- products and in markets witnessing strong customer demand. The portfolio is performing well in credit terms, a product of the high quality developers we choose to work with and the rigorous standards we apply to underwriting. Some facilities always need careful management from time to time, but our cautious underwriting, good LTVs, and highly experienced teams see the portfolio performing well and with high degrees of resilience. Notwithstanding the environment, our SME lending division performed robustly with stable origination flows and an increase in the loan book to GBP 780 million, over 6%.
The competition has been pricing aggressively, but we've been disciplined, instead choosing to prioritize risk and return over growth. We have continued to invest in new technology in this area. 80% of new business goes through our new SME Lending business portal using AI, which assesses over 4,000 pieces of customer data with each application, including access to customers' current account information as part of the underwriting and in-life monitoring processes. Auto decisioning has also been introduced using the extensive customer data, but calibrated against our experienced risk and credit analysts. This enables decisions to be reached faster and funds to land in our customers' accounts within hours rather than days, increasing their confidence and supporting them to expand their business and achieve their ambitions. It also enables our team to focus on more complex cases, ultimately offering an all-around better service.
Despite higher business insolvencies across the UK as a whole, the portfolio is in performing incredibly well, and there is no evidence of credit deterioration or any concerns emerging from the early warning indicators. Turning now to the remaining areas of the commercial division. Although motor finance business flows were softer compared to last year, the loan book growth was strong, up 9% year-on-year, with success being particularly evident in the leisure vehicle markets, one of the more strongly performing subsectors we target. The portfolio is resilient, and with SMEs, we are seeing a strong and robust credit performance. The motor finance industry has been focused on the FCA investigations into commission structures. We have a high quality book with low complaint levels, and whilst there has been an increase in complaints following the high-profile publicity, for us, they remain low.
It is not possible to make any forecasts at this stage, but with the quality of our loan book, the guard rails we had in place on commission structures and our late market entry and a market share of only 0.1%, if there is any exposure, it will be small. Finally, structured lending, which provides asset-backed lending to non-bank specialist firms, has had a strong period in terms of activity with a 22% increase in the loan book and delivering good customer retention. Its new business pipeline is strong, and we anticipate healthy growth in 2024. As seen elsewhere, the credit performance here is exemplary. Our commercial lending divisions are regarded as more cyclical in nature than mortgages, but have performed particularly resilient, resiliently in this more challenging economic environment.
And with a NIM approach in 6%, it provides the group with a strong risk-adjusted margin and structural NIM benefit as there is much further growth expected in the years to come. Okay, turning now to our funding. Our savings division has been a significant beneficiary of the rise in interest rate environment, where our cost of funds have moved from circa 100 basis points above SONIA to now being sub-SONIA. We have also seen a significant shift in demand from customers, with a material increase in flows into fixed-term products, although this structural shift has now slowed somewhat. We have provided good pass-through rates to our customers from the higher rate environment and ensured this approach, combined with excellent customer service, has enabled higher retention rates to exist.
Our Net Promoter Score has been consistently strong, alongside good Trustpilot reviews, with a rating of 4.7 out of five. The deposit book is up over 24% year-on-year and stands at GBP 14.8 billion as at the 31st of March, and has continued its strong growth trajectory since then, on the back of an extremely strong ISA season. Only two years ago, our balances stood at GBP 10 billion, and as such, we are one of the fastest growing savings franchises in the U.K. We have continued to strengthen our franchise, enhancing flows in both our direct-to-market proposition and through our third-party platform relationships with Hargreaves Lansdown, Monzo, Revolut, and many, many others.
New technology has already played an important role in the development of our savings division and will continue to be a crucial driver to growth, with further initiatives currently under development. Of course, we can also access wholesale funding, where the group has a long history in the securitization markets and a strong investment grade rating. However, whilst the debt capital markets are in good health and pricing has improved, it still remains unattractive to us at present. We are working on a covered bond program, and this has the potential to support wholesale issuance at pricing comfortably inside mortgage-backed securitizations. However, you will have seen that we have issued mortgage-backed securities this year, but they have all been fully retained and are being used as collateral for contingent funding lines, including repo facilities.
The strength of our liquidity position and the strength of our savings franchise has meant that we have been able to accelerate the repayment of the TF SME program. We have repaid nine hundred million pounds by the end of March, with a further four hundred million pounds repaid since then, bringing current outstandings down to one point four five billion. Our accelerated repayment profile will continue into H2, as we seek to get well ahead of the market before the maturity dates in October 2025. There have, of course, been deposit beta increases in H1, and we, as we expected, and we anticipate this to continue in H2 as TF SME gets repaid across the market. But this impact is fully embedded in our NIM guidance for 2024 .
In conclusion, the first half of 2024 witnessed an outstanding financial and operational performance, with customers showing resilience and renewed confidence. The disruption created by the significant interest rate volatility and the month-on-month rate rises led to new business flows weakening in H1, but this was expected and allowed for in the original guidance. However, the clear positive change in customer sentiment, combined with the strength of our franchise and the depth of our customer relationships, has led to a more optimistic outlook for our H2 lending activities. For 2024, we now expect to come in towards the top end of our guidance, which, to remind you, is GBP 1.3 billion- GBP1.6 billion for buy to let, and for commercial lending, GBP 1 billion-1.2 billion. If this market sentiment remains, we would expect stronger growth in 2025.
NIM has widened, partly due to the structural mix in the balance sheet and partly due to the transition to a higher interest rate environment. We are running ahead of expectations so far in 2024, but deposit betas have increased and much of TF SME has still to be repaid. Nevertheless, we are confident the year as a whole will now deliver a performance above 310 basis points, which was the top end of our previous guidance range. The credit performance continues to be resilient, and operating costs are being well controlled, notwithstanding the ongoing technology investment program, and we expect to reconfirm that we will be—our operating costs will not exceed GBP 180 million, a year-on-year increase of just 5.6%.
The 2023 underlying operating profit was the highest in the group's history, and in 2024, so far, we have made further progress, and we expect to deliver on our guidance of return on tangible equity towards the top end of the 15%-20% range. As has been seen, we generate strong levels of capital, and the buyback program has been enhanced this year, showing our ongoing commitment to managing our capital base for the benefit of shareholders. While the economic backdrop is more optimistic in 2024, there are ongoing political and geopolitical uncertainties, and now we have a general election in a month's time. But we have built a robust and high-quality series of franchises, and we firmly believe specialist lending markets will continue to outperform the wider sector, and we are confident in our long-term, ambitious growth plans.
We continue to want to diversify our business, spreading the sources of income and defraying the fixed cost structures that inevitably exist in a highly regulated structure. We believe Basel 3.1 could well prove to be challenging for some small and mid-tier banks. Whilst we await the final outcomes, we are also increasingly turning our attention to the opportunities that may emerge from the long-expected and perhaps much-needed consolidation in the sector, and we are incredibly well-positioned in this regard. So while 2024 may continue to have an uncertain backdrop, our business is in great shape. We have a high-quality customer base and a strong balance sheet, and we stand ready to react to the opportunities as and when they arise. So thank you for your attention, ladies and gentlemen. We're now ready and happy to take your questions. I can sit down now.
So, let me just say, make sure you, when you take the microphone out beside you, you have to hold the button, to connect. So in front, and then we'll come to Gary.
Morning, both. It's Ben Toms from RBC. Thank you for taking my questions. I'm conscious that your new updated NIM guidance of greater than 310 basis points for FY 2024 can imply quite a wide range for half two outcomes. You give a sensitivity on Slide nine, and thank you for that slide. It's really useful, the sensitivity to how tightening and deposit spreads might impact the NIM. The sensitivity is based on the performance you saw in half one. Is that the right way to think about the compression in NIM in half two, i.e., it should be similar to that seen in half one? And is the half two NIM the good best case estimate for the NIM in 2025?
And then secondly, just in relation to your last comments you made around diversification, your Buy-to-Let volumes are picking up again, which is great for balance sheet growth, but it means it's more difficult for you to achieve the diversification you desire. Can you just give an update or a bit more color on what you were talking about in terms of the opportunities that may arise, whether it's bolt-on or whether it's kind of larger transactions, and how close do you think you are to being on that long run rate to being an MREL qualifying bank? Thank you.
Okay, so there's a lot of questions in there. And if we miss one, then I'm sure you'll let us know. Richard, cover the NIM, but the one thing we won't do is we won't give guidance on 2025 yet. We'll come back and talk to you about that at the year-end. So if you give that, and I'll pick up on the others.
Yeah, so, I think that's a good proxy. If you look at the same sort of progress that we saw from September to March in terms of a March to September 2024 approach, that's probably the way we're looking at things in terms of the deposit point. That 18 basis point, if you like, spot deposit tightening clearly hasn't been translated through to a similar reduction in NIM in H1, and that's because we had a stronger period for mortgage margins. In large part, a lot of the old book reprices on a SONIA basis, and so that's a lagging indicator. So when base rates stopped going up in September, we were still seeing margin widening, if you like, in the mortgage book in the following quarter. That won't be repeated.
So you could see a slightly faster reduction than two basis points in the net position for H2, hence the guidance.
Okay. So in terms of... Yes, you're right, we have seen, you know, good recovery in pipelines, which will feed through to stronger organic growth in H2 and beyond. So the capital question is complex 'cause it's, there's a number of moving parts in there, not least which is Basel 3.1, which we await, the outputs from that. We expect that will be delayed. It was due to be announced by the end of June, but clearly, we're in the closed season for government at the moment. I imagine, not that anyone's told us, but the PRA are gonna want to engage with a new government, if there is one, post-election, in terms of the timing of that.
So it certainly won't happen before the original deadlines or the original expected deadline, and then it could well be pushed back. And the further it gets pushed back, if it's not out until the final quarter of the year, I wouldn't be surprised if Basel 3.1 implementation date gets pushed back from July 2025 to a later date. But again, this is my supposition, not anything that anyone's from told us from the bank or the on the government. We've also going through our IRB process, as I'm sure Richard will can give you an update on that in a second, but it continues.
And but we've also, when you look at our, our capital accretion, our capital accretion is strong, you know, 1.4% in the first half of the year. Kind of like if you just double that as a, as a proxy, that kind of gives you the strength of the internal capital generation that we can provide. Typically, what we found is that the capital generation has exceeded the, the realistic ability to achieve loan book growth on that. So the, you know, the, the loan book growth utilization of that, it generates more, hence, we have plenty of room for buybacks. So, so there's lots of complexity around the various moving parts of the capital requirements there. In terms of the M&A message that then flows from that, you've seen that we've not been frightened of doing acquisitions.
In fact, our commercial division has been built on a series of acquisitions that were made, then integrated into the business. You know, are we interested in growing our business? And we're, yes. I don't think it's changed in the last six months since we saw you last. You know, we have been for some period of time, but we're very careful in what we look at. And so if something comes along, then great. If it doesn't, then we've got a great organic plan behind it as well. Anything we do is gonna have to be set against a very high bar of standards that we set for our own business. So, and could it be small bolt-ons? Yes. Could it be something bigger? Yes. So nothing's ruled in, and nothing's ruled out in that regard.
And in terms of MREL, we understand the rules, we understand where the trajectory is. We do have engagement with the bank on understanding the application of that. And I think for the duration of our plans that you have and you have out there, this, you should build no expectation of MREL within that. I think Gary had his hand up first.
There we go. It's Gary Greenwood at Shore Capital. I just had a question around credit quality. I think you said that the flow into arrears was reducing. And therefore, should we think about the impairment ratio in H1, I think it was 14 basis points, being a peak, and then it trending back down towards the 10 basis points long-term average you spoke about? Obviously, note that your economic assumptions remain pretty conservative as well, so I don't know if there's scope potentially to relax those as well and get a little bit of a kicker from those later in the year. Thanks.
Let me just talk about the dynamics of the way arrears flow feeds through to the dynamics. Then, Rich, if you pick up on the application of it to the impairment charge. So if you look pretty much across everywhere in the group, it's like great. I mean, it's a really great story about how good the credit quality is, even in some of the areas that you regard as a bit more cyclical, like SME. The buy-to-let book has got two very different portfolios. The variable rate, pre-financial crisis, largely amateur landlord portfolio, going back to pre-financial crisis, and then everything else. We call it the new book, but it kind of started post-financial crisis, so I don't know when new stops being new. But that book has experienced 14 base rate rises.
Across a typical distribution curve, there's gonna be some at the edges that, of those customers will have found a stretched affordability as a consequence of that. The LTVs are low, so what you might have is might be a pickup in the PD, but actually, the LGD doesn't change that much, as a consequence. And usually what you find with those customers, there is a few idiosyncratic issues that tend to affect those customers that have struggled a bit, but they haven't affected the portfolio. Hence, you see it somewhat isolated. But the other thing is, you know, for every account that goes into three months in arrears, you know, it sometimes, somewhere along the way, it missed a payment once.
One of the things that we will monitor through kind of triangulation tables and the way in which you look at the cohort analysis is the degree to which accounts go from nought to one, one to two, two to three. The propensity for that to happen has slowed down. So that while you saw the arrears going up, I'll draw it this way, saw the arrears going up, you kind of would expect that to kind of plateau and maybe even ease off, if the environment remains unchanged. You talk about the provisioning.
Yeah. So you're aware that the way that we operate the buy-to-let business is we use receiver of rent as a, as a process to make sure that if there is an issue, we can stand between the landlord and the tenant to make sure that we secure cash flow. So we do that very, very well, I'm saying robustly, very swiftly in terms of the, in terms of our arrears management processes. The consequence of that, though, is that when we appoint a receiver, that account goes into stage three, and we provide accordingly.
So what you tend to find within the buy-to-let book is you provide early and then release at your leisure afterwards, if, like, when you find that you get the valuations in, you know, the, the, you end up returning quite a lot of property back to the landlord when they've resolved whatever their, their issue is, or you can get an accelerated realization of the security. So that works quite neatly, well, quite neatly, but it does mean that you provide quickly and then, and then release. So that's one of the reasons for the, the increase that you've seen in, in the first half. So, you know, it, it... the, the potential for doing a little bit more of that means that you could see some more in H2, and then, then it goes away.
Overall, we're still very comfortable with that, that strong, strong credit provision, position. You could see some, if you like, little lumpiness in the, in the impairment piece. On one of the charts that I show, it details what the impacts of the, the application of our current, economic scenarios would be if we use the weightings on IFRS 9 that we had when we first went on to IFRS 9 in 2018, and removed the, the PMAs. Now, from memory, the number is about GBP 14 million, adjustment. Now, you know, we don't, we don't hold PMAs and those higher weightings lightly. You know, there's a lot of uncertainty out there. You know, we try to position ourselves generally conservatively in terms of our, in terms of our provisioning.
So, you know, we're sort of not looking to do a quick release in H2 to bolster the numbers, you know, we'll take a, let's say, a conservative stance on all of those. The economics today, though, are better than we're forecasting. So, you know, house prices on a spot basis are probably about 3% above the level that we're implying in those numbers at the moment.
There's a question up there.
Sorry, just getting the microphone working. Can I just bring you back to the question of capital? Because, 'cause I hear what you say about earnings generating 140 basis points, but if you put in growth, and you put in the dividend, and growth is gonna be arguably picking up, so at the bottom, you know, net net, you're not actually generating much in terms of surplus capital. Which is fine. I don't have a problem with that. I'm not a buyback obsessive or anything, which I know some of my peers are. But the actual surplus generation is reasonably limited. And so I guess in that context, you've also got some very big moving parts around IRB, around the fair value adjustments, around Basel III.
So I just wondered, the sort of key points to me would be, firstly, how much of the fair value adjustment is still in there? So how much is capital today bolstered by the fair value, which we're going to lose, I guess, over the next, I think, five years, is it? Or three years? That would be number one. Secondly, on IRB, can you give us some idea of roughly... You might have done before, and I missed it, but I don't think you've given us an IRB number as to what your best guess is in terms of the potential benefit. And then finally, apologies, but the final question: If you don't get IRB, how low are you happy to see your capital ratio go in the event of Basel III?
I mean, pro forma, we're down to about, I guess, 12, 12.5. Are you comfortable with that? Would you be happy to see it go lower than that? Thanks so much.
Shall I go? Okay, so, if you just look at earnings, less growth, less our divi at policy, you're accreting 0.4%-0.5% of CET1 in a six-month period. So, you know, if you run, if you assume that Basel 3.1 happens in July next year, we'll have had two more periods, so 1% higher. I actually think it's remote that it'll happen in July next year now. I think that the... It'll take the industry at least a year from the point that the rules are established to actually have the systems and everything else ready to do it. So I think the general election puts that back realistically sometime now.
As Nigel said, we've not had the confirmation of that from the Bank of England, but it seems fairly obvious that will be the implication. So we're, you know, strong ongoing earnings, that core position. As I mentioned on the Basel 3.1 impacts earlier, they've reduced 0.2% year-on-year just because of the mix effects in the portfolio. That will continue. With the type of business we're writing and with the run off of the originally high loan to value extant book, you know, the original valuations of the legacy book were in the 85%-90% range, so they get really badly treated under Basel 3.1, where you're looking back at original valuations rather than an index. That runs off very...
Well, that's running off at, you know, double-digit percentage rates. So that, you know, that automatically will bring that, that figure a little lower. I made the point, you know, we don't have a plan today to do an AT1, but it's part of a capital stack that almost all of our peers carry, and it's one that we have the platform ready to go, so, you know, we could do it. We've got all the shareholder approvals. So in terms of managing the overall Tier 1 position, it's another tool that we have in our disposal, and we have the strong, you know, rating to support that. So, that, you know, that capital accretion is good.
In terms of the fair values, almost all of the fair value adjustment that we saw previously have now, you know, the pipeline that fair value is reflected against, those loans are now completed. So that is now amortizing quite evenly now over the next five years. There isn't a shock to come. There was a bit of a hit in October, in the beginning of November, when swap rates fell very rapidly, and those loans were still in the pipeline. So that was why the amortization for this first half was a little higher than normal, but you'd be expecting an annualized GBP 20 million-GBP 25 million over the next few years. And we can forecast that quite well.
So that's not to say a new loan in, sorry, new flow in six months' time will not have its own fair value effects, but that could equally be positive or negative. So from what we see at the moment, the, you know, that capital position looks pretty robust. And, let's say, on a 3.1 basis, if it went in next July with the share buyback, you'd still probably be looking at something north of a 13% CET1, with the accretion of the extra 1% net earnings over that period.
Okay, but obviously, with the fair value headwinds, you, it's not going to be 1%. I mean, those continue for the next five years, so-
But it's only 25, thereafter, you're still accreting, you know, GBP 25 million pre-tax is GBP 70 million or GBP 80 million post-
Okay.
-where you're making 140 basis points of CET1, so it's pretty marginal.
140-
But it's 13, a good number then, is that?
Sorry, it's 140. 140 basis points for a half year.
Yeah.
It's 280 for the full- year.
All up, just doubling up?... But I guess there's full- year growth as well, so, I mean-
Yeah.
And I just-
I think one of the other areas to look at, in particular for H1 this year, is that our development finance book was strong.
Mm-hmm.
And that carries a 150% risk weight. Now, I think to assume that in relative terms, that degree of growth happens in that same book at each point over the next two or three periods, you know, it'd be great if it does, because I think we'll be looking at a much bigger upgrade than 140 basis points of CET1 being-
Mm
... created from the earnings. But again, that's a feature of this last period as well.
Okay. But you mentioned 13%. Is that a number that we should feel is like a number that as a management team, you're, you know, you wouldn't want to go much below that? You, you-
We're not giving a guidance as to our target CET1-
Sure
... until Basel 3.1 has landed and IRB has landed.
Okay.
Only then, when all the moving parts of the E have settled, can we actually-
Yeah
... you know, make sense of what the target number should be. But we, you know, we'll have to wait until we come back up to that point.
But also flipping onto IRB, you know, as Nigel said, we've had a lot of engagement with the PRA in this last period. We're
Okay
... we're not at liberty to say what we think it's gonna do, to be blunt. You know, the final calibration will be down to the regulator.
Mm-hmm.
There's, you know, no point in us front-running that. You know, if we didn't think that it was going to add, you know, benefits to us in, you know, general capital management, risk management, and you know, bluntly, on those capital ratios, you wouldn't be doing it. So, you know, that's our core assumption is that IRB will be the basis for the group going forward.
Sure.
But it's a question of timing.
Yeah. Okay, thanks so much.
Yeah.
Hi, thanks. Sanjana Dadawala from UBS. Two questions, please. First on the costs. So retaining the GBP 180 million guidance while absorbing the GBP 1.7 million Bank of England levy, if you could talk about, what's better in the underlying costs to help drive that, and how should we think about medium-term growth there? And then secondly, coming back to the NIM performance in the half, just a 2 basis points reduction, and you mentioned some of the drivers. But could you touch a bit more upon the divisionals, especially on the commercial side, which didn't do as well?
Okay, I'll cover the costs.
Yeah, sure.
So in terms of the costs, yeah, so we gave that guidance of GBP 180 million, and despite the Bank of England levy, that was not expected at the time, you know, we've absorbed that cost within that target, as it were. So why is our costs doing well? And I think they are. And I think one of the things to bear in mind is banking is a really high fixed cost structures. You know, and it's increased over the years, you know, where regulatory costs have gone up, and they've created layer upon layer of additional costs.
And so when you are able to then achieve growth, but you're not necessarily adding to the fixed cost structure, you know, you see the operating leverage in dropping through to the to the bottom line. So you see our cost income ratio has come down to 36.5% from a figure. If you go back to maybe 10 years ago, it was kind of where the cost income ratio was then, and you saw it went up and has then come down. And I think that going up as a consequence of being a bank, the banking sector becoming more regulated, and thirdly, you know, 4 acquisitions that then went through a process of integration. So, you know, all of that has created that dynamic to come through.
On the way through now, what we have is there's a lot of time, effort, and money being spent on technology. You heard me talking about that, a little earlier. We, Richard takes a very, very prudent approach to capitalization in that he doesn't like it, and the consequence is the amount of capitalized asset we hold on the balance sheet is very low. So we don't, therefore, that means two things. One is you don't have a dangling debit about to come in year, in the years to come through depreciation charges. Equally, it does mean the costs are going through the P&L now. So, you know, most of our IT costs are expensed, not capitalized. So, what you then see is that's all being managed in this process as well. Do we have the full benefits of technology at the moment? No, not remotely.
Not remotely. This is a long-term project, if you will, series of projects, and each of them have got various degrees of implementation, some of which have happened, some of which we are in mid-process, some of which have not even started yet. So this is a long-term transformation of our business, which will... One of the benefits of that, clearly, there's got to be a lot of benefit going through to the customer experience, the broker experience, but one of the benefits is actually improving efficiency as well. So a lot of things we do and a lot of the things we focus are, are about ensuring that we have a very sharp eye on the cost management of the business.
On the margins, I think we've been very transparent in terms of the three divisions, and what we don't do is, if you like, subsidize the mortgage and commercial divisions by the outperformance, if you like, on the central piece in terms of general funding. So, for example, on Development Finance, as rates have gone up, we've probably passed on-
... 2.5%-3%, in terms of the 5% increase in Base Rate, in terms of new business pricing over that last, you know, 12 or 18 months. So the, the, if you like, the inception margins, or on the asset side for that business has been much reduced, but we're getting a big benefit in the central area. So, you know, we're, we're, we're not uncomfortable at all with the, with that margin profile, but it's just one that people just need to understand. I think the, the, the just the spreading of those, those fees because of the slightly, elongated process that we're seeing, you know, we're only looking at about an extra three months in terms of the average, the average time it's taking to get to practical completion.
But that's probably moved our NIM in the commercial area by five basis points in the period. So again, all of these things have impacted. We would expect that to reverse. So, you know, unless U.K. house building is, you know, it has the same issues in five years' time as it has today, I think the, you know, you ought to get back to, if you like, a more normalized process for those developments. So that ought to come back. But, I think, you know, when you're looking at the overall PNL, it is important to look at the group position, because the reality is that the, you know, the actual NIM performance for the group is also driven by those, you know, those strong liquidity flows that we have centrally.
Portia.
Thanks. Portia from Canaccord. Can I just ask on the Bank of England levy, is that a charge that repeats in the second half, and what factors will influence how... well, the quantum of the charge going forward in future years? And secondly, assume it's not material to you, but if you could just confirm whether you've been affected by the borrowers in financial difficulty review, which some of your peers are reporting with respect to Motor Finance, that would be helpful.
Yeah. No, nothing on the borrowers in financial difficulties. We do have borrowers, some of them end up in financial difficulties, but we think we do a good job in looking after them.
And that's it for this financial year. But there will be another charge next, on the levy. The absolute scale of that is set annually, though, by the Bank of England. They'll tell us what the aggregate levy needs to be, and then it's divided up across the deposit takers. So, you know, our hope is that it grows at a sensible level next year, but it's not in our gift. Are there any more questions in the room? Jason.
Hi, it's Jason Napier from UBS. Two, please. The first on deposit growth, very, very strong TFS-ME repayment. Some of the larger banks are muttering darkly about the upcoming liquidity requirements of some of the sector. I wonder whether you could talk a little bit about how sensitive the NIM outlook is to those sorts of issues as others come to refinance, whether you think you can recover that through the asset side, whether maybe you'd have lower volume growth and so on. So, you know, very strong performance to date. How does the TFS-ME repayment sort of fit into your future plans? And then secondly, on the credit side of the balance sheet, you know, as you've said, phenomenal credit risk numbers through this cycle and a very sharp rate cycle.
What has happened to your acceptance rates on credit through this period? You know, have you been attenuating the risk that you've been taking? Is there room for more risk appetite as demand, assuming demand comes back as rates start to fall? If you could just talk a little bit about the embedded risk in the portfolio and how that might have changed over time. Thanks.
Yeah. So, in terms of, I mean, what we highlight and the fact is that the guidance that we've given for NIM bakes in an expectation of some tightening as a consequence of the TFSME refinancing. So in one sense, you know, we got ahead of the curve, but we're kind of sitting there looking about, wondering where everyone else is. We're kind of happy that we've got ahead of the curve. It doesn't mean we're immune from some of the pressures from the sector if that comes about. So that's what we have allowed for within the forward guidance on the NIM side. It's an interesting point about if the industry as a whole does feel some pressure, and I thought...
I think I saw your note from your second favorite client after us, talking about this the other day, where actually the view is that if there is some liability cost increase, there will be an ability to pass that on through wider asset spreads. I think our asset spreads have been pretty resilient, actually, in this period. I think what becomes a little more challengeable, challenging is actually the volatility. You know, one week, the market's going, rates are off, coming off. Next week, oh, rates are not coming off. And you get, you know, you've seen 30, 40 basis points on the five-year swap movement within a month taking place. I know, appreciate going back to the time of the budget, that would have been a delight just to have 30, 40 basis points.
But, but actually, there's still quite a lot of volatility that comes, and it does require careful management between, you know, the business line and the treasury teams in ensuring that we don't either overexpose ourselves on the swap side to, to, in the pre-hedging or, or on the asset side, because you can, you can get caught on that. So it does require a lot of careful management. I think, I think, you know, whilst we think there is a risk of some spread compression, we've baked that in. Do we think if it kind of becomes more, becomes more than that, is there, is there an ability to recover some of that on the asset side? Yes, there probably will be.
'Cause if you look at these things, I mean, they're obviously you've got asset markets and liability markets and various different guys, but they all come connected at one point back to the banking system, and they're all driven back to your return on capital requirements. So there is a common link there. In terms of risk appetite, our risk appetite changed during COVID. You know, we certainly tightened up things during that period, and I would say we're probably just about back to where we were pre-COVID now, but it's been a kind of a slow step to recovery. If you look at those credit numbers, you know, they, they're outstanding. Not outstanding in one year, but outstanding in 10 years. So, you know, could we be accused of being too prudent?
It has been leveled at us. But you know what? Banking is a long-term game, and we have highly leveraged balance sheets. All banks have highly leveraged balance sheets. Get small things wrong in a bank, they become big things to the bottom line. So we're kind of like not looking to change our risk appetite in any material way, as a consequence of that.
But, Ed, again.
Yeah, we've got two minutes. I might as well... I don't want, don't want to, to leave the time begging. Can I ask you about buybacks? Because I guess one of the leading lights in the sector has now said that his share price is too expensive to buy back shares. And I guess you stand out as one of the possibly only or very few banks in Europe that's buying back shares at materially above book value. Do you think about it that way at all? Is that the way? Do you make a judgment on the value of your shares when you're doing buybacks, or is it more of a sort of mechanical process? And how do you compare sort of buybacks versus special dividends, and how do you decide how to balance the two?
Because it'd be interesting to know how that thought process goes. Thanks.
Yeah. So, on buybacks vs. specials, we like the, we like the optionality with a buyback. So every time that we've announced one, we say we'll do up to. So back in 2018, you know, we bought a standalone, the little Development Finance business. We stopped the buyback halfway through the process because we could have... We wanted the capital to deploy on growth rather than rather than be committed. You know, the special dividend is all on one... It's all on, it's all done in one go. So you get a little bit more flexibility around the around the buyback. We do monitor the price very carefully. And when we're looking at it, you know, we look at the, you know, the opportunity cost of just doing something with that cash.
We've not been at a position yet, though, where we feel that the capital that we're buying back is holding us back in terms of deploying it in growth. You know, that would be an example where you would probably wouldn't do the whole buyback. You'd do something else instead. So the alternative is just a cash return, and where we're, you know, our plans show us, to our point earlier, continuing to be very capital generative. On that basis, actually, you are getting a material return back from the buyback. It's probably. It wouldn't be as high as the ROTE for the whole group. So it's about GBP 7.50.
I think we get the equivalent of, like, 13 or 14% return, or you'd have to do something similar with that same money to get to break even. So, you know, it's something that we keep under, you know, under review, but we're not at a point yet where you'd say it's uneconomic.
I think the other way to look at it is the fact that we've got, you know, just reporting a 20% return on equity. If you think that's sustainable in the 15%-20% range, and yes, we're trading above book, but, but actually, the implied cost of capital relative to those two data points still in suggests the cost of capital is quite high.
I guess, you know, market sentiment may change over time as well, but, you know, we see a lot of our shareholders after each set of results, and the overwhelming feedback has been, we like the buyback. You know, it's not a huge number, and it's sort of 5% or 6% of, if you like, a value in a year. So, you know, at that level, I think that kind of quite a lot of them appreciate having the bid because, like, you know, there have been liquidity issues with, you know, a number of funds investing in small and mid-cap banks. So again, at the margin, it's got some, if you like, qualitative benefits as well.
Okay, are there any more questions from the room? We need to just check the webcast. No? Nothing from the webcast. Okay, we can let you go. So thank you very much for your attention this morning. As you would gather, we're delighted with the results, and, of course, we're very happy to answer any of your questions. Richard has set aside the rest of the day and tomorrow to talk to you, if that's, if that's of interest. And, if not, then just have a, have a great day. Thank you.