Virgin Money UK PLC

LSE:VMUK

Earnings Call Analysis

Earnings Call Transcript 2023-Q2

[David Duffy, executive]

Good morning, everyone. And I know that some of the people know me in the room are on the call, and welcome to all of you who are dialing in from Australia as well. And Clifford and I, as you know, will follow the usual format. And we'll update you on the details of our performance and then we'll move to questions.

As we deliver the half 1 results, I'm conscious that, interestingly, we're halfway through the delivery of our 3-year strategic plan at the same time which, as you know, began in '21 as we came out of COVID. So I thought it would be useful just to share an overview of where we are at this stage at the midpoint of our strategic plan and then just drop into the half 1 results with that as a background.

So if we look at the first 18 months of our strategy, we're delivering against what is our stated strategy and ambition of building the best digital bank in the U.K. And we've successfully developed our digital growth propositions to enable our acquisition of new customers, assets and deposits as more people are choosing to bank Virgin Money.

These digital products, you'll have seen, included PCAs, BCAs, buy now pay later flexibility, travel insurance and a digital investment and pensions proposition as well as the wallet. We have also delivered a digital transformation of our business bank, which is now acquiring record monthly new BCA accounts, and we have built a high-quality cards business. And our next goal is to deliver a digital transformation of our mortgage business.

Our strategy to drive digital growth in relationship products and particularly savings in the past 18 months has also been very successful. And since 2019, we have increased relationship deposits from 34% to 53% of deposits. During this period, we have also delivered a reduction in our cost-to-income ratio from 58% to 51%. And over the next 18 months, we will deliver a further reduction, bringing us to a cost-to-income ratio of less than 50% in 2024, and that obviously helps us to underpin our target RoTE of double-digit returns.

Finally, we've also constructed a strong balance sheet with robust asset quality, great liquidity, really strong liquidity, and a capital base with a surplus of GBP 1.2 billion to regulatory requirements.

Now as we look at the second half of the 3-year strategy, I'm confident that we'll continue to grow our assets and acquire lots more customers with our digital products. And as we accelerate our automation and reduce our costs, I think we will ultimately -- we are very confident that we will deliver on our target of double-digit returns in full year '24.

As our strategy continues to drive this higher level of stronger capital generation, we're building a growing track record of capital returns and share buybacks. And that's supporting a much stronger return to investors, especially when you look at the next 18 months. So I thought it would be just useful to have that reminder of where we are on the journey and that context as we drop into the half 1 presentation.

So on that note, let me now turn to Slide 4 of the half year presentation. So in the first half of our strategy, the rate backdrop and our strategy have continued to translate into good financial performance. We saw the benefit of our digital investment in our relationship banking model, as I said earlier, and that's come through both in terms of income and customer numbers as well, obviously, as in the strength of our balance sheet.

Our previous investments in efficiency and automation of the customer journeys have delivered GBP 93 million of the GBP 175 million cost savings target that we set. In other words, half of the planned savings have been achieved half the way through our plan. And whilst our costs are temporarily 5% higher in half 1, I'll come back to that, our cost-to-income ratio has declined from 54% to 51% in the half.

I'm also pleased with the earnings momentum in half 1. Our pre-provision profits of GBP 456 million are up by 16% year-on-year, and we have seen a strong performance in income growth of 10%. And that's primarily driven by further expansion of our NIM, which reached 1.91% for the half.

Given the recent market volatility, we've been very focused on delivering profitable growth. And we've priced mortgages in that regard tactically, given the margin compression with a 41% reduction in mortgage volumes. And we've also tightened our credit criteria in the unsecured area, unsurprisingly, whilst in the business bank, we've targeted growth in those sectors which we believe are delivering growth in these cyclical periods. So the growth strategy, I think, is delivering -- it's proving effective in delivering improved margins.

In terms of the balance sheet, our funding and liquidity are really robust. And we have strong deposit inflows, which grew 3% in the half, and our LCR is now up to 153%, with 72% of our total balances insured under FSCS, and our LDR has declined further to 108%. So when we talk about provisions, the updated provision coverage already reflects the expectation that arrears will continue to increase from low levels. But the changes you're seeing today are model driven. We are catching up after our other peers did that the last quarter. So we've caught up with them, and the changes we've seen are model driven, not arrears.

Now we do expect them to increase but we haven't seen any material arrears in our portfolio. And given the historical performance and the asset quality of our portfolio, I think 72% basis points coverage is -- represents a very strong provision profile. And that, for those of you who remember, remains above our pre-pandemic levels.

Our CET1 ratio of 14.7% is strong. And that also, by the way, includes the absorption of the 30 basis points for our latest view of hybrid models and the completion of our buyback in half 1.

As we look out over the remainder of the year, we now expect our cost-to-income ratio to be in the range of 51% to 52%. And that reflects some temporary spending, we flagged customer service at the beginning of the year, to improve that customer service and a bit of a slower implementation of our mortgage platform. Now as we reaccelerate our automation in half 2, because we fixed those issues, those temporary costs drop away. So we're confident in delivering our 50% -- below 50% cost-to-income ratio at the end of '24 as a result. So just think of it. We look at the costs, we put them in temporarily, we get rid of them. So we have line of sight to where we're going.

So in conclusion on that, we're upgrading our NIM guidance for full year '23, and that's based on the strong margin performance during the first half. And we now expect to deliver circa 190 basis points level, which is at the top of the guidance range, as I said. Finally, given the level of surplus capital being generated, we'll continue to build our track record of returning capital to our shareholders this year, and we're announcing a 3.3p dividend in half 1. And as we've previously guided, we'll make further announcements on buybacks later in the year after the ACS process.

Let me now turn to Slide 5 and the macro environment that we're operating in. So our strategic delivery, as we would all know, has been delivered despite a muted economic backdrop. But we are seeing signs of an improvement in that backdrop, it's already starting. Inflation, though, is -- remains stubborn, particularly in some areas of core spending like obviously food, though, we -- at the same time, we see offsets through lower energy pricing than expected and, very importantly, a tight labor market. So when we look at GDP, it's modestly lower, but at the same time, the U.K. looks increasingly likely to avoid a significant recession.

And as the markets and the economic outlook starts to improve, we've seen the rate curve flattening out, driving a lower outlook compared to Q1 and full year '22. But even at lower levels, the rate outlook offers us opportunities in the refinancing of our structural hedge. And I think that could be meaningfully higher, but Clifford will talk about that in more detail later in the presentation. And critically, we see that unemployment continues to remain low by historical standards, which is clearly underpinning credit quality. So overall, the more balanced outlook is setting the tone in our minds for a good development of the next phase of our strategy.

So let me turn now to Slide 6. And I think here, it's important, so it's encouraging for us to see that the investments we've made in driving strong customer growth have enabled us to add almost 70,000 active relationship accounts in half 1. And the investment in the -- in our business bank is starting to show as well with 7% growth in BAU business lending in half 1, which is material. Our business account growth is also strong with 52% higher sales year-on-year. And we've now seen net BCA inflows for 17 consecutive months with a 5% growth in active accounts in the last 6 months. So March, in fact, represented the highest ever level of acquisition of new BCAs in the business bank, demonstrating the strength of that proposition.

In the personal current account side, we're continuing to grow the book of relationship deposits, which I mentioned earlier. And the customers there, we've sold over 300,000 accounts since the launch of our digital Virgin Money PCA with 16% higher sales year-on-year in half 1. And the PCA proposition is very competitive, it's compelling and it's rewarding for our customers. Across the PCAs and credit cards, in total years, we have over 700,000 cashback users, and those users are receiving on average 7% cashback on transactions. And that's a market-leading offer and that really does build deeper and more enduring customer relationships.

In unsecured, we've tightened our credit standards, as I said, given the weaker credit environment. However, we still attracted over 0.25 million new account sales with notable growth in the Virgin Atlantic affluent category of customers. Virgin Slyce, our buy now, pay better offering, has launched. And customer numbers and the use of the product continue to grow well there.

If we look at other income propositions, we sold 300,000 travel policies since the launch of our new digital proposition. And I'm delighted also too that we've launched our digital Virgin investment proposition in partnership with Aberdeen. We're excited about the potential in this particular area as we have GBP 3.6 billion of assets under management from the existing business and see real potential to grow that business in the future.

So turning now to our near-term investment on Slide 7. As we've discussed, in the full year, we experienced a significant increase in customer contacts across savings and mortgages, and that was generated by the volatility, if you remember, from the mini budget. Those service issues have now been resolved with outstanding complaints reduced by 80% and call waiting by 75%. And the nonrecurring costs of fixing those issues are now being eliminated.

So I'm just being explicit there. 300 staff hired to fix that, contractors, 300 leaving. So when I say nonrecurring, it's cost come in, costs go out. So to ensure that -- also in the mortgage side that our launch meets the expectations of customers, we're going to take more time to deliver that new mortgage platform. Now -- well, that is a decision we're making for the benefit of the customer. That delay does not impact our business execution, and we have a market share of around 5% of broker flows, which is consistent with the highs of the past.

We've continued to make good progress on the other strategic key initiatives that we have such as our digital wallet, which has received overwhelmingly positive feedback from our closed user group working with Virgin Atlantic. And the live app has now been launched, and the initial take-up has met our expectations. We are also continuing to work on the single app to bring together all of our offerings and are working closely with Virgin Group on enhancing the Virgin Red loyalty offers, which will be part of that.

And finally, just a quick word on our flexible operating model. A Life More Virgin continues to drive a hugely positive brand outcome. Employee engagement is at a record 83%, turnover is down by 50% and applications for each role are up by 200%. So it's just hugely positive. And we are now rolling out, in support of that, an agile delivery model which will help us to accelerate our execution of our restructuring activity.

So overall, as we move into the second half of our digital strategy, the continued investment that we've described here in new products as well as our existing products and the combination of that with our operating model and platform leaves us in, I think, an increasingly strong position to drive customer growth, which is what our ambition is. And that will drive income as well.

I'll now hand it over to Clifford, who will take us through the financials in more detail. Thanks.

[Clifford Abrahams, executive]

Thanks, David, and good to see you all. You've just heard how our strategy positions us well in the current uncertain and volatile environment. I'm convinced that our consistent approach will deliver the full potential of our equity story set out here. We've managed our balance sheet prudently with strong funding, liquidity, provision coverage and capital. Besides resilience, we continue to digitize the bank, delivering cost savings and launching new digital propositions. And we're now growing relationship customers and targeted lending despite the weaker credit environment.

You can see our strategic progress translating into financial momentum on the next slide, 10. Top left shows the growth we're delivering in our targeted margin accretive propositions. This, alongside the rate environment, has driven a sustained expansion in our net interest margin, top right. We're building a track record for sustainable returns, bottom left, and as a consequence, we're generating capital and increasing our distribution through dividends and sustainable buybacks, bottom right. We're confident in delivering our full year '24 targets as we continue to execute our strategy.

Now turning to the details of our performance for the first half on the next slide. I'll comment first on profitability, then the balance sheet, capital and finally our forward guidance. I'm pleased to report here on Slide 11, good underlying performance with continued top line momentum. We delivered good growth in income of 10%, reflecting our strength in deposits alongside higher rates. Costs were 5% higher, reflecting wage inflation and short-term investment to safeguard customer service. And together, this further improved our cost-to-income ratio to 51% from 54% this time last year, driving strong growth in pre-provision profit of 16%. Meanwhile, underlying profit was down year-on-year as impairments normalized from last year's lows.

Moving now to statutory profit on Slide 12. I'm pleased to say the underlying earnings power of the group has translated into another period of solid statutory profit. Restructuring costs were GBP 53 million in the first half, modestly higher than last year, reflecting costs from reducing our office property footprint and digitization. Following our service recovery, we expect to step up restructuring activity and related spend in the second half.

You'll see here that we are now reporting fair value movements arising from hedge ineffectiveness below the line. We're adopting this practice to give a clearer picture of the underlying trends in noninterest income following the significant rate volatility over the past year. We'll continue to report some other fair value movements above the line relating to risk management products we sell to customers. However, these are not expected to be material going forward.

Finally, you'll note that tangible net asset value is down 33p relative to year-end '22, and this reflects the reduction in the cash flow hedge reserve as swaps fell back after spiking around the time of the mini budget and our September year-end as well as a lower pension surplus. These factors offset positive effects from statutory profit in the period and lower share count given our share buybacks.

I'll now talk through the key balance sheet items from Slide 13. I'm pleased with the strength of our funding franchise, supporting both a robust balance sheet and our margin outlook. It's good to see our continuing growth in relationship deposits over the first half. In line with the market, we're also seeing higher flows into term deposits reflecting the rate environment. We are actively participating here, which enables us to lock in term funding at pricing below swaps. Altogether, we grew relationship deposits and overall customer deposits at 3%, outperforming the market and our large U.K. peers and reducing our loan-to-deposit ratio to 108%.

In the first half, we successfully accessed wholesale markets, issuing EUR 500 million of MREL senior notes. We also repaid GBP 200 million of TFSME drawings in the period and we'll continue to repay TFSME ahead of contractual maturity. Overall, our liquidity position is very strong at 153% LCR, and we now expect to issue towards the low end of the GBP 1.5 billion to GBP 2.5 billion range of secured issuance that we communicated full year and with no further capital issuance needs. The strength of our deposit gathering capability and our continued improvement in our funding mix leaves us well placed, despite recent turbulence, to support our lending growth and the refinancing of TFSME over coming years.

Moving now to lending on Slide 14. In lending, we traded well over the course of the half against a tougher backdrop. Overall, lending finished flat as growth in our business book was offset by a reduction in mortgages while unsecured was stable. Mortgage balances were a little lower at just under 1% lower, a decent performance in a challenging market as overall activity levels have slowed. In particular, I'm pleased with our growth in business despite the slower market, reflecting the strength of our national and sector specialist franchise.

And in unsecured, we saw modest growth in credit cards, offset by a small reduction in personal loans. Our card balances were up around 2% during the first half, a slower pace of growth versus last year, reflecting our further tightening of credit criteria and our disciplined approach to profitability.

Looking forward, we expect total lending balances to remain broadly stable in the second half. In mortgages, we expect market activity to remain muted. In business, we expect a more moderate pace of growth through the remainder of the year. And in unsecured, we look to grow balances modestly further. So overall, broadly stable.

Moving on to margins on Slide 15. I'm really pleased with our net interest margin performance shown here, a major driver of the improvement in our income year-on-year. Following a strong performance last year, we've added a further 6 basis points to net interest margin and the positive factors comprise improved deposit mix and spread, together with the benefit of our structural hedge rolling. More about these later. Set against these positive factors, mortgages continues to be a headwind to margin, although the gap between front and backward spreads has narrowed further, which means it will be less of a headwind going forward.

Following the strong first half performance, we're upgrading our full year NIM expectation to around 190 basis points, reflecting base rates peaking at around 4.5%. So we're expecting a relatively stable underlying performance in the second half of the year, reflecting ongoing tailwinds from higher rates, structural hedge reinvestment and our high-yielding asset mix, offset by headwinds from mortgage spreads, which we expect to remain tight, and higher deposit rates following a lag from the pass on of previous rate rises. So a pretty balanced picture for the next few quarters.

I'll now talk through our deposit franchise in more detail on Slide 16. The high quality of our deposit franchise has supported both our resilience and our margins. In terms of resilience, top left shows we've diversified funding base with a large retail bias of around 75% deposits with around 75% of business deposits weighted to the SMEs with no outsized sector concentrations. Top right, you can see that we've continued to attract strong deposit inflows across the first half, demonstrating our deposit gathering capability and the strength of the franchise.

And turning now to income. I mentioned in the last slide that our deposit performance has underpinned our margin performance. And looking back, you can see bottom left that we've significantly matured our deposit mix, growing lower cost relationship deposits while reducing reliance on secondary savings. More recently, we've been active in the market for term deposits, given the pricing opportunities available, and this demonstrates our ability to trade tactically where market conditions are favorable.

This mix shift, alongside higher rates, has contributed to a material improvement in our deposit book spread whilst also delivering good value to our customers, as you can see bottom right. And at this point in the cycle, we feel we are less exposed to rising deposit rates and deposit attrition than some of our larger peers given the strength of our franchise, deposit mix and customer-friendly propositions. So we expect to continue to grow deposits further into full year '23.

Turning now to our structural hedge on the next slide and rate sensitivity. That's Slide 17. We've set out here how our structural hedge is supporting margin alongside our usual rate sensitivities. The hedge is a strong underpinned margin outlook. We reintroduced the structural hedge when the rate environment was significantly lower and so now continue to benefit from materially higher reinvestment rates. And you can see from the chart on the left how we expect the structural hedge to continue to support the net interest margin. Even before considering reinvestment, hedges already written will deliver gross income in full year '23 higher than full year '22.

And alongside this, you should consider the reinvestment yield available on the current 5-year swap rate at around 4% relative to an average redemption yield on our structural hedge in the second half of around 1% to a pickup of 3%. We expect the hedge notional of around GBP 30 billion to begin to reduce somewhat over the second half of the year given the modest shrinkage of our variable savings book. However, this will have little effect on our net interest income given the shape of the rate curve that's with SONIA broadly equivalent to the 5-year rate. So we have built-in tailwinds.

On the right, we've set out our usual interest rate sensitivity using our standard pass-through assumptions. And you'll know our rate sensitivity remains positive in year 1, even in a 25 basis point down scenario, and this reflects prudent assumptions in product pricing from the more elevated rates today. So overall, the combination of our structural hedge and rate sensitivity leaves us well positioned to maintain margins in the current rate environment.

I'll now move on to noninterest income on Slide 18. Noninterest income was slightly lower during the period, down GBP 4 million year-on-year, excluding fair value and one-off gains. This reduction was entirely driven by business fee income due mostly to lower merchant services income, and this reflects the group changing its merchant services provider to Global Payments.

Looking ahead, we expect growth in OOI to be muted in the short term, reflecting that change in merchant services provider but also changes to our current packaged account, our Club M account. And here, we've made it easier for customers to select the individual benefits they wish to enjoy, while at the same time reducing their monthly account fee. But over time, we're targeting growth in OOI as we see contributions from the various initiatives we've set out on this slide, and these include Virgin Money Investments, which we recently launched -- relaunched, as David mentioned earlier. We'll also drive additional merchant services income as we acquire additional merchants with Global Payments, our new provider.

Turning now to costs on Slide 19. I'll first update on our cost performance and then on our restructuring costs. And as a reminder, our primary target is to deliver a cost-to-income ratio of less than 50% by full year '24. Our underlying costs of GBP 477 million were around 5% high year-on-year. Given our stronger income growth, the cost-to-income ratio reduced further to 51%.

And on the left, we set up the cost bridge from the first half '22 to the first half of '23, and you can see our cost programs are delivering savings as we digitize the bank. However, during this period, these savings were more than offset by higher staff salary costs, reflecting wage inflation, and also the short-term investments that David talked through earlier to safeguard service, including strengthening our cost center resourcing as well as additional digital investment spend mainly reflecting further investment in our digital mortgage platform. In total, we expect costs in the second half to be broadly stable on costs in the first half, resulting in a cost-to-income ratio for this year of 51% to 52%.

We've set out our multiyear investment program at full year '21. And you can see on the right, we've made further progress this year, delivering a total of GBP 93 million of cost savings on an annualized basis at a cumulative cost of GBP 135 million. And in the second half, we expect to increase the pace of restructuring activity and accordingly expect most of the remaining GBP 140 million of restructuring costs to be incurred in the second half.

And these initiatives will benefit our cost performance meaningfully next year, that's full year '24, as they earn through, giving us further capacity to offset inflation. And at the same time next year, we expect to dial back the short-term investment that David talked through earlier. So more cost savings together with lower short-term investment underpins our confidence to deliver a cost-to-income ratio of less than 50% next year.

So now moving to asset quality on Slide 20. I'm pleased with the quality of our lending book, and we remain well positioned to manage through current risks and uncertainties. On the left, we've set out our ECL over time, and you can see that during the first half, the increase in ECL was primarily model driven. We updated our macroeconomic scenarios at the half year, which reflect only now the post mini budget downgrade to the economy. And given the timing of our reporting cycle, it seems like a long time ago, but our macros are now broadly in line and, in fact, in many cases, more prudent than the December reporters who took most of that downgrade at their full year in their Q4 in December.

So alongside this, we've reduced our model -- post model adjustments relating to the potential cost of living impacts as these risks are now reflected in the model outcome. And the net impact of all of this is that at headline level, total provisions have increased from full year '22, resulting in a GBP 144 million impairment charge. And that equals an annualized cost of risk of around 40 basis points, modestly above our previously guided run rate.

While our credit quality is resilient, we do expect to see continued normalization of arrears, and that expectation is reflected in our provision coverage, which we strengthened further to 72 basis points. As you can see from the chart on the right, this coverage level is prudent and well above prepandemic levels, as David indicated. And given the increase in our credit provisions in the first half, we now expect the cost of risk to be in the range of 35 to 40 basis points for the full year '23. So while our credit quality indicators remain benign, we're well positioned for uncertainty that lies ahead given the strength of our provisions which we've already booked.

And I'll explain the resilience of our lending book on the next slide, 21. You remember this slide from November, our full year, and we've updated it here. And this shows the strength of our loan portfolio and why we're comfortable with our credit quality and our underwriting. So overall, our total portfolio is defensively positioned with balances strongly weighted to mortgages, which reflect around 80% of total loans.

Within mortgages, the book is low risk, prime book weighted towards owner-occupied, originated within strict affordability assessments and with only 6% above 80% loan-to-value and largely on fixed rates. Our business portfolio is well diversified with strong collateral levels on skewed to lending to resilient sectors. We have minimal exposure to commercial real estate, which comprises just over 8% of business lending or 1% of our total lending. And this itself is conservatively positioned with an average loan to value in commercial real estate of around 50 basis points.

In unsecured, our underwriting criteria are prudent and we've tightened these further over the year to reflect affordability stresses on our customers. Virgin Money's unsecured customers are generally more affluent, and their retail spend has remained resilient over the past year and continues to be weighted to discretionary and luxury items. Their repayment rates remain stable, all indicators of credit quality.

Turning now to capital generation on Slide 22. The group remains very strongly capitalized, and our capital generation continues to be strong with 72 basis points of underlying capital generation. We announced today a 3.3p interim dividend, in line with our dividend framework which is 1/3 of the full year '22 total dividend of 10p. We were pleased to announce our GBP 50 million extended by the end November, which was fully executed during the period, and that consumed around 20 basis points of capital.

In the first half, we also recognized a management adjustment reflecting the impact of adopting mortgage hybrid models. So this resulted in an additional GBP 400 million of risk-weighted assets and modest increase in our -- in excess expected loss, taken together consuming around 30 basis points of capital and below what we'd originally expected. So we've now absorbed the impact of industry-wide changes to hybrid mortgage models.

And altogether, this resulted in a 14.7% CET1 position, considerably above our target range which I've set out on the next slide, 23. Again, you'll recognize this slide from our full year and our target capital range of 13% to 13.5% CET1 ratio. And as we said in November, we expect to stay above 14% this financial year given the economic uncertainties.

So we currently have around GBP 300 million of surplus capital before future capital generation relative to the 13.5%, and we have a surplus of around GBP 170 million relative to the 14%. That's this year's aiming point. And we're committed to further sustainable buybacks alongside dividends as we target getting into our 13% to 13.5% range by the end of the next financial year. We expect to resume buybacks following the results of the industry-wide stress test to be announced in July.

Now finally, I want to conclude with our guidance on Slide 24. I've summarized here our guidance for this year, full year '23, on the left and repeated our outlook for full year '24 on the right. We've talked through the various details through the course of the presentation.

Today, we're upgrading our full year NIM to around 190 basis points. We expect the cost-to-income ratio for this year, full year '23, to be around 51% to 52% cost-to-income ratio. And following the increase in credit provisioning levels in the first half, we now expect the full year cost of risk to be in the range of 35 to 40 basis points. Furthermore, we expect to resume buybacks after the results of the ACS in July while maintaining our CET1 ratio above 14% this year.

And now turning to the medium term. We are committed to our double-digit target returns set out in November '21, supported by a cost-to-income ratio of less than 50%. And finally, we expect to operate within our target capital range by full year '24, enabling further buybacks. So overall, our strategy remains the right one in the current environment, and we continue to make good progress during the first half, and our outlook is positive.

Now back to David.

[David Duffy, executive]

Thanks, Clifford. You pointed at me when you said the outlook was positive. So yes, just to try and wrap that up, I think we have good momentum going into '23, and I think you've got plenty of detail there which will cover our questions. But I feel pretty comfortable about the second half of this year.

As I mentioned earlier, we're halfway through this 3-year journey, and I'm pleased with the momentum that we have, particularly in digital transformation and the success that this has created in acquiring new customers and assets and clearly deposits. And we're going to continue to invest in that digitization and the diversifications of those products and the propositions in the next 18 months driving what we think will be strong further profitable growth.

So given the momentum, I am confident, as Clifford just described, in reaching the '24 targets and a cost-to-income ratio of less than 50% that underpins that. And clearly, that capital slide shows, this performance implies meaningful capital returns for shareholders, and we'll provide more details on our dividend and the buyback quantums as soon as we can.

So I think that brings us to the end of the formal presentation and we're going to move to questions. I think Richard is going to control. We're going in the room first. [Operator Instructions] And then we will move to online calls. So thank you, and over to you, Richard.

[Richard Smith, executive]

Ben, do you want to go first?

[Benjamin Toms, analyst]

It's Ben Toms from RBC. Firstly, on the NIM, you described the full year '24 outlook as being resilient. Can you just give a bit more color on the puts and takes here, please? I think in the full year '22 results, you described the dynamic for '24 for NIM as expansionary. Am I reading too much into the slight change in language?

And then secondly, on shareholder returns, can you just run through any potential headwinds to capital for the next couple of years just to ensure there's nothing out there that could eat into the excess capital that you mentioned in the presentation?

[David Duffy, executive]

Last one for you, Clifford. Go ahead.

[Clifford Abrahams, executive]

Yes. On NIM, look, we feel good about our NIM, as I indicated, at half year and looking out to the second half of the year. That's why we upgraded our guidance. I didn't comment explicitly on full year '24, that's next year, but we're comfortable where consensus is, which is -- it's around 192 bps. I think what gives us confidence, I ran through the details, is some of our structural drivers. So you've seen that -- given we are a smaller franchise with a real track record in deposits, we feel that's given us an advantage to navigate through the environment.

So we don't have this conundrum, which is, do we offer good rates to customers and then have to pass them on to our existing customers or see attrition. Some of the very large banks have that conundrum. We're a challenger bank and it's coming into its own. So we've been able to offer good rates to existing and new customers to grow our overall deposits at better margins, and we think we can do that going forward.

I think our structural hedge, all big banks have structural hedge. We put our new hedge on at historically low rates. So that big -- you see that big delta, I think that's bigger than some of the other banks because of the timing. So that 3% pickup gives me confidence.

And finally, our deposit mix, you've seen how we've grown business deposits in a tougher market. And that -- we're small, right? So it's the benefits of scale. So we have a 2% market share. For us, to grow that is a lot -- frankly, a lot easier than some of the very big institutions.

Now set against that, we clearly have uncertainties in the rate environment. The mortgage market continues to be competitive. So that means we're not guiding specifically to next year's NIM, but you can see we have some of those structural tailwinds that some reflect the environment, some reflect our strategy, that gives us confidence to upgrade our NIM guidance at this point.

I think on -- moving on to capital and buybacks. I think we flagged the hybrid model, and that's industry-wide. I think we've been one of the latest banks to incorporate that. And we're pleased that we've done so at an amount lower than we previously expected. That's still subject to final PRA approval. So it's not the final end, but we're getting more and more confident. We talked about Basel 3.1 at Q1, and we don't expect to see that as a challenge, at least in the short term.

And generally, you look at our capital intensities, they've been a bit higher than some of the bigger banks. And that reflects some of the more -- bluntly, the more basic approaches to models that we've adopted, standard approach or the foundation approach. That gives us a bit more resilience going into a weaker credit environment. Now we will hope we've seen perhaps the worst of the economic outlook, but we think that modeling approach provides some resilience and confidence around some of the surplus figures I talked about earlier.

[Unknown Analyst]

Can I just start with funding, please? So as you say, you've got less, I guess, cannibalization or migration issues than your bigger peers. But I'm just interested in this kind of the pass-through that you're seeing. So I think you showed a 143 basis points average cost of deposits in the half. I was just wondering if you could tell us what that would be spot today, but including the current cost of new time deposits and how quickly that would flow through. So just to sense where the deposit cost is going.

And then the second one on funding would just be on TFSME. I think you've got about GBP 7 billion. You've started to repay that. If you could just remind us of the plans for repaying TFSME, that would be helpful.

And then I had a final one, please, if you don't mind. Just on the margin, I think at the full year, you were very clear in some of the assumptions behind your margin outlook, so 100 basis point mortgage spreads and 400 basis points swap rates. Just wondering what you're anticipating today to give you comfort in consensus NIM for next year?

[Clifford Abrahams, executive]

Yes. So on deposit pass-through, we have passed through around 1/3 of rate increases to date. In our outlook, we -- our assumption is to pass through more of the future rate rises, so around 40%. I think what gives us -- so a pickup but not a dramatic pickup, and we're not expecting a, call it, step up in that lag. And I think it reflects the scale of business and how we go about financing it. So you've seen in the first half, frankly, a bit of a switch from non-linked savings, so easy access savings to term.

Now all this deposit beta debate relates to easy access savings, right? Because you don't have beta on term deposits. So we've been able to manage the book, given our scale and our franchise, to be really quite competitive on term where we're funding below swaps. So we're locking in 1, 2 year, often longer swap rates. We offer some of those really attractive term deposits to our current accounts. So we have linked rate, nice support, where we're really competitive.

So [indiscernible] beta immune. And that enables us to be perhaps a little bit more defensive on our non-link book. So we're tactically targeting different groups. In each case, we are convinced we're offering good value to our customers. But what this does is it enables us -- given our scale, where we're meaningful but not enormous, enables to manage our deposits effectively whilst also giving good rates to customers. And that reflects the heritage of the group. We had deposit teams who really know the market in place for the last 15 years, right, given the nature of the business.

I think around -- perhaps linked to that, your last question around margin and assumptions. I talked a bit about rate assumptions. So we're saying -- we expect rates to rise, peak at around 4.5%. There's obviously a debate as to whether it will go further. It's probably skewed to the upside now given recent events. But we're seeing 4.5% from current swap rates, swap rates as of today.

I think around mortgages, just to give you a flavor, and I've seen what other banks have said. And we're operating in the same market. So I think for us, we're seeing application spreads of around 70 to 80 basis points now. So it's less than our book. Our book is a little over 100 basis points, so that's our mortgage book. And we were not as active as some other banks during the sort of heydays of COVID.

So we've seen -- we feel we've seen a big chunk of the mortgage spread attrition already flow through. And whilst at current spreads, it continues to be dilutive, it's moderated. And frankly, it's good to see some of the issues that the other banks have talked about because that might lead to perhaps a more normal environment where banks are making money on both sides of the balance sheet.

And I think lastly on TFSME, there is a slide in the pack, Page 34. And you can see, we've set that out. Look, we have GBP 7 billion of TFSME. So it's -- I would say, it's about average for the sector. But I'm pleased to show there that it's quite -- it's nicely termed out. And given the strength of our wholesale funding franchise, deposit franchise, we're comfortable with this. And we'll continue to repay meaningfully ahead of contractual maturities.

[Unknown Analyst]

Do you mind if I just follow up on 2 of those things? So the 143 basis point cost -- average cost of deposits in the first half, could you give us a number in terms of what that is today based on new term deposit pricing and what you're offering on the other accounts?

[Clifford Abrahams, executive]

No, I'm not -- I won't give more granular information on that. We'll obviously report at the full year.

[Unknown Analyst]

Okay. And then TFSME, just -- so you've given us a sort of refinancing schedule. But typically, how are you refinancing that? Is that deposits? Or is that wholesale funding? Combination of the 2?

[Clifford Abrahams, executive]

I mean it's a combination. You can see -- look, we're really pleased with our LCR, 153%. We've let that drift up, frankly, reflecting the environment. We think it's the right thing to do. It gives us flexibility. We've been very pleased with our ability to also -- I've got Justin, our treasurer, sitting in the back there. I think we've been able to tap the markets, again, given our size.

So we have -- we have a recognized brand, but our wholesale needs are not enormous, so we can step in quickly. And you've seen that with our MREL issuance. We're really pleased with that. And that, together with continued deposits, means we'll take the opportunity to repay TFSME. We're not desperate to do so, but we'll do that in a staged way to manage it down over time.

[Richard Smith, executive]

Ali, do you want to take it?

[Alistair Woods, analyst]

It's Ali Woods from Morgan Stanley. And I just want to ask you about your deposits and what you expect for the future. So obviously, you talked about the pricing, you're taking advantage of on term deposits. Is that a trend you expect to see? And do you expect to see further growth from those? And also, your current accounts are also growing. Is that something else you expect to grow?

And then also on mortgages, you're talking about sort of these headwinds coming to an end in terms of higher rate mortgages coming off. Is this something we're going to start seeing from next half? I know you said it's -- you didn't take as much on in COVID when there were higher ones. Is that something we're seeing soon? Or is that something more of a '24 and beyond benefit?

[David Duffy, executive]

Maybe I'll just make a comment on deposits, Clifford, and you'll pick up mortgages. Just one thing that's interesting is the changes in the structure of the market on this. So the bigger banks pass-through is less. They're being written to by regulators about why. And that's got mostly to do with the back book repricing, which is a material headwind for them. And what we are seeing in behaviors on that is their deposits dropping or letting accounts go or some combination of both. So we see ourselves as a beneficiary.

So if you look at the market dynamic, we see the opportunity to competitively obtain more current accounts at reasonable prices with our linked savings offer. So that's been a really attractive part of building our deposit structure. So we see that as being even more advantaged on a structural level in the next period of time. So -- and I think we would always want to grow both term and the normal-linked savings deposits because it's a balanced structure in terms of your total exposure. So we will see both growing, I think, quite well.

And then on mortgages?

[Clifford Abrahams, executive]

Mortgages, I think -- we have -- the total market is down 40% in terms of new applications. And you've got well-capitalized, well-funded banks competing over a smaller pool. So it's natural for us to perhaps be a bit more cautious in that environment. We're still in the market. I think for some propositions on some days, our market share moves up. And you talked about 5% occasionally. Other times, it will be lower.

I think the -- so I think expect us to operate that. I don't expect or want the total mortgage book to decline materially. And one thing we're seeing is a really good share of remortgages coming through the business. And whilst we have phased the delivery of our new mortgage platform, I think we're both really excited about the prospects of that. So I think this year we'll trade as we normally do. As that comes in next year, it will really open up us to the full intermediary market.

The brand is well known. We'll be able to trade, perhaps, more agility. We'll be able to move up and down a bit more because still be digital end-to-end. And I would hope that our mortgage share would tick up as a result, but only if the spreads are attractive at that time.

[Richard Smith, executive]

Okay. Operator, I think we're ready for the first question on the phone line, please.

[Operator]

We have our first question coming from Ed Henning from CLSA.

[Ed Henning, analyst]

A couple of questions from me. Firstly, just to continue on the NIM line. I just want to clarify something. With your second quarter NIM at 194 bps and that will trend down to see a broadly flat second half outcome from a higher quarter, you talked about reducing mortgage headwinds. Is that what gives you confidence next year to maintain a resilient NIM, roughly where consensus is, with the offsets being hedge benefits and mix benefits just without reducing mortgage headwind in '24?

[Clifford Abrahams, executive]

Yes. Look, we were pleased with Q2, 194 bps. And our calling around 190 bps for this year, I think, just reflects like natural caution and we've got more visibility on Q3 than Q4. So we want to maintain our track record of prudent guidance and delivery on NIM. I think around -- I didn't formally confirm guidance for next year but just commented that our -- we're comfortable where the consensus is at this point.

Personally, my view is rates will naturally move broadly where they are now. And I've seen brokers' notes talk about 3% to 4% as the sort of sweet spot for rates. And I think we can really leverage our deposit franchise well in that sort of -- with those sorts of rates with the propositions that David talked about. And I think the mortgage market has a prospect of normalizing into next year.

So mortgage pricing is always a little bit stickier as rates are volatile. And as rates stabilize, frankly, seeing how the bigger banks have seen deposit outflows and perhaps needing to pass on more of the benefits of rate rises to their customers, we'll also be conducive to, call it, a more orderly mortgage market, maybe looking out 12 to 18 months.

So as of today, we're comfortable with consensus for next year, and we feel good about our net interest margin through the second half of this year. We already -- it's only 5 months to go for us.

[Ed Henning, analyst]

That's helpful. And then just on your guidance for the '24 RoTE. Previously, you were talking about 11 and now you're talking about greater than 10. What's driven the slight change in that? Is it the cost outlook or is it the revenue outlook? How should we think about that?

[David Duffy, executive]

Ed, it's David. I think for us, it's really the rate cycle and it's not the cost dynamic at all. And as you heard me talking about the cost dynamic, I'm very, very comfortable with it. I pretty much have line of sight, and I'd hope to even come in tighter in our range than we've talked about in the presentation. So that's not the factor. It really is where the rate cycle settles.

So if you treat it as double-digit returns or our floor, in a way, that's how we think about it. Depending on the rate cycle, it will settle at a point above that. So we will probably have a good line of sight by this year-end on guidance on that.

[Operator]

Our next question comes from Grace Dargan from Barclays.

[Grace Dargan, analyst]

If I could just first one on costs. What's giving you confidence on your less than 50% into next year on the cost-to-income ratio? I guess, in particular, what are the moving parts you're seeing falling away? What are the key drivers there? And how much inflation are you capturing in that guidance?

And I guess linked to that, I appreciate you don't give absolute numbers, but maybe you could give an indication of whether in absolute terms you're thinking about a higher cost number in '24 than you previously were.

And then secondly, on capital. I appreciate the commentary around the buyback after the ACS. Is there anything to stop you announcing a buyback again at full year? I guess how are you thinking about the phasing of that distribution?

[David Duffy, executive]

Grace, it's Dave. I'll start first. I think just on the cost dynamic, we do operate it in our hedges as cost-to-income ratio clearly for the reasons that we're looking to grow the bank and fund that growth. So you see, even though the costs were up now, we're still 3% down on the cost-to-income ratio in the half. But I think you should take it that we see costs in absolute terms as down in '24. So if you do the math with that, you would see a decline in cost, but the cost-to-income ratios, they're leveraged -- are therefore, leveraged.

So I feel that the dynamics are there. We've absorbed the inflation, Clifford talked about, on staff costs, which are the material element, and that's all built into the forecast. So a below 50% cost-to-income ratio with net cost reduction. Maybe, Cliff?

[Clifford Abrahams, executive]

So I'll pick up, just -- maybe just to build on cost because you talked about the short-term costs. We give a bit more disclosure in the IFR, and you can see, frankly, a step-up in costs in professional services. So in order to handle the capacity that we saw in our contact centers around the rate increases, we saw -- we retained some of our own staff.

And as David said, we had contractors. We had third parties dealing with calls and dealing with customer issues. And we've got very good line of sight on that, and that was the GBP 20 million that I flagged earlier. And so we're confident that, that will get dialed back next year. So that's a sort of built-in improvement underpinning that cost reduction.

I think around savings, I'm pleased with the cost savings, the GBP 93 million. But we're really looking to accelerate that. So we haven't shrunk our store footprint, for example, for 18 months, and that reflects some of the traffic that we've seen post-COVID. But you can see that we have a really good line of sight on our restructuring programs that will re-energize through second half of the year, and that will earn through next year.

So I think inflation, it's clear that inflation is coming down. We're hopeful that it gets back to within the Bank of England's range. But I think that's probably not my best estimate for next year. My hunch is inflation will be -- will prove a bit more durable than others, but at the same time that interest rates will remain a little bit elevated and in that 3% to 4% sweet spot that I talked about. And so we've got good line of sight on our costs.

On the net interest margin, I talked about the confidence in the net interest margin for next year. And in terms of balance sheet, you can see even in a difficult half year, we've managed to keep the business stable. And we've got the growth drivers in our unsecured, our business book and then on mortgages as and when the platform delivers through next year. So that underpins our confidence around the cost-to-income ratio.

I think around timing of buybacks, we do want to see the ACS results, that will be in July. Clearly, buybacks need regulatory approval. There's a process around that. I mentioned I expect that we do the buyback by full year, but there's no -- we're not going to wait, right? So we will -- if we see an opportunity and we follow the necessary processes of the regulator, we would do a buyback ahead of that subject to close periods and so on and, obviously, macroeconomic conditions and the Board's view at the time.

But we won't wait to do that necessarily for full year. And you've seen that's been our practice last financial year, where we've seen opportunity and followed the processes. We've done it outside of formal results.

[Operator]

Our next question comes from Guy Stebbings from BNP Paribas.

[Guy Stebbings, analyst]

The first one was on the stress test, and I just had 2 points of clarification. So on the stress test, I'm just interested as to what from of exercise you and the rest of the Board are looking forward to get comfort coming out of that to support the distribution plans and operating back down into the capital range? Is it the headline ratio you print in the stress test? Is it the sort of size of the drawdowns? Or is it more simply just what the PRA tells you behind closed doors on performance and the green light for buybacks off the back of that?

And then the 2 points of clarification. I think you referenced that you expect the hedge notional to fall slightly. I don't know if you could size that for us at all. And then the mortgage hybrid model change, I believe that's an anticipated number. But can I just check, you've got sort of complete conviction that, that's the sort of right number that you've got in, or complete clarity and visibility there?

[Clifford Abrahams, executive]

Okay. This is like Master Mind, isn't it? We've got the chairs. So on stress test, I think -- it's interesting, a very big bank to announce a buyback early in the week. They have particular circumstances despite stress tests being ongoing. I think for us, this -- we're really pleased with our stress test first time. We're going through it again together with the industry for the second time. So we don't -- we think it's important not to prejudge it, both at Virgin Money, and we want to go through the process with the peer. I wouldn't read anything untoward in that.

I think in terms of the results of the stress test, there's again nothing untoward to comment on there. I think it's just not prejudging stress test or preempting the regulatory view. I think the regulator has a right to have a view. We make our submission alongside other banks. The regulator has views. We get into a dialogue on those. We feel that our capital target range, 13% to 13.5%, is robust.

We struck it prudently. We struck it in consultation with the regulator. And you can see, notwithstanding -- we're not systemically important. It's a robust target. I think it's serving us well in the current environment. So I don't currently expect that to change. But I think that's all I would say around stress test. I mean it's fairly imminent now, isn't it? July is around the corner.

I think around hedging amount, it's -- the figures we've disclosed previously have been, I think, GBP 32 billion. We talked about that hedge. And it may come down a couple of billion, and that reflects -- our relationship deposits have been maintained really quite well. But our non-linked secondary savings, you saw, we've dialed that back. So I think in common with some of the other banks, we're seeing that come down.

But the whole game of, call it, terming out, getting the benefit of the upward sloping yield curve has actually gone now, isn't it? Now the yield curve is flattish. So we -- and they don't expect that to change in the short term. So that gives us confidence that it's not going to be a material indicator from a net interest margin perspective.

And then finally, on the hybrid mortgage model, I mean to be super clear, and I think it's set out in the notes to our accounts, we have made a submission regarding our hybrid mortgage models in common with other banks. That process for us and others is in dialogue with the regulator. So it's not a black box that you're putting in. If we make a submission, then that reflects our views, so we need to book it, which we have. And so the GBP 400 million reflects our best view -- management's best view of the new hybrid models.

Those models are subject to final review and a formal approval by the regulator. It's possible they have other comments. However, I would say we're one -- I think we're one of the last banks to do this. So clearly, we don't analyze from the outside of all the other banks. But there are enough advisors, and the PRA has a view that there's a consistent approach or a fair approach being adopted across the market, reflective of the various books.

So that gives me confidence that we are there or thereabouts. But there's always a possibility that the regulator has a view, as there is, frankly, in any other aspect of our model landscape, which will continue to evolve over time. That's probably beating that topic to death, but that gives you an idea of how we're thinking about it.

[Operator]

We have our next question comes from Joshua Freiman from Macquarie.

[Joshua Freiman, analyst]

Just one from me, actually. Just on your consumer credit or your cards, on slide -- I think it's about 14. You actually state that the moderation in growth reflects a disciplined approach to credit and profitability. I'm conscious you've raised your impairments. And I just want to check, the other statistics that you guys show on your cards book highlighted quite a high-quality book.

If you're moderating growth because you're taking a disciplined approach to credit and profitability, what are you seeing in your book that's concerning you or causing you to raise provisions here?

[Clifford Abrahams, executive]

So a few things. So around -- so the bulk of the raising of provisions reflected the models that David talked through earlier. We're also seeing a, call it, increasing credit bureau scores, customer indebtedness, and that flows through to our staging. So I would say they're more technical factors. We are seeing a modest pickup in arrears. We've set that out in the slide at the back.

So the -- I think they're not spiking, but they're more normalization, which you'd expect at this point in the cycle. So I think those are arrears and impairments. I think the points around moderation of growth and profitability are a little bit separate -- obviously, related, little bit separate. So when we talk about underwriting criteria, when, for example, utility bills go up, that affects the affordability for our customers, even well-off customers.

So we tightened our criteria. So we plugged that into our models. And that will naturally reduce, frankly, the amount of new business that we're getting. So instead of -- and we -- the way we talk about it, we might have a 10% reduction in our underwriting criteria. That means where we took on 10 customers, now we're going to take on 9 because some customers just drop out because they don't meet our affordability needs.

Now as rate -- as utility bills start to come down, that will unwind. So that's one factor. I think around profitability, what we've seen, we're active in the balance transfer market. When interest rates are very low, all banks, including us, can offer quite long balance transfer periods, up to 30 months, and still earn decent returns. Now as 5-year swap rates have gone from 1-ish to 4, that erodes returns, all other things being equal. So we have been, I think, one of the leaders in dialing back balance transfer periods. So our leading balance transfer period is less than 30 months now.

We've also increased our go-to APRs. So the rate that we will pay after the balance transfer period has ended. Now some institutions have maintained quite long balance transfer periods, 30 months and more. And what we've done is we've let growth moderate. So we've slipped down the ranking in terms of proposition attractiveness because we -- it's a business, frankly. So we want to earn our target returns, and we'll only write business if we can see a way to do that. So that's -- it's not -- those 2 effects are not a direct function of arrears performance. Does that give you a feel...

[Joshua Freiman, analyst]

Understood. It seems like it's more of a -- yes, that makes sense. It seems like it's more of a serviceability question for future growth and balance transfer.

[Clifford Abrahams, executive]

Yes, and we'll grow. We -- I think David talked about Slyce and some of our other propositions. I mean those will be -- those -- I'm really excited about the prospects of profitable growth there at the right time. And now is not the right time.

[Operator]

Our next question comes from Chris Cant from Autonomous.

[Christopher Cant, analyst]

If I could just come back on costs, please. So during the Q&A, you referenced you would expect costs to be sequentially low in '24 versus '23. Obviously, the guidance today would imply consensus costs for '23 are a bit too low. What's your view on '24 costs? Would that be down sequentially enough? Or do you actually see room to potentially beat '24 cost expectations of about GBP 940 million? I think your guidance implies about GBP 950 million for this year.

And just in terms of your gross cost saves target, the GBP 175 million, and the pacing of delivery of that. You talked about accelerating the restructuring efforts during the second half of this year and, I guess, into 2024. So presumably, the fruits of that effort will be building as we go through 2024. But 2024 itself, you don't necessarily see the full impact. So would you then be expecting potential costs to be lower again into '25 as we see the full effect of those cost efforts, assuming a moderation of inflation, obviously?

[David Duffy, executive]

Thanks, Chris. I'll let Clifford give you through your guidance. I'll steer away from that. But seriously, the first step is in the cost reconciliation, which Clifford could do for you, is that acceleration in the second half. And that's the key element because we paused a bit of it, branches, that type of initiative, whilst we dealt with the customer service issues. So we were very focused on getting that right. So we had costs built to solve those issues and costs not cut as we didn't want to impact the initiative.

So on both fronts, you will see the acceleration in the second half, so picking up what we had planned to do before at a faster pace and then removing all the costs that we put in place to solve the problem. And that momentum going into next year with the plans we already have gives me the confidence on the run rate to actually get to a lower cost number next year. But I don't know if you want to add on the reconciliation.

[Clifford Abrahams, executive]

I think that's fair. I think -- we are -- we take -- made some effort to pivot to cost-to-income ratio because we think that's right for a growth business. Our view is costs will be lower next year in absolute terms, and we see consensus as costs of around 50% next year. We think it's going to be lower than that for the reasons David ran through. I do think -- yes, that's based on our current expectations.

We're really committed to our 10% ROE target floor. We think to do that, our cost-to-income ratio needs to be below 50%. And we'll manage the business in that context. And as we get closer to a full year, we'll guide more specifically. But I think -- yes, I think our view is more ambitious than cost set out in consensus next year.

[Christopher Cant, analyst]

Just to follow up on that. You indicated you're comfortable with consensus NIM of 192 bps. I guess, the balance sheet growth in the first half is a little bit better. So presumably, you're comfortable with consensus NII or potentially think you might see some [indiscernible] there. And then therefore, the overall revenue picture, presumably you're comfortable with consensus to sort of circa GBP 1.9 billion. So in complicity of that saying, you expect to beat consensus costs of GBP 940 million to get [indiscernible] reasonable to mention?

[Clifford Abrahams, executive]

Well, the short answer is yes. I mean we're targeting, as I think you've heard from both Dave and I, commitment of 10% plus returns. So I think we've been consistent when we talk to you and investors who've penciled in 8%, I think broadly speaking for next year. Some of the delta -- so there's a delta around costs, and we've given you the rationale as to why we're confident.

I also think that the Street doesn't have us moving into our target capital range at the end of next year. Now none of us has a crystal ball for next year, all the pluses and minuses. But the way we run the business is we really want to deliver that 10% plus, and we'll manage the business to deliver that whilst doing it in a safe way within credit risk appetite and so on. So that should give you -- that's the rationale for our confidence in those figures.

[Christopher Cant, analyst]

That all makes sense. I guess, the part of the reaction today is probably around costs. And I'm struggling to remember the last quarter where we had objectively good news on the cost front, so -- hence the question. Just coming on to the sort of delivery phasing of the GBP 175 million, do you expect to be delivering the majority of that GBP 175 million by the time we get to end '23 in terms of the run rate benefit?

I'm just trying to get a sense of how much that cost base delivery is still progressing as we go through '24 because it feels like something that may be relevant as we think about '25. And I appreciate you might not want to give a specific figure of '25 costs. But obviously, consensus -- you're saying consensus is probably too high in absolute terms for '24 and consensus of costs up again into '25. So just trying to understand how you're thinking about delivery of that GBP 175 million.

[Clifford Abrahams, executive]

It's fair. We recognize that. We can go through the quarters, but I think we've been consistently transparent around costs and the service recovery that's now done. I think we flagged that at the full year and Q1. So I don't think this is a surprise, although we've clearly given some figures around it.

I think the way we've quoted cost savings, we do it in 2 ways. One, we talk about run rate -- cost savings delivered, that's the GBP 93 million. And we also give an indication on the bridge of how much is the earning through. So what we've seen, I'm really pleased actually that we've spent GBP 135 million. So we spent just under half the GBP 275 million, but we delivered just over half the cost savings at GBP 93 million. So they're sort of broadly matched.

So I think you can assume that we'll only spend the money if we think it's going to result in business benefit. And as we will spend most of the remaining GBP 140 million during the next 6 months or so, you can expect that we will deliver most of the remaining annualized cost savings, and those will earn into 94 -- sorry, full year '24.

[David Duffy, executive]

And, Chris, just to add something there because I listened to some of the commentary around the cost side. In 18 months, we've taken the cost-to-income ratio down from 58% to 51%, not many have. We're looking at taking it down to below 50% in the next period. And we're a smaller firm, we're subject to more volatility as we grow and transform. So I look at that trend, and then I look very carefully at the volatility, which you're obviously referencing. And there's a difference between cost [indiscernible] and cost management of events.

So what I was pointing out today was that we were dealt an event around the mini budget, which created hundreds of percent of increases in costs into every aspect of the bank on mortgage rates and savings rates, which drowned us in volume which we had to respond to. And I made the decision. I wasn't too worried about what the quarterly or half number was going to be. I was much more worried about what the right answer for the business was. So I spent the money. But I'm saying equally, at the other side of that, that I'm taking the cost out.

So for me, where we were before today and where we are after today is exactly the same answer as it was before, to quote the Talking Heads. But it is -- I just want to frame it that way because that's how we think. The cost-to-income ratio is about both sides of the cost-to-income ratio. We will have volatility from time to time. But the most important statement is, do I believe we will deliver below 50% cost-to-income ratio in '24? Absolutely. And do I have line of sight to that? Absolutely.

[Operator]

Our next question comes from Edward Firth from ABW.

[Edward Hugo Firth, analyst]

Could I change the subject slightly and talk about tangible book? Because if I look at where that came in against the consensus that you sent us, it was about 26p lower, which is quite a big delta. And I obviously get the movements around cash flow hedge reserves. But I guess, the key difference looks to be the pension adjustment.

And if I look last year, in the same -- you've got Slide 45 showing the bridge. But on the sort of trust budget, et cetera, the pension increased by about 5p of tangible book and it's now down 20p in this half. So could I just ask you just to tell us a little bit more about what's going on in the pension in terms of the surplus or deficit, et cetera, and how we might expect that to evolve?

And then secondly, in terms of the sort of what's left in the cash flow hedge reserve, could you just tell us -- it's probably in the numbers somewhere, I haven't seen it, but roughly how much is still in there? And is it -- I think you said in the past, it will be about 3 years for that to amortize. Is that still the sort of headwind we should be expecting on the tangible book?

[Clifford Abrahams, executive]

Yes, I'll pick that up and refer to Page 45. I think around -- in the -- around pensions, we have seen some really sort of odd behavior. I mean our period end was September. And I think you'll know, it's disclosed that effectively it was credit spread spiking that was the real issue because that's the discount rate for the liabilities more than rates per se. So rates should really hit both sides of the balance sheet. But that -- effectively, we had a high discount rate in September that's unwound.

I also think that our -- that surplus is always quite leveraged. So it's the difference between 2 large numbers coming out. When we look at it on a kind of an economic basis or a pension trustee basis, we're really pleased with the resilience of our pension fund. You saw that we derisked the pension fund to longevity. Actually, we announced that a couple of days ago. So I think we feel in good shape. But yes, I would say, have a look at our disclosures around pension fund, and we can pick it up with Richard afterwards.

I think around -- on Page 45, around the cash flow hedge unwind, it's broadly as we expected. I mean you'll note -- you'll recall, some of that had already unwound by the time we met at our full year results. And we've unwound now down to about GBP 400 million. And we expect that to unwind another GBP 100 million. So I think we've seen, I would say, the large part of the accelerated runoff. It's now stabilizing into '24 and I think has another couple of years left to it. So it should be less of a factor as we head into..

[Edward Hugo Firth, analyst]

Can we just get back on the pension fund? I mean is this the sort of volatility that you would expect? I mean it feels, looking at you versus other companies. I mean that's almost worth 5% of your -- 4% of your tangible or something is moving around, around your pension deficit or paying your pension surplus. I mean is that like -- are you comfortable with that? Or are you looking to sort of try and reduce that and try and reduce the volatility in that? Or is that something that you feel is reasonably normal?

[Clifford Abrahams, executive]

No, I think it reflects the abnormal environments we've been in, so the spiking up of rates and credit spreads. I'm comfortable with the pension surplus. And I think we have a good relationship with our pension fund trustees. The asset side is substantially derisked now. We're going through our triennial process. We'll see how that pans out.

But I think the longevity exercise that we've just gone through is an opportunity for people to crawl all over the pension fund and gives me confidence that we're in good shape. But pension fund is one of those issues that all institutions need to manage through. I think -- predates my arriving a couple of years ago. I think the pension fund is in good shape. You can see we've not made capital contributions for a little while, reflecting that surplus.

[Operator]

Our last question comes from Jonathan Pierce from Numis.

[Jonathan Richard Pierce, analyst]

I just wanted to come back to the delta between consensus, RoTE expectations for next year in your own guidance. I mean it's clear within the underlying P&L, I think, where you're seeing the deltas versus the market. It sounds something like it's essentially interest-earning assets and maybe costs. I wondered if you could talk a little bit more, though, to some of the other moving parts.

Cost of risk, for instance, and I think there's some moaning this morning about increased guidance for cost of risk this year. But as far as I can tell, the Stage 3 -- sort of genuine Stage 3 default charge is still running at 20 basis points, which is well below where consensus is for next year. So I'm wondering if there's a bit of a delta in your budget there.

I'd also like to get a sense as to where you think the below the line items next year will be. Consensus has still got fairly chunky number in there. And I guess, restructuring charges, in particular, could be somewhat lower than consensus has got in. But then the denominator, unless you're going to tell us that there could be further movements in the pension, which I guess is very difficult to predict at this point, I suppose the only real delta versus consensus may be on buybacks.

So I was hoping you could just remind us exactly how the buyback speeds back us through to TNAV because I think in your case, quite a lot of the announced buyback hits TNAV on day 1, so that would probably help the RoTE number next year as well. So just a bit more color really on the deltas between the market and your own budget for RoTE next year would be helpful.

[David Duffy, executive]

Yes. I'll make one comment just on the arrears again because I just wanted to be sure everyone is following it clearly. We're sort of out of cycle with the other firms who all did their macros. So when we come in and do our macros now, that's actually what our provision change is. So it's not arrears. So just -- if that's the point you're making.

And Clifford, you can cover the underlying points, but the principle is there that we were behind the curve in terms of our year-end versus other year-ends and half years. So this quarter, we're updating that drives the macros, that drives the increase, but it's not got any correlation to arrears, in fact. So -- but Clifford, do you want to...

[Clifford Abrahams, executive]

I'd make a couple of other points. I think we're covering it. I think on impairments, point of IFRS 9 is to accelerate impairment recognition going into a down cycle. And so I think we -- bluntly, we feel we've picked up the mini budget and, frankly, looking at other banks, a number of other banks have upgraded their macros from December, reflecting the good work that Rishi and the team have been doing to stabilize.

So I'm not preempting full year, but we think we're catching up. And that's not a past catch-up, but that's a look-forward catch-up. So if I look at consensus, consensus is 37 basis points for cost of risk next year, and that will be outside our through-the-cycle cost of risk of 30% to 35%. And I think at this point, my best estimate is 30% to 35% for next year because we think we've included all available information on our current balance sheet. So we should be reverting to the mean next year.

So I think that's one delta. And I think on -- as I said -- I think you put your finger on it, which is on CET1. I've guided to overall surplus, consensus has just under 14% next year. We think our target range is appropriate and prudent, and we're targeting getting within that range by the end of the year and the phasing will reflect dynamics at the time and the recognition that you referred to.

[Jonathan Richard Pierce, analyst]

And the TNAV implications of that are, what, about half of the buyback as it is announced comes out of the TNAV? You don't have to wait for the actual buyback to be executed?

[Clifford Abrahams, executive]

Yes, that's right. But you've seen our practice, which is, I would say, call it, fairly sustainable buybacks, right? So don't expect very large sort of one-offs. That's not been our practice. I think our challenge over the last period has been inaugural stress test and then changes in terms of the stress test timetable. So what we'd like to do is to do sustainable kind of medium-sized buybacks, which I think is best for all stakeholders.

[Richard Smith, executive]

Okay. That brings us up on time. So David, pass back to you for any closing comments.

[David Duffy, executive]

No, just to say thanks. And I think the picture I'm drawing is probably slightly outside of the half year and I'm recognizing that. But I am looking at the half year and the halfway point in our strategy. And if you look at the lag effect of execution in actions, I'm thinking of those, and I'm saying over the 3-year period, we'll deliver the targets. And that's kind of what's in my head. And so we're dealing with today cost events, that we're taking cost out, so we're comfortable with that, and a macro model-driven provision arrears category rather than anything else.

So when I look at where we are, I feel pretty comfortable, and that's why I'm trying to make that point today and be clear on that. And then I look at the distribution for our shareholders. That's a key part of what we think about. And Cliff has gone through the numbers and I see a huge opportunity over the next 18 months on that front as well. So a combination of those factors -- I would be, as a CEO, the optimistic one of the 2 always. But I do see the next 18 months is a momentum play for us with rapid increases in execution on all parts of the business and a confidence level around what we'll deliver and a substantial delivery for our shareholders in terms of distribution.

So I'll close on that happy upbeat note. And we'll see you all again soon. Thank you.