Good morning, everyone. Lovely to see you, and welcome to Paragon's 2023 interim results presentation. Today, we'll run through the financial and business performance for the first six months of the year and provide you with our view on the outlook, as well as, of course, leaving plenty of time for your questions. First, I'd like to start with five key messages, which, for me, represent the key highlights from these results. The first is that this excellent performance has been achieved despite the environment. The backdrop has certainly been challenging, with market volatility disrupting normal business patterns, interest rates reaching their highest level post-financial crisis, and the U.K. economy, while not in recession, has been weak throughout the period.
It's particularly pleasing that we've delivered an outstanding and record set of interim results, alongside a robust trading performance, while continuing to deliver good progress in our strategic priorities. Trading has been good in virtually all areas of the group and better than our expectations six months ago. All divisions have performed well, savings has been a standout performer, delivering good growth, broadening its addressable market, and driving down the cost of funds to below SONIA.
There is also good momentum, with many early indicators pointing to further growth opportunities in the H2, giving us the confidence to upgrade our mortgage lending volume expectations and NIM guidance, the latter for the second time this year. Our loan portfolios continue to perform resiliently; prioritising the widening NIM bears testimony to our approach to digitalisation, risk and margins over volume.
This will remain important as we are clearly now in a further period of uncertainty. Internal capital generation has been strong, supporting robust loan growth, the progressive dividend, and the increase in the buyback program to GBP 100 million announced today. The final message is the growing importance of technology, where we have made further progress this year, supporting improved customer propositions whilst achieving efficiency benefits. Technology is changing rapidly in almost every facet of business life. This is very true at Paragon, as we transform every corner of our business to exploit the opportunities that the new technologies can provide. Turning now to the next slide, we can briefly look at the key financial highlights.
Operating profits stood at GBP 129 million, up 22% on last year, driven by strong growth in the loan book and NIM 38 basis points wider than a year ago at 2.95%, resulting in our underlying return on tangible equity reaching 18.7%. Operating expenses are in line with expectations, delivering a cost income ratio of 38.1%. This results from tight cost management and some of the benefits of our digitalization program. The loan book grew better than expected at 4.6%, and savings balances, 94% of which are FSCS-backed, grew over 20% year-on-year, delivering improved cost of funding and supporting the widening NIM referred to earlier. Underlying EPS is up 28% year-on-year.
As mentioned, we have today announced a further GBP 50 million buyback program, which we hope to complete in the H2 of the year. Notwithstanding this, our capital base is strong, with CET1 at 15.6%, providing ample capacity to continue to support our ambitious growth plans in the years ahead. I'll now hand over to Richard to run through the detail of the financial performance. I'll return to discuss the business performance and our strategic priorities, as well as the outlook for the period ahead.
Good morning. As Nigel has just said, we've produced another really strong set of results for the H1 of 2023, and I'll run through some more of the financial details now on the next few slides. Starting with the overall income statement, both net interest and other income were up over 20% in the period, taking total operating income to GBP 220 million, an increase of 21.2% on last year's level. Operating costs grew by just under 12% to GBP 83.8 million and remain on track to total around GBP 170 million for the year, in line with our initial guidance. Provisions were higher in the period, with the impact of harsher economic scenarios being offset by a slight reduction in the overlays we held at the year-end.
These combined to take our underlying profits to GBP 128.9 million, 22% up on last year. As we've discussed at the year-end, the fair value gains we made in 2022 will all reverse to zero over time. Part of this has been accelerated into H1 2023, with the rest expected to arise reasonably evenly over the coming five years as the associated derivatives mature. Underlying EPS rose 28% to 42.5 pence per share. This reflects the ongoing benefit of the share buyback program, as well as the increase in underlying profits. On our segmental results, we sold the unsecured item portfolio in the H2 of last year and moved to a 2-segment disclosure at the last year-end as a result. The figures on the table, on the screen, follow this approach.
The 2021 H1 comparative has been restated to reflect the change. Pre-provision profits are higher in both core divisions, and we've also seen an improvement in Central, where funding benefits have offset the impacts of cost inflation in the period. Underlying operating profit for the commercial segment now stands just under 48% of that generated by mortgages, demonstrating the progress of the diversification strategy. The latter point also supports our continued NIM expansion, and I'll move on to that next. With the group's margin having been on an upwards trajectory for some time, the chart clearly shows how NIM progress has accelerated in the higher rate environment. We're positively geared to higher rates and have guided in the past to a circa GBP 10 million per annum benefit per 1% increase in base rates.
This benefit has been augmented by savings, pricing benefits and a continuation of our structural asset side accretion, which comes from the growth in the commercial division and the run-off of legacy buy-to-let loans. There's more detail on divisional margins in the appendix, but it's worth noting that further growth within the commercial division, which generates a 7% spread, will be an important element in maintaining margins above their longer-term trends when base rates eventually do start to decline. On the liability side, at over 94%, our depositors are well covered by FSCS insurance. Sorry, of the balance, the majority represent term rather than on-demand deposits.
You'll see from the absolute deposit and cash balances that LCRs have risen over the year, with the average for the six-month period more than 20% up on the equivalent in 2022. The March spot position on LCR was higher still, reflecting the strong inflows seen in the period. Moving on to costs. As I mentioned earlier, operating expenses rose 11.9% from H1 2022's level as we continue to push on with our digitalisation plans. The increase also reflects the generally inflationary environment. Core wage growth gets set on the 1st of October each year at Paragon. This was 5% last year. The delta from that 5% to 11.9% reflects a combination of higher absolute headcount and non-inflationary, sorry, non-headcount inflationary influences.
The group's FTE headcount, it moved up 2.6% from March 2022 to this March, with the rest of the cost change arising from inflation and volume-related costs. The bulk of the latter relating to our savings activities, where costs grow in line with the deposit book size rather than having a direct inflation link. When combined, our guidance for NIM and full-year costs deliver a sub-40% cost-to-income ratio for 2023. Cost discipline and the delivery of operational efficiencies remain key priorities for the group. Our economic outlook sees the key 2023 macro indicators being worse than the levels we used when we undertook the exercise at the year-end, with GDP trending lower and house prices softer.
Across the scenarios, we are now assumed, house prices are now assumed to drop by 12.5% in 2023, compared to the 8.2% we used at the year-end. We've maintained our scenario weights for 2023. If 100% weighted, the severe scenario would add GBP 21 million to our model provisions. The same effect last March was GBP 41.5 million, with the difference largely due to the house price forecast and their impact on the buy-to-let portfolio. The multiple economic scenarios translate directly through to our provisioning levels, with the recent reduction in house prices taking the buy-to-let portfolio LTV to 62.5%, compared to the 61.2% of the 2022 interim, together with the softer outlook that I mentioned earlier.
Despite the model provisions being higher, book performance and underlying collateral levels have remained strong; we've trimmed the overlays we hold to GBP 10 million, compared to the GBP 15 million we held at the year-end. We still haven't seen the full impact of the cost-of-living increases over the last year; we've not taken our overlays any lower. We'll keep these under review to assess the degree to which underlying models adequately reflect the impacts of emerging performance themes. The coverage ratio at the interim is 47 basis points, and that's 40 bips without the overlays. This compares to the COVID peak of 64 basis points and, as detailed in the bottom left table, a level of 36 basis points on the environment. Let's move back to a more normal MES weighting with no overlays.
We continue to monitor the credit performance of the book. As detailed on the right-hand side on the charts, our behavioral scoring outputs suggest a continued stable output. Our usual capital walk is shown in the chart. The main difference to the norm has been the impact of the fair value amortisation on the capital accretion in the period. Here, the underlying 1.3% growth has been offset by 0.8% fair value charges as the gains from 2022 unwind. In total, these gave us a 2% benefit last year. Distributions in the period totaled 1%. Our period-end CET1 stood at 15.6%. Total capital was 17.6%. These March numbers exclude the extra GBP 50 million of buyback that we've announced today.
Our attractively priced Tier 2 bond still has over 3 years to run, and the group is not impacted by MREL, so we have no corporate debt-raising requirements in this period of elevated coupons. On IRB, we continue to engage with the PRA. We've been reflecting their feedback and are nearing a position where our Phase 2 submissions will be ready for a formal panel review. Phase 3 is ready to follow any successful panel review, and we'll update the markets as and when we get any tangible progress on the IRB side, but we continue to be moving at the pace dictated by the regulator. We've seen the Basel 3.1 consultation paper in this half year. As drafted, it would have reduced our CET1 ratio by 2.3% from the 1st of January 2025....
Any changes to the final supervisory statement should partially reduce this level, and it'd be fully mitigated by the group receiving its IRB accreditation before the Basel implementation date. We've also announced, I just mentioned, the additional GBP 50 million of share buyback on top of the 50 we've already done, taking the 2023 full year program to GBP 100 million. Finally, for me, you'll see that our interim dividend will be 11 pence per share. This is slightly above our normal policy approach, where 50% of the 2022 final would have been 9.6 pence. However, we've decided to restore a more normal relationship between the interim and final dividends, following some material intra-year moves in the COVID period. Our total dividend policy remains unchanged at 40% of underlying EPS. Thank you.
Okay. Thank you, Richard. Let me now 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've shared with you previously how we focus on these priorities and how they are interconnected, and are supported by our strategic pillars of a strong customer-focused culture, a passionate and committed workforce, and strong financial foundations. Turning to the first of our individual strategic priorities. You've seen that our new lending increased by 6.9% compared to 2022, and the loan book expanded by 4.6%. This is not just a one-off good year, as the group's new lending compound annual growth rate since 2015 stands at 16.6%.
Furthermore, the specialist markets in which we operate are witnessing good underlying growth in most areas and offer excellent long-term prospects. Our diversification strategy is an important ingredient in exploiting centralised operational leverage and broadening our sources of income. Commercial lending typically delivers a net interest margin materially higher than mortgages, but with a highly experienced risk management team and a deep understanding of the sectors in which we trade, strong risk-adjusted returns can be achieved. New commercial lending represents 36% of the group's volumes, while delivering a GBP 56.7 million profit contribution, compared to just GBP 13.7 million only three years ago. It operates typically in less mature sectors, where we have an underweight position, giving us market share growth opportunities, and we expect this outperformance to continue for the foreseeable future. Digitalisation transformation is now well progressed.
84% of our core and support systems are in the cloud, and we are systematically digitalising and transforming our customer-facing platforms across every corner of the group, enhancing propositions, product delivery, flexibility, greater access to data, and further improving cost efficiencies and operating leverage. AI is already being used in parts of the group, but it is early days, and the opportunities for this exciting new technology are extensive. Excellent progress has been evident in supporting the growth in SME new lending, where the initial phase of the new platform has enabled us to broaden our customer reach and increase our addressable market, while capturing extensive new data sources to support the underwriting process. Internal capital generation is strong, with 1.3% added to CET1 in the H1, pre-distribution and fair value.
Uncertainty exists on the regulatory changes with IRB and Basel 3.1 in particular. Such is our confidence that we have been able to increase our buyback program, bringing this year's plan to GBP 100 million, our largest ever in one year, taking the total since 2015 to GBP 383 million, including today's announcement. Finally, with regard to sustainability, we continue to make good progress in doing the right thing. The area we can control, our operational emissions, have seen an acceleration towards our net zero objective by 2030, with a 39% reduction since 2019. Our financed emissions are more difficult to deliver as we await a government framework and policy directives.
Nevertheless, we have extensive product offerings with more in development across each of our business lines, offering customer incentives to support their own long-term sustainability requirements. Turning now to each of the business lines' performances. The wider mortgage market is down year-over-year, including the buy-to-let sector. It was heavily disrupted at the beginning of our financial year when the so-called mini budget led to a wholesale freezing of the mortgage market, when the sector was effectively unable to price its cost of funds for a period of time. Given the wider economic backdrop, demand is therefore generally lower. As we saw at the year-end, the year-end results, our hedging was highly prudent and extensively applied, protecting our customers and our margins.
Consequently, there was a temporary but significant slowdown in new business flows and a step up in conversion levels, thereby reducing the pipeline for a period of time. Completions have been strong over the last 6 months at over GBP 1 billion, some 19% up on the equivalent period last year. Due to timing, and as we guided in December, the H2 will inevitably see a lower volume whilst the pipeline rebuilds. We now expect the volume for the year to be in the top half of the range we guided to in December. The pipeline has rebuilt rapidly from its low point of GBP 681 million in January and was GBP 811 million at the end of March. It is significantly above this figure now, and we expect the pipeline to continue to build further in the H2.
Whilst activity in the housing market has been weaker, we have also made further progress in customer retention, with 77% of maturing fixed-rate customers choosing to remain with us, supporting the growth in the mortgage loan book. The redemptions we are seeing are typically centred on the legacy pre-financial crisis portfolio, where there is a larger cohort of amateur landlords. Some amateurs have left the market affected by tax and regulation, which leaves further growth opportunities for professional landlords. To remind you, nearly 100% of our buy-to-let business is specialist in nature and to professional landlord customers. The buy-to-let market has been professionalising over a number of years, and this benefits our customers. It's not surprising that whilst the market has been weak, we are still achieving good levels of new lending.
Rental demand remains very strong. The supply shortage in the private rented sector will only serve to keep our landlords' rental income firm. Despite the robust lending volumes, we have not chased new business by weakening credit standards, as is evident from our risk performance, as can be seen on the next slide. We continue to use extensive data analytics 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 the data we hold is unrivalled in the UK, helping us to employ methodologies to more accurately align capital with the allocation of risk. Despite the environment, arrears are just 10 basis points higher than the equivalent figure a year ago and remain materially below industry averages.
Much of the increase is in the legacy portfolio, where, as described earlier, there are larger numbers of amateur landlords. The average loan-to-value stands across the portfolio at 62.5%. We are conscious that affordability concerns have been in the spotlight in this higher interest rate environment. We've always operated conservative stress testing in this area and have applied rigorously throughout, including employing tests over and above the regulatory requirements. Our current debt service ratio, the ICR, sits at around 200%, even at current rates. Loans coming off 5-year fixes are typically seeing rates move up meaningfully, rents have kept track. Over the last 5 years, rents have increased by around 30%, meaning that the ICR is broadly unchanged.
The ICR and LTV requirements are connected such that should interest rates rise without a compensating benefit from rents, our credit assessment will typically demand lower loan-to-values to adjust the position and therefore equalised cash flow coverage. Rental demand has been strong, with rental growth running this year at an estimated level of 11% per annum. Our research and data analysis does not stop with our customers, but includes assessing the financial resilience of tenants, thereby producing confidence in the strength of our customers' cash flow. Should we now turn to the commercial lending line? Commercial lending has been the main vehicle 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 13% of the balance sheet, it is 36% of new business volume and importantly, 33% of income. Additionally, commercial lending is not one homogeneous product line, but a number of different businesses providing further diversification in itself. Within SME, there is a broad spectrum of customers, including SMEs, corporates, and the U.K. government, and a range of sectors from construction to logistics, from agriculture to education, manufacturing to transport, and indeed, many others. Turning to each of the commercial lending lines themselves. As signalled at the year-end, we expected that development finance was likely to see weaker activity in 2023 due to the combination of supply chain disruption, cost growth, the uncertainty of the environment, including the outlook for house prices. Consequently, our development finance lending division delivered a performance in line with those expectations.
That being said, the loan book now stands at GBP 766 million, nearly 14% up on last year. As witnessed by the larger national house builders, there has been a modest recovery emerging in demand since the turn of the year. We've also witnessed an encouraging improvement in customer engagement levels. The pipeline is now growing again, which, given extensive lead times in this sector, bodes well for 2024. In line with our general credit standards, we have a high-quality customer base in development finance. We are highly selective of the developers with whom we work, many where our experience of working with them goes back decades. The portfolio is performing well, and we expect this to continue for the foreseeable future. Now turning to SME.
Notwithstanding the economic challenges, our SME division has witnessed strong growth in new lending and a robust performance in the portfolio. Volumes for the six months stood at GBP 220 million, 21% above last year, with the loan book now approaching GBP 750 million. The division has been a real beneficiary of our digitalisation strategy. Over 72% of our applications now pass through our new lending business portal, which assesses over 4,000 pieces of customer data with each application, including online access to the customer's current account information as part of the underwriting process. This is a significant benefit for us, as previously, this was only something accessible to the, and available to the large banks. Further technology changes are being implemented in the H2 of the year.
Even with the weaker environment and higher business insolvencies, the portfolio is been performing incredibly well, and there is no evidence of credit deterioration, nor any concerns emerging from our early warning indicators. Turning now to the remaining components of the commercial lending division. First, motor finance, which experienced a steep slowdown during the pandemic, has now witnessed another period of strong growth despite the environment, following a more targeted approach to the specialist sectors. New lending increased by nearly 14%, bringing the loan book outstanding to GBP 286 million, with stronger growth being achieved in leisure markets, LCVs, and electric vehicles. As with SME lending, motor finance is also seeing a strong credit performance, with no credit deterioration evident in the portfolio or in the lead indicators.
Finally, structured lending, which provides asset-backed lending to non-bank specialist firms, has had a stable year in terms of new business flows, achieving good customer retention and delivering good profitability. The new business pipelines are encouraging, and good growth is expected in the H2 of the year. The credit performance in the portfolio has been exemplary.
Our commercial lending divisions are certainly more cyclical in nature than mortgages, but have performed, as you've heard, particularly resiliently in this more challenging environment, and to date, the credit performance has been strong, reflecting the longer-term, prudent approach to risk management applied across the group. The environment may well get worse before it gets better, but the business is well-positioned to deal with these challenges, and we will therefore maintain our cautious risk appetite, prudent provisioning coverage levels, and continue to apply close in-life monitoring across the various portfolios.
Turning to the savings division. The savings division has been a significant beneficiary of the rising interest rate environment, where our cost of funds has moved from around 100 basis points above SONIA to now being sub-SONIA. We have also seen a significant shift in customer demand, with a material increase in flows into fixed-term products, where there is now a meaningful return available across the curve. Since September 2022, there has been a GBP 53 billion switch from easy access and personal current accounts to the term deposit market, and we believe that this trend will continue. If you compare the position to pre-financial crisis, a time of comparable interest rates, term deposit flows should still expect to see significant ongoing enhanced demand for the foreseeable future.
Whilst it's clear there has been spread compression in many asset markets, it has been, for us, more than compensated for wider liability spreads, providing the opportunity to upgrade our NIM expectation for the year with our quarter one results. However, the performance has been even stronger, and we're now guiding to a 30 basis points increase in NIM to around 3% for 2023 as a whole. The deposit book is up over 20% year-on-year and now exceeds GBP 12 billion. We have continued to strengthen our franchise, enhancing flows in our direct-to-market proposition and through our third-party platforms like Hargreaves Lansdown, Monzo, Revolut, and 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, helping to broaden the proposition in the future.
We can also, of course, access wholesale funding, where the group has a long history in the securitisation markets, and whilst pricing has improved, it still remains unattractive at present. However, it remains open to us to access this funding source tactically as and when conditions improve. In conclusion, the H1 of 2023 has been an outstanding period in terms of delivery. Originations have been strong, and our improved customer relationship management is leading to greater retention levels, supporting good loan book growth at the same time as margins are widening. The credit performance has been resilient, and operating costs are well-controlled, supporting the strong growth in profits. However, underlying return on tangible equity reaching 18.7 is particularly pleasing. Capital accretion is strong, supporting the H1 buyback and the additional GBP 50 million announced in the H2.
Basel 3.1 is meaningful, perhaps a little more unhelpful than previously thought. IRB is inextricably linked here and will more than compensate for the additional capital requirements. We are very well positioned because of the extensive work already done with the PRA and the depth and quality of our data, somewhat unique in the UK. There is a significant cloud-based technology re-platforming program underway across the group, capable of being transformational over time. Much of it has the potential to level the playing field further with the larger banks. Our portfolio has been underwritten prudently and has been carefully managed over the years. We therefore expect our business will perform resiliently, both financially and operationally.
It is clear that the environment will continue to have uncertainties, but we are well prepared should a weaker environment emerge, both with the quality of the loan book and in the prudent level of provisions already taken, and we stand ready to support our customers should it be required. Whilst the greater level of uncertainty in the wider environment can create challenges, it will also inevitably create opportunities for further organic growth and potentially M&A. We are financially strong and well-positioned to react to opportunities as and when they emerge. That ends the formalities of the presentation, and of course, we'd be now happy to take your questions.
Okay, let's start front row, and then we'll move across. Yes, you need the... Pull the mic and press hold the button down, I think.
Hello, it's Harley from KBW. Thank you for the presentation. I guess thank you for the new disclosure on Basel 3.1. I think you said you think IRB is going to more than compensate. I guess just the way you're thinking about it, is it going to be, you know, broadly offsetting, or do you think there'll be... I mean, I know it's hard to say and depends on the regulators, but do you think there's capacity for, you know, additional benefit from IRB for, say, capital distributions? I guess that's question number one. The second question's on Stage 2 balances.
From what I can see, your economic assumptions have got more severe, and I think in the report, you also talked about actual arrears increasing and Stage 3 balances also increased, you know, by, I don't know, GBP 30 million or something like that. I just can't really understand how the Stage 2 balances fell so much by 60%. I think the text talked about model assumptions and inputs, but given that your economic assumptions haven't got better, just wondering how that was calibrated. Thank you.
If you cover the second question about the impairment calculations. In terms of IRB versus Basel 3.1, they are two separate pieces of regulation, in effect. Basel 3.1, as you know, it's kind of industry-wide. It's going through the consultation at the moment. We will find out in the last quarter of the year whether the consultation transforms itself into a policy statement in exactly the same form, or what will get amended. There's a variable there. We don't know what the outcome is. The second part is IRB. There is an extended and somewhat protracted process that we, and frankly, every bank that's going through this process has to deal with.
Again, it is a case-by-case calculation by the PRA specialist team on what your portfolio characteristics dictate the capital requirements can be. Again, that's another item that's a variable, and it's a PRA decision, both in terms of the capital requirements and the timing. The reality is, both of those factors, we, it's in the gift of the PRA and the Bank of England to be able to determine when that is and exactly what it is. To determine whether there's gonna be, what it is exactly, it's impossible technically to say that, but we've gone a long way through the process. We know kind of where we think the 2.3% impact on the CET1 is based on the current figures, estimated figures for the Basel 3.1.
If you kind of take that as a base case, the industry is kind of pushing back on a whole bunch of things. You know, let's assume that's the worst case. Do we believe our IRB, based on the level of information we have to date, will be equal to or better than that? Probably, yes, but it's a PRA decision, not our decision, and so I can't guarantee that number to you. Based on our experience, you know, it, we believe it's gonna be at least compensating for the current CP increase in the CET1. Do you cover the impairment figures?
Yeah, sure. The Stage 2 piece is really a combination of, if you like, journey and arrival. At the end of September last year, we were predicting a worsening economic environment. You're right, we've seen some very modest increase in arrears. The models, though, were saying an awful lot more was going to happen. That hasn't happened, you rebase at the new position and then put the increment in for the rest of the year, and that's not as bad as.
... from the start position than we were expecting. The performance of the portfolio has been so much better than was predicted by the models in the first six month, that the absolute level of Stage 2 is lower. It's just following the math through. It's still a very large number relative to the arrears numbers that we're seeing as well, though.
Good morning. Thank you for taking my questions. It's Ben Toms from RBC. Firstly, just to follow up on the Basel 3.1, the 230 basis points. I was wondering whether you might unpack that number slightly for us, we can take a view on if some of the measures get softened in the standard, what the benefit might be. I think previously you've said indexing was worth or no indexing was worth about half of the total. Are there any other bits that you might be able to unpack? Secondly, on the ROTE guidance, you've reiterated the greater than 15% guidance. Your print was 18.7 in the H1. I'm just wondering what the messaging is there to take away from that.
I assume from whatever you said that you're not going to have a material reduction in ROTE in half two. Is the point here that just consensus, don't get too carried away, this year might not be an indicator for future years to come, or is it just that you're being super conservative?
Okay. Dealing with those two, I don't think we're going to unpack Basel 3.1. We're getting into too much granular information at this stage of there. We are back in December for the full year update, and the CP will be turned into a policy statement, we believe by then. What we'll do is we'll give you that granularity when we when we've got the outcome from the from the CP. What was the second question? The ROTE. Don't read anything into the fact that, you know, we've got a target of equal to or greater than 15%, and it's 18.7%.
At the moment, one of the things is we've got two key elements that are recalibrating what the E is. What we'll do is, once we have greater clarity on what the equity level is going to be for the business going forward, we'll relook at that stage. You know, we are currently above, correctly, as you point out, above 15%, but I don't think we're going to reset any targets at this stage until we have greater clarity on what the E is in the ROE.
Hi, it's James Invine here from Soc Gen. I've got three, please, if that's all right. The first is just on the legacy mortgage book. I'm guessing that the arrears there have risen by 30 to 40 basis points, given kind of what you've said about the arrears overall. I was just wondering if you could give us, please, the interest cover and the LTV for that book specifically. The second question was on your savings platform. Clearly, you know, you're doing incredibly well there. I was just wondering at what point you start to pivot, kind of away from volumes and more towards margins. And on that thought, do you have complete control over the pricing on your savings platforms, you know, with Monzo and so on?
Have you given any commitments to your partners on pricing? The third one is just a comment in the release that in the structured lending business, you're looking at moving into new asset classes. I was just wondering if you could give us a flavour of what you mean by that, please.
Okay. I think you managed to squeeze 4 in there, but the legacy, I don't know whether... I mean, I don't have the exact details of those individual cohorts, subcategories of the portfolio. I don't know whether you know it off the top of your head. It's likely that the ICR for these portfolios are gonna be above the average just because they are highly seasoned. Those portfolios predate the financial crisis. Those customers are going to be on the books for at least 15 years. They've had 15 years worth of rental growth, 15 years worth of house price appreciation as well. You know, we can get the detail for you.
I don't have it, and I suspect you don't either, to the at our fingertips, but I suspect that's probably gonna be the likely outcome. Savings, you know, we've grown our savings book very well. It's up to GBP 12 billion. We expect to achieve good, strong growth there. I think one of the things which I highlighted was the shift from easy access and PCAs to term, the term market. That I think still got a long way to go. Kind of if you try and recalibrate what that market should be, 'cause you've had 15 years of 0% interest rates where, you know, you were getting no benefit for extending the duration of your deposit, and but now you are.
we've seen GBP 53 billion shift in the, in the first, you know, in the period that we've just reported on. The current size of the term market is about 9% of the whole. If you go back to the comparable period, pre-financial crisis, it was 22%. that's gives us the confidence to think there's a lot more traffic going to move from shorter duration to longer duration, deposits. that provides two opportunities. One is to provide stronger flows. Equally, it provides the opportunity to, you know, be a little more beneficial to the P&L on price as well. In terms of the platforms, no, there's no commitments. We make no commitments on price.
We, you know, we always want to offer competitive products, 'cause that's what, you know, one of the key points of differentiating us, particularly from the larger banks. There's no commitments that we make in that regard. Structured lending, I mean, structured lending is a small part of our overall business, but the new asset classes. If you imagine what structured lending does, it lends money to other smaller non-bank financial institutions secured against their portfolio of assets, and it's got using securitization technology in order to secure itself and supported by the underlying cash flows of the assets that it's financing. It can be anything from right the way through from consumer receivables, right the way through to property, SME, asset classes, bridging finance, a whole manner of things.
There's nothing dramatic apart from an evolution of that. It's not like anything transformational that takes us into anything esoteric and weird and wonderful. Just further extension, I think that's covered all those points. I can't remember where we were. Gary?
Thanks. It's Gary Greenwood from Shore Capital. I've got three questions, please. First one on credit quality. I think the pushback sort of generally given by investors on credit quality is that we haven't really seen the full impact of rate rises on customers yet because they haven't come off their fixed-rate mortgages, and they're still rolling. Can you just give us a feel for sort of what proportion of your book has already rolled on to higher rates? Of those customers that have rolled on to higher rates, how those conversations have gone, what proportion maybe are struggling with that? What proportion are finding it, you know, readily absorbable, can continue? Second one was on funding. Obviously, your loan-to-deposit ratio has been coming down over time as you've grown that retail deposit book.
Is there a level at which you're sort of targeting to get to, in terms of optimising the mix of funding? How should we think of that? Lastly, on capital, I think previously you've talked about quarter one ratio target of around about 13%. Obviously, you have no AT1 in the stack at the moment. AT1 market's probably a bit more difficult now than they have been in the past. Do you think about that 13% in Tier 1 ratio terms as well? Thanks.
Right. Okay. In terms of the credit quality, there's about this... In this whole of this financial year, there's about 2 billion of fixed-rate maturities, as you saw that we said around 77% of those are being retained onto the books. There's a good level of visibility over their credit performance. Last year, that equivalent number was GBP 1.4 billion. The fact is that we highlighted that the increase in arrears that we'd seen was not on that, those portfolios; it was on the legacy book. You should take it from that that repricing effect has not had a significant impact on the credit performance of those loans that have repriced.
I think one of the things I pulled out in the presentation is that loans that refixed from five years ago, there's been a broadly similar increase in the rents. What we were able to track is , if you looked at the pipeline today, what were the rents they received about five years ago? It was about 30% lower. You've had that benefit to the cash flow, and that's why the ICR is around about 200% still. Do you want to cover the loan-to-deposit ratio?
Yes. We've been driving to a higher, well, a lower level of overall encumbrance within the balance sheet. I think we've, you know, we've gone through, or we've met our initial targets. You know, initially, we wanted to try to get encumbrance numbers below around 30%. It's now sub that, very comfortably sub that level in terms of external wholesale funding. We, you know, we've still got the TFSME facilities from the Bank of England. You know, my expectation is that we'll carry on taking that gross 30 down. It is important that you have wholesale funding as part of your mix.
At the moment, it's unattractive in terms of price, but at the point it was, you could easily add some more. I don't, you know, we don't have a hard and fast target. We're in that range, and we'll try to optimise, for you know, our available liquidity, having a diversified funding stack, and the right price over the next few years.
I think the final question you had was around the CET1. You know, I think what we'll be looking at is post-IR . We'll have a look at the CET1 targets then, but what we won't know is that when you go through the IRB process, you should expect your Pillar 1 to come down, your Pillar 2 will probably end up with an adjustment as a consequence. Once we know that, we can then make a better judgment as to what we think the this kind of the CET1 baseline is that we expect to operate from.
It was more around whether you think of the sort of Tier 1 and the CET1 ratios as being sort of similar targets on the basis you have no AT1.
Yeah, I don't, I don't think you'd want to sort of have one and not the other, just because I think, quite rightly so, as we've, as we've seen, you know, the regulators in particular apply significant value to the quality of the capital, not just the absolute. At the moment, let's say we've not issued an AT1, and you're right, it's not necessarily an attractive time to do so. You know, we wouldn't at this stage be planning to look at a core Tier One target as opposed to a CET1 target.
Thanks. I think John.
Thank you. It's John Cronin from Goodbody. Just a few follow-up questions, please. One is, getting back to this question on the AT1, just thinking about, look, your current CET1 ratio, the level of headroom, the buyback you've announced, potential future headwinds in the form of further fair value gain reversals. With Basel 3.1 in mind, how likely is it realistically that you would creep below 14 or even 14.5% CET1 ratio at any point pre-2025? Second question is, just a small technical point. On the development finance portfolio, are you able to provide the debt service coverage ratio on that? Thirdly, on the just a wider question on competition.
Over the years, we've heard a lot of the other specialist challenger banks or mainstream challenger banks talk about professional buy-to-let, at various stages, HSBC, most recently last June. Are you seeing any encroachment or developing interest on the part of other players in your, in your markets, or do you feel that they are unlikely to see much by way of significant shift in the competitive landscape over the medium term? Thank you.
Okay, in terms of competition, I'd say probably there's a bit more competition around that at the moment than there was a year ago. I think you've seen Kensington Mortgages got eventually bought by Barclays. The process did take a while. They've utilised in Barclays, you know, strength, you know, capital and liquidity. They've been a bit more active. Starling Bank, through Fleet Mortgages, have been a bit more active. As for the others, though, I'm not sure there's been much difference. I mean, the wholesale lenders have largely not been there. There's been a few, one or two who have been a bit more aggressive in terms of growth, maybe because they're looking for strategic options in due course.
I don't think the fundamentals has changed dramatically, apart from those few. HSBC, we haven't noticed. I mean, you mentioned them there. We haven't noticed their any activity from them in the marketplace. Don't forget, I mean, it's, you know, 99% of what we do is specialist in nature, so tends to keep a lot of the bigger players who are looking at more mass market products and less focused on those areas. It's a narrower competitive landscape there as a consequence.
The development finance discount, the debt service coverage ratio, we don't disclose that individually because I think it is significantly strong, because that's what we set, but it's also not just going to be about that. You're going to have a combination of factors to take into account, ranging from the long-term experience. I think, as I said, I think around 60% of our business flow is for people we've already had relationships with over an extended period of time, so that's an important ingredient. You want to know, particularly in more troubled markets, that these guys have been around the block a little bit.
You also want to look at, you know, the gross development value, but also how much cost is being contributed from the individual developers, as well as the level of guarantee coverage as well that comes into it. It's a, it's a far more holistic figure than just looking at the debt service coverage ratios, but they are strong because we just simply wouldn't do it otherwise. Then, and then finally, what will happen in terms of... I mean, Richard, I don't know whether you want to comment on the unwind of the fair value adjustment? There's a big chunk of it has gone already in the first six months.
The balance will go over the remaining four and a half years, but you might want to talk about what's happened this year as well.
Probably fairly evenly from now. If the bulk of the big credit that we had at the start of the year, those loans have now completed. There's either been the fair value adjustment that we booked in H1, or you're now amortising those remaining fair value items against the underlying derivatives. That's fairly even over the next five years. You know, GBP 20 million-25 million a year for that portfolio, that's going to be influenced by new swaps that we put in place and new volatility. You know, in the couple of months we've had since the half year, swap rates have gone up, fair values will have gone up as well. That will actually be contributing back to the capital position rather than rather than denuding it.
If you look at the...
... 2.3% impact for a Basel 3.1. With the gradual accretion that we have for underlying earnings, you probably would get down to somewhere in the mid-14s if you were on a Basel 3.1 environment for your CET1. One thing to point out is we, as you would expect, we run stress tests. One of the stress tests we do is, what if we never get IRB? We fully expect to, but, you know, just for academic purposes, what if we don't?
What if Basel 3.1 is like it is today? Can we therefore do we have the capital, even allowing for the regulatory requirements and then the management buffers above the regulatory requirements, therefore getting to the CET1 targets that we have publicly, do we have enough capital to then support the ambitious growth plans that we've got? The answer is yes, we have. There's nothing. The kind of worst-case scenario that you can paint there about all those big regulatory changes not going in our favour doesn't stop the growth plans. Okay. Is there any more questions before we wrap up? Okay. No? Okay. I don't think there's any questions from outside either. In which case, thank you for your time and attention this morning.
I know a number of you are gonna have a chat with Richard. If you want to speak to us at any time over the next few days, as you try and come up with other questions and things like that, please do so. You know where we are, and we're very happy to engage with you. Thank you very much for this morning, and we'll see you soon. Thank you.