NatWest Group plc (NYSE:NWG) Q3 2022 Results Conference Call October 28, 2022 4:00 AM ET
Company Participants
Alison Rose – CEO
Katie Murray – CFO
Conference Call Participants
Aman Rakkar – Barclays
Jonathan Pierce – Numis Securities
Benjamin Toms – RBC
Fahed Kunwar – Redburn
Guy Stebbings – Exane
Martin Leitgeb – Goldman Sachs
Raul Sinha – JPMorgan
Andrew Coombs – Citi
Ed Firth – KBW
Jason Napier – UBS
Alvaro Serrano – Morgan Stanley
Omar Keenan – Credit Suisse
Operator
Good morning, and welcome to the NatWest Group Q3 Results 2022 Management Presentation. Today’s presentation will be hosted by CEO, Alison Rose; and CFO, Katie Murray. After the presentation, we will open up for questions.
Alison, please go ahead.
Alison Rose
Good morning and thank you for joining us today. I’m here with Katie Murray, our CFO. And I’ll start with the business update before Katie takes you through our financial performance, and we’ll then open it up for questions.
So let’s start with the headlines on Slide 3. Against a volatile and challenging economic backdrop, we continue to demonstrate the strength and resilience of our business, delivering a strong financial performance while supporting our customers. Operating profit for the first nine months of the year was £4.1 billion, up 15% on the same period last year, and attributable profit was £2.1 billion.
Our return on tangible equity was 10%, and we are reporting positive growth of 21% as a result of strong year-on-year income growth of 23% generated across our core customer franchises, along with cost growth of 1.8%. We maintain our cost reduction target of around 3% for the full year and are on track to deliver that. Our cost/income ratio for the nine months was 54%.
We continue to lend responsibly and support our customers with strong net lending growth of 5.4% since the year-end to £372 billion. Our strong capital generation gives us confidence in our ability to continue delivering for all our stakeholders in challenging times.
Our common equity Tier 1 ratio of 14.3% is approaching our 2022 target of around 14%, and we continue to return excess capital to shareholders. We have now paid or accrued £750 million towards our committed dividend distribution of at least £1 billion in 2022. And together with a special dividend of £1.75 billion announced at the half year and the directed buyback of £1.2 billion in March, this brings total distributions accrued or paid in the nine months to £3.7 billion.
Clearly, the macroeconomic environment has become more uncertain since we spoke with you in July. Inflation, interest rates and energy costs have increased further amidst a heightened market volatility, while supply chain disruption continues. The outlook is now more challenging for our customers with a drop in business and consumer confidence, together with lower economic growth.
In light of this, we have revised the combined weighting to our downside scenarios to 55% compared to 34% at the half year. As a result, we have taken an impairment charge of £242 million in the third quarter compared to a release of £39 million in the second. However, we are not revising our full year impairment guidance. While we believe our economic scenarios are conservative, it is important to note that we have not yet seen any material signs of stress from customers.
We continue to grow our lending responsibly with disciplined risk management. We have remained open for business, deploying capital in the mortgage market whilst pricing appropriately. We have a well-diversified, high-quality loan book with limited exposure to areas such as unsecured personal lending, mortgages with a high loan to value and commercial real estate. We are on track to deliver our 2022 targets on cost and capital and have increased our income guidance for this year to around £12.8 billion, based on the current Bank of England interest rate of 2.25%.
In this uncertain economic environment, our purpose-led strategy puts us in a position of strength. Our four strategic priorities remain as relevant as ever, and we continue to deliver against them to create and protect long-term value for all our stakeholders.
Let me talk more about how we’re supporting our customers on Slide 6. Though we are yet to see signs of customer stress in our credit metrics, we know that many people, families and businesses are worried about the pressures they face. And we are doing what we can to stand alongside them as they navigate through this economic uncertainty. Our strong balance sheet and capital generation enable us to lend a helping hand to those most in need.
So we have created a £4 million hardship fund to support individuals and businesses through charities such as Citizens Advice and Money Advice Trust. This includes £2 million to fund a dedicated team at the Debt Charity Step Change, helping small businesses that are struggling to manage their finances.
We are supporting mortgage customers who face higher financing costs by extending the refinancing window from four to six months. Some eligible customers who took advantage of this early window during the quarter saved around 2% on their next mortgage rate.
We have also carried out around 600,000 free financial health checks in the first nine months this year via our app, whilst also helping people to understand and improve their credit rating. This month, we launched a benefits calculator, which enables customers to check their eligibility for state benefits and access income they may not have realized they were entitled to. And year-to-date, we have made over 8 million approaches to personal customers with information to help them manage the increased cost of living.
For commercial customers, we are tailoring support to sectors that are most likely to be impacted. For example, we’re helping 40,000 customers in agriculture, which has been hit by rising prices, especially in fertilizers. And this includes making available a £1.25 billion lending package for U.K. farmers with capital repayment holidays where appropriate. We have a well-established ecosystem for SMEs, providing them with sector specialists as well as business hubs around the U.K.
In July, we froze SME current account fees for 12 months, and we continue to monitor our customers carefully to identify those that are having difficulties early on. We have also reduced TIL transaction fees for micro businesses to help them weather the increased cost of living. We’re also supporting our colleagues by making targeted pay rise for the lowest paid across the group as well as investing in learning and development programs and parental leave. So we are working with our customers, colleagues and communities to alleviate the worries of those who are most vulnerable.
Let me turn now to how we are delivering our strategic priorities on Slide 7. Notwithstanding the near-term challenges, we continue to invest for the long term and grow across our core franchises by acquiring new customers and broadening our product offering to meet more of their needs. In doing so, we are diversifying our income by customer, by product and by generating more fees and commissions.
We are also actively supporting our customers in their transition to a net zero economy. A good example of how we’re investing for the future is the strategic partnership we recently announced with Vodeno, which aims to create a leading U.K. Banking as a Service business. This will enable other businesses to embed digital banking services such as payments, deposits, point-of-sale credit and merchant cash advances directly into their own propositions and customer journeys.
Our new strategic partnership combines Vodeno’s technological capabilities and cloud platform with banking technology developed in Metal, our digital bank for small businesses. This allows us to leverage our position as a leading supporter of U.K. businesses in order to meet the evolving needs of our corporate customers and expand our client base in a rapidly growing market.
It also enables us to grow our fee income and diversify our revenue streams. As importantly, we will continue to lend responsibly and support our customers and, in turn, the wider U.K. economy. We’re delivering a wider range of our products and services more effectively across our franchises. For example, by extending our asset management expertise to customers in retail as well as private banking, we have increased our affluent investment customer base and attracted new net inflows, which amount to £1.7 billion for the first nine months of 2022, of which 17% was via digital channels.
And finally, on Slide 7, as the U.K.’s leading underwriter of green, social and sustainability bonds, we are well placed to help our customers transition to a net zero economy. Last year, we set a target of delivering £100 billion of climate and sustainable funding and financing by 2025. And we have contributed £26 billion towards that target to date.
Slide 8 shows how our investment in digital transformation is continuing to improve the customer experience as well as increase our own productivity. 90% of retail customers and 84% of commercial customers now interact with us digitally. And we are making this easier and simpler as we continue investing to improve customer journeys. 72% of retail bank accounts and 96% of credit card applications are now opened with straight-through processing, and we’re seeing this feed into continued improvement in customer satisfaction.
For example, our retail NPS is now 20 compared to just four in 2019. Our affluent score has increased to 29 from minus two, and we have one of the leading scores in commercial banking at 22. In the current environment, a strong balance sheet, disciplined risk management and effective capital allocation are important differentiators. Our loan book is well balanced between personal and wholesale lending and well diversified by sector, and the level of defaults across the group remains low.
Our personal lending book is largely secured, and 93% of our mortgage book is fixed. We have limited mortgages with a high loan to value. Those above 80% represent less than 3% of our book. Commercial real estate represents around 5% of our total loan book, and the average loan-to-value is 48%.
Looking at liabilities, deposits remain elevated in both Personal and Commercial Banking, supporting our strong liquidity position. We continue to actively manage our liabilities, offering strong propositions for youth in digital savers and fixed term accounts for business customers. We’re managing our capital allocation to maintain a strong balance sheet and our phased withdrawal from Ulster Bank Republic of Ireland, which we expect to be capital accretive is on track.
We have binding agreements in place for 90% of the loan book, and deposits have reduced 42% since the year-end as customers move to other providers. Our strong capital generation gives us the ability to support our customers in difficult times as well as invest for growth, consider other strategic options that create value and return capital to shareholders. As I outlined earlier, capital distributions accrued for or paid in the nine months amount to £3.7 billion.
And with that, I’ll hand over to Katie to take you through our Q3 results.
Katie Murray
Thank you, Alison. I’ll start with the performance of the Go-forward group in the third quarter using the second quarter as a comparator. We reported total income of £3.3 billion for the quarter, up 2.1% from the second. Excluding all notable items, income was £3.4 billion, up 10.7%. Within this, net interest income was up 14.3% at £2.6 billion, and noninterest income was broadly stable at £800 million.
Operating expenses rose 5.3% to £1.8 billion. And we made a net impairment charge of £242 million compared to a release of £39 million in the second quarter. This reflects an increased weighting to our downside economic scenarios rather than any underlying deterioration in the book, which remains robust.
Taking all of this together, we reported operating profits before tax of £1.2 billion for the quarter. Attributable profit to ordinary shareholders was £187 million, after the impact of losses in Ulster Bank associated with our withdrawal from the Republic of Ireland. And the return on tangible equity for the Go-forward group was 12.1%. I’ll move on now to net interest income on Slide 12. We saw continued strong momentum in net interest income, which increased 14.3% to £2.6 billion as a result of strong lending and higher margins.
Net interest margin increased by 27 basis points to 299 basis points, driven by wider deposit margins, which added 47 basis points. This reflects the benefit of higher U.K. base rates, which increased by a further 100 basis points in the quarter, and higher swap rates on our structural hedge, net of pass-through to customers.
These increases were partly offset by lower mortgage margins on the front book, which reduced net interest margin by 7 basis points and by the mix effects in Commercial & Institutional, which decreased NIM by a further 8 basis points. Net interest margin of 273 basis points for the first nine months was supported by the faster-than-expected pace of interest rate rises. And at current interest rates, we now expect NIM to be above 280 basis points for the full year with strong momentum into 2023.
I’ll move on now to look at volumes on Slide 13. We are pleased to have delivered another quarter of balanced growth across the group. Gross loans to customers across our three franchises increased by £9.2 billion or 2.7% to £347 billion. Taking Retail Banking together with Private Banking, mortgage balances grew by £4.2 billion or 2.2%, with flow share of 13% and good retention.
Unsecured balances increased by a further £200 million across credit cards and personal loans. In Commercial & Institutional, gross customer loans increased by £4.8 billion. Lending to large corporates and institutional customers was up £5.6 billion, driven by growth in working capital and supply chain finance as well as funds lending. This was partly offset by continued repayments on government lending schemes of £600 million.
I’ll turn now to look at deposits on Slide 14. Our robust deposit profile with a loan-to-deposit ratio of 76% has allowed us to support our customers through this period of market volatility, maintain our mortgage offering and provide lending across the economy.
Customer deposits across our three franchises decreased by £7 billion or 1.5% in the quarter to £448 billion. This was driven by outflows of £8 billion across Commercial & Institutional, reflecting the withdrawal of short-term institutional inflows made in the second quarter, coupled with some seasonality.
Across Retail Banking and Private Banking, deposits increased by £1 billion, a slower rate of growth than in prior quarters. We are not seeing any significant change in customer behavior in terms of switching balances between noninterest-bearing current accounts and savings.
In retail, we saw some seasonal reductions in saving balances over the summer holidays, offset by higher current account balances. We have provided new disclosure on the split for deposits for commercial and institutional by customer segment to match our loan disclosure. You will also see on this slide the cumulative pass-through on our interest-bearing deposits by franchise, including customer rate changes effective on October 18. This equates to an average pass-through of 25% to 30% across interest-bearing deposits, which account for around 60% of total Go-forward group customer deposits.
Our deposit pass-through decisions consider current and expected behavior across all our customer accounts. We continue to expect pass-through rates to increase with higher levels of interest rates. And our interest rate sensitivity disclosure provided at the half year, which incorporates a 50% pass-through, remains relevant.
Turning now to our hedge, where we have an ongoing income tailwind into 2023 as maturing swaps are being reinvested at higher yields. As you know, we hedge the majority of our current accounts and a small portion of savings. So £205 billion of balances are included in the structural hedge. The notional increase by £1 billion during the quarter, reflecting growth in balances over the last year. And if deposits were to remain broadly flat from here, we would expect the hedge to increase a further £5 billion over the next three to six months.
I’d like to turn now to noninterest income on Slide 15. Noninterest income, excluding notable items, was £800 million, stable on the second quarter. Within this, income from trading and other activities increased a further £28 million to £250 million, driven by higher foreign currency cash management and treasury. Fees and commissions decreased by £25 million to £550 million due to seasonal lower financing fees and to our no-fee foreign exchange offer for our retail customers through the summer.
Turning now to costs on Slide 16. We have delivered strong operational leverage or positive jaws of 21% over the first nine months. Other operating expenses for the Go-forward group were £4.9 billion for the first nine months. That’s up £87 million or 1.8% on the same period last year, reflecting higher strategic spend in areas such as financial crime and data. Along with strong income growth, this has contributed to a 10 percentage point improvement in the cost/income ratio to 54%.
We continue to expect to reduce costs by around 3% for the full year. As we told you at the half year, we expect inflationary impacts on our cost base to be more significant next year, but inflation is now forecast to be higher than projections at the half year. So we no longer expect costs to be broadly stable year-on-year in 2023. As you would expect, given our strong track record, we remain committed to maintaining cost discipline and improving operating leverage.
Turning now to credit risk on Slide 17. We have a well-diversified prime loan book. Over 50% of our Go-forward group lending consists of mortgages where the average loan-to-value is 53%. 64% of balances are on five-year fixed rates, 27% at two-year and just 9% are on variable rates, including SVR. Our personal unsecured credit exposure is less than 4% of group lending and is performing in line with expectations.
On the wholesale side, we have derisked over the past decade to bring down concentration in single-name exposures. You can see this from the reduction in our RWA intensity, which is down 15 percentage points since the end of 2019. For example, our commercial real estate exposure represents less than 5% of group loans with an average LTV of 48%. Our corporate book is well diversified, and we have shown here selected exposures that we expect to be more vulnerable to cost of living pressures.
So our strategy has delivered a well-diversified, high-quality loan book, which is not showing any significant signs of stress. However, we recognize the economic outlook has deteriorated. So let me tell you how we’ve addressed this on Slide 18.
We will update our economic forecast at the end of the year, but you can see at the top of the slide that we have increased our weightings to the downside and extreme downside scenarios from 34% to 55%. This has driven a deterioration in our weighted average expectations for GDP growth and unemployment, the key drivers of expected loss sensitivity. You can find details in the appendix and the IMS.
The net effect of these changes is £127 million increase in the good book expected credit loss provision, which was more than offset by the reclassification of Ulster mortgages to fair value. The post-model adjustment for economic uncertainty reduced slightly in the quarter to £545 million due to further releases of COVID-related adjustments. We continue to be cautious on the release of these provisions as we have yet to see the full impact of the economic challenges play out.
We reported a net impairment charge for the group of £247 million in the third quarter, equivalent to an annualized 26 basis points of loans. While the economic outlook remains uncertain, we continue to expect the full year loan impairment charge to be under 10 basis points, given the current performance of the book. As you know, our through-the-cycle impairment guidance is 20 to 30 basis points. And as I sit here today, I see this as an appropriate level to think about for 2023.
Turning now to look at capital and risk-weighted assets on Slide 19. We ended the third quarter with a common equity Tier 1 ratio of 14.3%, in line with the second quarter, as Go-forward group earnings were offset by Ulster exit costs as well as dividend and linked pension contributions. This includes IFRS 9 transitional relief of 19 basis points, up from 16 basis points at Q2. We generated 46 basis points of capital from Go-forward group earnings, net of changes to IFRS 9 transitional relief.
This is partially offset by higher RWAs, which increased by £1.5 billion due to growth in lending balances and market volatility. Progress on our phased withdrawal from the Republic of Ireland consumed 9 basis points of capital in the quarter as we incurred EUR 514 million of the EUR 900 million expected exit costs. This is net over EUR 2.8 billion reduction in RWAs due to the ongoing transfer of the corporate loan book to AIB.
Turning now to our balance sheet strength on Slide 20. Our CET1 ratio of 14.3% is moving towards our target range of 13% to 14% as planned. Our U.K. leverage ratio of 5.2% is in line with Q2 and a 195 basis points above the Bank of England minimum requirement.
We have maintained strong liquidity levels with a high-quality liquid asset pool and a stable diverse funding base. Our liquidity coverage ratio of 156% is down from Q2 due to growth in customer lending and dividend payments of £2.1 billion. Headroom above our minimum is £68 billion. We are pleased that Moody’s has recognized our strong balance sheet by upgrading both NatWest Group plc and NatWest Markets by one notch.
Turning to guidance on my final slide. As you heard from Alison, we have strengthened our income guidance for 2022. We now expect to deliver income, excluding notable items, of around £12.8 billion, with net interest margin of more than 280 basis points for the year. This assumes U.K. base rates remain at the current level of 2.25%, though we clearly expect U.K.
base rates to increase further before the end of the year. Rather than predicting that increase, I suggest you look at our interest rate sensitivity disclosures to help understand the benefit this may bring in the final two months of the year.
On costs, we expect to deliver a reduction of around 3% this year. And on loan impairments, we still expect to remain below 10 basis points for the full year given the current performance of our book, and we reaffirm our guidance on capital.
As we look ahead to 2023, we are confident in our plan to deliver a return on tangible equity of 14% to 16%. However, we expect the make of these returns to change given the evolving macroeconomic outlook. Inflation is pushing up interest rates and, in turn, we expect both income and cost to be higher next year, together driving an improved cost/income ratio. And based on the current performance of the loan book, we expect impairments to be within our 20 to 30 basis points through-the-cycle average.
And with that, I’ll hand back to Alison
Alison Rose
Thank you, Katie. So to conclude, against an uncertain economic backdrop, we are pleased to report another strong performance as we continue to focus on supporting our customers, communities and colleagues and delivering our strategic priorities. You have heard today how we’re helping those most in need as well as investing to create sustainable growth for the long term, continuing our digital transformation to deliver product innovation and improve customer experience and higher productivity and deploying our capital carefully.
With a strong balance sheet, well-diversified loan book and robust risk management, we continue to drive operating leverage in the business whilst managing the macroeconomic challenges. And we remain confident in our ability to deliver returns in the range of 14% to 16% next year. Katie and I will talk more about our outlook for 2023 and beyond at our results in February.
Thank you very much, and we’re now happy to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] Now our first question comes from Aman Rakkar of Barclays.
Aman Rakkar
Two questions, if I may. First of all, on costs, please, in 2023, obviously, note the stepping back from flat cost guidance ’23. I guess, first of all, can you help us understand exactly what’s changed versus, I guess, a couple of months ago when you issued the guidance? I guess my take is the inflation backdrop probably hasn’t shifted too too much versus what, I think, kind of the market and where the conversation was back then. So it would be really helpful to understand in your mind exactly what’s changed.
And can you help us think about — sorry for the background noise. Can you also help us think about — if you’re not going to point us to a number in ’23 just yet, can you help us think about the moving parts about where costs potentially could land a range or anything to kind of tighten that up? I think it’s actually quite an important thing based on the kind of market reaction and conversations we’re having so far.
The second question was around revenues. So I’m just noting the £12.8 billion revenue guide for this year. I think it implies kind of Q4 revenues of around $3.5 billion, that annualizes at £14 billion. Again, I know you might not want to give us exact numbers for next year, but directionally, do you see kind of scope for that annualized revenue run rate to grow from here? I guess that’s probably mainly about net interest income.
Do you think the kind of Q4 annualized net interest run rate can grow in ’23?
Alison Rose
Great. Thank you. So let me take the revenue one, and the short answer to your question is yes. But a slightly more detail, I think, look, for the remainder of ’22 and into ’23, we will see the full year benefits from the previous rate rises flowing both through the hedge and the managed margin. So that is going to give us a significant tailwind in into next year.
And I think if you can see from our rate sensitivity disclosure, we’re also going to benefit further from any further rate rises and that will also drive improvements in NIM. So I think a very positive and significant tailwind into next year on revenues. So hopefully, that gives you comfort on that.
Katie, do you want to pick up the cost question?
Katie Murray
Yes, no, absolutely. Specifically on costs, we know that costs have been lumpy over the course of the year as it was last year. I think — I mean I probably differ from you slightly differently. I see, since H1 2022, that there has been increase in the macroeconomic uncertainty, and this has driven greater inflationary and pressures. That’s certainly what we are experiencing on the ground.
So while we expect future increases in interest rates against this, we don’t believe that we no longer expect costs to be broadly flat given those increased inflationary pressures.
I think to be very clear, cost management remains a significant priority for myself and Alison and our executive. We will continue to manage tightly on costs as we have done over the past number of years. And I think where we have a very strong track record, we expect positive jaws in 2023 and an improving cost/income ratio in 2023 as well. We will talk more about our expectations for the 2023 through our outlook for the business when we meet again in February.
Aman Rakkar
Can I just ask one small follow-up, which is sort of what inflation assumption are you making now around 2023?
Katie Murray
So if you look to the inflation, the assumptions that we’ve used in terms of IFRS 9, that’s probably your best guide in terms of that. So if I look at my — the CPI in 2023, it’s 6.2%, 9% for this year and 6.2% on a weighted average basis. We will do a bit of an update of that, obviously, when we do the year-end piece, but that if we look at what we’ve done on our IFRS 9, and we work very hard to make sure that the economics align across the whole income statement and balance sheet. So that’s probably a good guide for the moment.
Operator
Our next question comes from Jonathan Pierce of Numis Securities.
Jonathan Pierce
Sorry, I got to push you on this cost point again, if that’s okay. I mean we’ve had, prior to today, two revisions to cost guidance this year. And it’s understandable, inflation is obviously much higher than one would have thought, certainly early part of this year. But we’re flying very blind now into 2023 with no guidance at all, and I really would encourage you to help us as much as you can on this. I mean maybe if you’re not going to be any more precise on full year ’23 versus ’22 guidance, is it sensible for us, as you just alluded to, to look at the CPI on your weighted economic scenarios, which is now 6.2%?
That was 3.9% at the interim, so call the delta 2.5%, maybe add a little bit on. Is that the sort of way we should be thinking about this if you were guiding to flat before? We should now maybe be thinking about up 3%, maybe up 4%. We just need, I think, any sense of scale because if it is up 3% or up 4%, your shares probably wouldn’t have been down 9% this morning. So a bit of help with that would be useful.
The second question on deposits. I mean you’ve encouraged us to look at the Go-forward deposit number ex central items where the repos are, which makes sense. And then most of the rest of the drop is in corporate and institutional at £5.5 billion in the quarter. Is that very low margin stuff? So the stuff that’s really generating the deposit revenue in the retail bank, the SME, to some extent, commercial mid-market, deposits there are pretty stable.
Is that the way to read the deposit numbers?
Alison Rose
Thanks, Jonathan. Yes, on the deposits, yes, that’s the way I would read the deposits. In terms of on our commercial bank, the deposits that have fallen have really been a combination of just timing of year-end sort of and timing of the quarter end and some payroll. We’re still seeing a lot of excess liquidity sitting in our SME and our commercial book, which are the valuable deposits, and deposits remain at high levels. So I think that’s exactly how you should read the deposits.
Katie, do you want to take the cost?
Katie Murray
Yes. No, sure, absolutely. Jonathan, I’m probably going to disappoint you a little bit on cost at the moment, and I’m not going to give you any kind of more refined guidance. I think we will — we have a very strong track record on cost management. We are seeking to continue to improve the operating leverage of the business over the plan through continuing to reinvest opportunities that we have in terms of the savings that we make.
We do expect as we go into next year that we’ll see positive jaws throughout 2023, and we’ll see that improving cost/income ratio. Thanks, Jonathan.
Operator
Our next question comes from Benjamin Toms of RBC.
Benjamin Toms
Firstly, thank you for the disclosure on the cumulative deposit betas. I think your weighted average cumulitive deposit beta is about 27%. Do you have a feeling of how it will take this number to converge to 15%?
And the FDA came out this quarter and said that they expect banks to clearly explain to them how they’ve decided on the pace at which banks pass on base rate increase to savers. Does this nudge change the trajectory of deposit beta progression from here, do you think?
And then secondly, I guess you’re not going to push any further on costs, but maybe you could give us a direction of the magnitude of any headcount reductions or direction of headcount reductions for next year. Louis told us this week that they’re hiring about 1,000 people to help manage the cost of living crisis on NatWest Group doing something similar.
Alison Rose
Okay. Well, let me address a couple of those, and Katie will pick up the rest. On FTE reductions, we would always speak to our staff first about any changes, but we are not hiring extra staff for cost of living. We have sufficient capacity we’ve invested, as you know, a lot in our digital transformation, our financial health and support team to look after issues around defaults and distress.
And just to remind everyone, we’re not seeing defaults and distress on our book, have had significant investment in them. journeys are much more digitized, which means we’re able to help customers self-serve, and we have sufficient capacity be able to deal with any challenges. A good demonstration of that would be, for example, around our operational capacity during the volatility in the mortgage market where we stayed in the mortgage market, we saw 5x the normal volume, which operationally, we were able to manage very well with our team.
So I think we’re not expecting an increase in FTE as others have indicated. On deposits and your SCA question, as we’ve said, we will manage our deposits in a very — and the pass-through in a very sensible way and competitive way and thinking about how we help people. If you look at where we have put support in place and put deposit rates in place, our digital regular saver paying at 5% or use accounts paying at 1% and — on our business side, we have some of the best fixed term deposit rates for our business customers. On the whole, they’re largely preferring to stay liquid and keep cash in transactional accounts. So we will continue to manage that on an active and competitive basis in the right way.
Katie, anything you want to add?
Katie Murray
I mean the only thing I would add is the sensitivity that we give you in terms of is it a 50% rate. We think that’s quite appropriate. We obviously, at the last and the most recent rate rise, we passed through about 40%. So you’re absolutely right in terms of your numbers, Benjamin.
It’s kind of — it’s moving upwards from where it kind of started, which is perfectly natural given the low rate that it started. And we have said consistently as the rates go higher, you’d expect to see a little bit more pass-through coming through, and that’s what we’re seeing on the ground in there. And I hope that you sort of found some of the analysis around how much of it is interest-bearing and noninterest-bearing, helpful within there. And I think we spend a lot of time looking at what do we think customer behavior is, how do we think that they’re reacting to rate rises. Alison has already talked about the rates that are on offer.
And what we’re not seeing at the moment is people moving, particularly in that, but we obviously spent a huge amount of time looking at that for any indicators of movement. Thanks, Benjamin.
Operator
Our next question comes from Fahed Kunwar of Redburn.
Fahed Kunwar
Just a couple. The first one is just on assumptions. I mean, from what we can see, the CPI hasn’t changed that much in the cost guidance and that’s clearly led to an increase in or a change in your cost guidance. On your loan loss guidance for 20 to 30 bps next year, how are you confident on that number? I mean, no one else has really given the ’23 or proper ’23 guidance is quite low.
Given the small change in inflation leading to a cost change, why are you confident enough to give that 20 to 30 basis point guidance on loan losses given the uncertain environment we’re in? That was question one. And the second question was just kind of following up on Aman’s question earlier, actually. If I look at your exit NIM, obviously, it depends what greater than means.
You’re looking at like 315 to 325 basis points of 4Q. A, is that right? And secondly, does the NIM grow from that level, flat? Does it go down from that level? Just some color on how it progresses through 2023 would be incredibly helpful.
Alison Rose
So I’ll get Katie to take you through the detail. But I think just in terms of our impairments and the outlook, what I would remind you is the shape of our book — we have good risk discipline. The book is well diversified. It is largely a secured book less than 4% of our group loans are unsecured lending. We’re largely a fixed mortgage book.
Commercial real estate is less than 5% of our book at 48% loan-to-value. Our loan book largely fixed at 53% loan-to-value, and you’ve seen the active capital management that we’ve done on our book. So it’s well diversified. We’re proactively helping our customers. We’re not seeing any significant signs of stress. So I think I’d just point you as a starting point to the shape of our book.
And then, Katie, do you want to sort of add a bit of color to that and take the next question?
Katie Murray
Yes, no, absolutely. So in terms of the assumptions, so we moved from slightly below 20 to 20 to 30 basis points. Well, what we’ve done is, obviously, we’ve updated our economics in terms of changing the weightings that we’re applying to them. And then we spent a lot of time looking at the book and what we’re seeing within there. What I would say and point you to is that we still hold significant PMAs, £545 million.
There was a small release. That gives us some protection as we move into next year. But when we look at what we’ve seen in terms of how these books are performing, we look at what we think the economics could do. And now they could actively manifest themselves in terms of Stage 3 and also look at the sensitivities that we had at the half year.
That is what got us comfortable in terms of that 20 to 30 basis points. Looking at the book, looking at what we know today, we felt that, that was a good place to land.
If I look at the NIM, obviously, 299 for the quarter, we’re guiding you to over 280 for the year. So clearly, a further increase in NIM as we go into next year. And going to the last quarter, you need to take your own view of what the NPC might do next week. But looking at the market, I think we could all be comfortable there will be more rising rates. That’s obviously going to be positive to that as we go through.
And I think the other thing, obviously, to remember as part of the NIM is the importance of the structural hedge within there. At the moment, when I look at the structural hedge, it’s been rolling off at 78 basis points, and we’re reinvesting that 305 basis points. That’s obviously a strong benefit. And you know from our sensitivity that year one, the benefit is lower and it grows as you get the full annualized impact on that. So we would — we’re pretty comfortable on NIM, and we’re comfortable on that income trajectory as we go into 2023 will be strong.
Fahed Kunwar
I’m just — I missed how we should grow from the exit NIM in ’23 rather than growing in Q4?
Katie Murray
So I think when you look at the trajectory for income into next year, one would expect that to dribble into the NIM definitely.
Operator
Our next question comes from Guy Stebbings of Exane.
Guy Stebbings
If I could firstly come back to costs one more time. I think it seems entirely reasonable you wouldn’t want to hold yourself to a flat cost base next year given the inflationary backdrop and favorable rate tailwinds. But I would imagine most people are certainly consensus is assuming very significant positive operating jaws next year, not [for us] 10%. So can I just check we’re not talking about low single-digit positive operating jaws and something more significant, otherwise anticipated — given anticipated revenue growth, we’re talking about north of 5% cost growth for nearly six months ago, the guidance was 3% takeout, and that level of revision looks largely even set against the inflationary backdrop. So maybe we can just talk around jaws that we’re not talking low single digit might be helpful to the market today?
And then the second question was just on capital. I appreciate there’s no change to headline targets. But given the more uncertain backdrop, would it be fair to think that you might want to target more towards the upper end of the range just to give us a bit more of a cushion into an uncertain environment?
Alison Rose
Thanks, Guy. Well, look, yes, I mean, I think you can expect to see very good positive cost jaws next year. We are continuing to focus on driving operational leverage out of the business. You can see, for example, the continuing improvement in things like our adoption of digital, our straight-through processing, the benefit of our investment in digital and technology. So yes, you can expect to see very positive cost jaws going into next year.
We definitely see the higher rate environment is a positive for us. So the tailwinds are greater than the headwinds. So we’re feeling increasingly confident in our 14% to 16% rate guidance. But yes, positive cost jaws. On capital, there’s no change to our guidance. We’re very clear on the 13% to 14% we’re focused on our strategy on a well diversified, well risk-managed business.
You can look at the shape of our book — we’ve made sure that it is in a good and secure place. We’re lending responsibly into the economy, the benefits of our investment program are delivering real benefits and we’re seeing continuing customer acquisition, continuing growth in our customer scores we’re feeling — I’m very confident on that. So I’m not changing my guidance. Risk diversification is good. The book is performing well.
We’re being very proactive in how we manage it, and we’ll continue to do so going forward.
Operator
Our question comes from Martin Leitgeb of Goldman Sachs.
Martin Leitgeb
Could I just ask you in terms of revenue outlook a little bit more? I’m just trying to understand what if the kind of market implied policy rate outlook is correct, then we’re heading into kind of more towards a 4% rate environment. And obviously, conscious about your conservative guidance on the back of the 225 current rate environment. I was just wondering with your disclosed sensitivity in terms of interest rates, £275 million year one benefit from for a 25 basis point increase, could you just help me understand how to think about the potential 2023 NII figure as we progress? Because I mean, looking at the — at least consensus at this stage around 13.9 total revenues around 11 NII, it seems like a lot of the step-up from 2022 to 2023 is driven by the hedge rollover, which I think is around £100 million a year for 25 bps just in we had around eight-point-something hike so far.
I was just wondering how conservative, if anything, consensus is.
And secondly, with regards to deposits, if I — thank you very much for the new disclosure on Slide 14 in terms of the split of your deposit base in interest-bearing and noninterest-bearing. I’m just trying to see if I understand correctly that the pass-throughs you show is interest-bearing only. So on a blended basis, the pass-through so far are below 20% and that your assumption here going forward in terms of the sensitivity is around 50% pass-through on the entirety of the deposit base, which implies kind of 100 percent-ish pass-through on the interest-bearing bond.
Alison Rose
Thanks, Martin. So look, I think on — I’ll let Katie dive into the detail. Look, we continue to take a conservative view on the path. I mean clearly, the NPC is next week, you can see our assumptions are on the 225. I would point you to the fact that we think the tailwinds for us going into next year are greater, and there’s a good benefit from that.
But there’s a lot of fiscal policy being announced over the coming months, and we continue to take a conservative path in our assumptions. Katie, do you want to try and answer the detailed question?
Katie Murray
Martin, I won’t comment too specifically on some of the detail of your math, but let me help you think about how I kind of think about it. If I look at the hedge. When we spoke at H1, we said that the hedge was giving us in comparison to 2021 for the full year a £600 millionof benefit. That’s now £700 million of benefit as we’ve seen the improvements that have come through in the second half. What we know and from the sensitivity you’re purely very familiar with, we know that the first year in terms of those rate benefits from the hedge movement are lower, and it grows from there.
So if you look at year two and year three of your sensitivity, the managed margin stays relatively static, but the hedge continues to grow almost — it looks like almost another 100 for each of the different years. And if you take that on your — the number of rate rises we’ve had, you can have some thinking about that. I think we’ve also got a volume benefit in that the hedge has grown and also the margin benefit. So both of those give us a positive flow into income as we move into next year.
I said earlier, it’s rolling off about 7 to 8 basis points during Q3. We put on at an average of sort of 305 basis points. Obviously, in Q4, in early October, we’d have put on it slightly higher than that. So I think that’s one way to think about it. That more than offsets any pressure that we’re getting in terms of the mortgage margin.
So as you can see, strong tailwind into the income for 2023.
When I look at the deposits, and we’ve given that extra disclosure and when you get a chance, Martin, you’ll see in the financial supplement, we’ve given you the shape of the commercial book over the last number of quarters as well. So you can kind of see how that’s moved. But yes, so you’re absolutely that pass-through is on the interest-bearing balances. 40% of our balances are noninterest-bearing. So when we talk about the pass-through, it is looking at those that we’re paying pass-through to, not those that we are not paying pass-through to.
Our sensitivity is done on the basis of 50% of any rate rise being passed through. We’ve always said that as rates go up a little bit, you’ll see that pass-through move. The exact timing of the move will depend on what’s happening in terms of market activity as well. I hope that helps you a little bit.
Martin Leitgeb
Can I just follow up on the deposit comments you made earlier that you haven’t seen. Could you just help me understand, you haven’t seen any meaningful migration from current accounts into savings accounting either on the personal or corporate side at this stage. Did I [indiscernible].
Alison Rose
No, Martin, we haven’t and behaviorally, what we’re seeing, I mean, interestingly, on our consumer deposits, is actually what we’ve seen is a £0.4 billion reduction in savings accounts as people use their savings perhaps in the summer to pay for their holidays, but a £0.8 billion increase in cash sitting in their transaction accounts.
And on the commercial side, as I said, we’ve got some very compelling fixed deposit accounts for businesses. But largely on the whole, they’re wanting to stay liquid, and a lot of the deposits are sitting in transaction accounts. So we’re not seeing any meaningful movement. Deposits remain at elevated levels. We’re not seeing those deteriorate or being spent and a preference for liquidity.
And just to give you another sort of a little bit of an example on our bounce-back loans, around 24% of those are still sitting in cash in people’s transaction accounts rather than paying down the loan. So no meaningful change.
Operator
Our next question comes from Raul Sinha of JPMorgan.
Raul Sinha
Maybe the first one, just to follow up, Alison, on what you were saying just now. The other banks are suggesting that the deposit pass-through on commercial and institutional deposits is going to be much higher, clearly than retail. And I think one of your competitors has suggested that we should be ready for deposit betas of greater than 100% as rates go up beyond 3%. So I was just wanting to follow up in terms of your assumptions. And I suspect you probably will update your interest rate sensitivity at Q4 for the higher rate environment.
But in terms of your assumptions, is that consistent? Do you think that commercial deposit beta will be above 100%? Or do you think that your deposit base is perhaps slightly different?
Alison Rose
Yes, I’m not going to comment on other people’s assumptions, but that’s certainly not ours. I think Katie has given you the view on our assumptions. And we are, as I said, behaviorally are watching very closely what’s happening and the behavior of our customers. We’ve got some really compelling notice accounts for our business customers and there is a preference to stay liquid and cash staying in transaction accounts. So that certainly wouldn’t be our assumption.
We’ll continue to review and manage competitively and what’s right for our customers. I think also the other thing is to consider the structure and composition of deposit books. Our commercial deposits sit within the ring-fenced bank, where there is a high — where there are high levels of liquidity. So maybe that might be a distinction between other banks that you’re looking at in their comments.
Raul Sinha
That’s very helpful. And then the second question I had was just on — sorry to come back on costs, but just looking at the implied Q4 cost number, given that your costs are up 1.8% year-to-date, obviously, you’re sticking by your guidance of reduction. I mean that does imply double-digit cost reduction in Q4, unless I’m getting my maths wrong. Is that fair? And can I just try and understand what might be driving that? Is there a sort of significant item that we should be aware of in Q4?
Alison Rose
So on costs for this year, we’ve reiterated our guidance very clearly that we’ll be around 3% cost reduction. I have consistently said throughout the year, it will be nonlinear. The benefit of our cost reduction is coming through on the back of the investments that we make, the operational leverage we’re driving through. It will be lumpy. I have — Katie and I both said it will be lumpy. We remain confident of the around 3% guidance for this year.
Raul Sinha
And then I guess what I’m trying to understand is, is there some kind of externality that you might be waiting to get clarity on perhaps the rate of inflation where it settles before you can give us more detailed thoughts? Because three months ago, you were giving us guidance on 2023. So I’m just struggling to understand why we don’t have an updated guidance for 2023 now?
Alison Rose
I think we’ve answered the question on costs going into next year. Look, we’re very confident with our guidance on cost this year. As we go into next year, we’re very comfortable with positive jaws. If you look at the tailwinds going in and next year, they’re very strong. And we are increasingly confident in our 14% to 16% rate guidance for 2023.
As Katie said, the mix of that may change, but I would point to the fact, we have a very strong track record and continue to have the discipline to manage our costs on operational leverage. It’s clearly a higher inflationary environment. We’ll be considerate of that. But our ROTE guidance remains very strong. Our tailwinds into next year remain very strong.
You should be confident of positive jaws and us continuing to drive operating leverage out of the business as a result of our investment. And you can see the momentum that we’re continuing to deliver.
Operator
Our next question is from Andrew Coombs from Citi.
Andrew Coombs
I’ll give you a break on costs. So let me ask one question on the mortgage role and one on impairments more broadly and scales. Thank you for the additional disclosure on the mortgage book, the split between five-year two-year and variables, it’s very helpful. Can you just give us some thoughts. Obviously, what we don’t have is the time series of that.
So how much of the book you expect to enroll in Q4 and then going into next year as well, that would be helpful. And then second question, if I look at Slide 34 and 35, where you provide the Stage 1, Stage 2 and Stage 3 coverage, the Stage 3 coverage, I think, has dropped from 40% to 31.5% over the course of the year. I think that’s really largely to do with the move in the Ulster Bank assets, but perhaps you could just clarify the driver of that?
Alison Rose
Thanks, Andrew. So look, on the mortgage book, let me try and sort of give you a bit more color. So as you know, our book is largely fixed, and we’ve given you the five-year, two-year. It’s — and as we look towards the end of the year, the 70,000 customers who will roll off their fixed mortgage at the end of this year, 80% of them have already rolled into a new deal. And the fact that we opened up the period from four to six months when we’ve helped 100,000 customers go on to new deals.
As then we roll into — and just to be clear, 90% are on capital repayment. So it’s a good quality mixed book.
As we look into next year, you’ve got 17,000 in February, 38,000 in March. And as we look at the whole year, there’s around £51 billion of fixed rates expiring by the end of ’23, and then that’s broadly half and half between the two-year and the five-year. So that’s sort of the shape of the book. Obviously, with our reach-out program, the extension of the window, we’re helping more people sort out their mortgages as they move forward. But hopefully, that gives you a little bit more color of the shape and the movements and the dynamics of the book.
Katie Murray
Should I take the Ulster question? And Andrew, you’re absolutely right, it is the movement of Ulster. If you go to sort of Page 18 to 20 of the RMS, you can see it broken out by segment and by staging. And what we did see in terms of the Q-on-Q is that in June, it was £350 million of Stage 3 within Ulster and it’s — that’s 68. And that’s because, remember, we talked about at Q2, the mortgage book because we’ve done a transaction, it would move to fair value.
So it was moved out of here and it’s part of the fair value accounting rather than the amortized cost. So that’s what’s driving it. And then you can see that the — within the Stage 3 for the main group, it’s up slightly, but not anything of any particular significance in that.
Andrew Coombs
Just on the ECL, even if I look at the disclosure in the reform, Page 18 and 19, I look at the numbers excluding Ulster Bank, your Stage 3 coverage still looks like it’s dropped quite meaningfully from 39% to around about 31%. So there seems to be something more in it than just the Ulster Bank transfer. So I don’t know if it’s just a function of mix or anything else you can comment on.
Katie Murray
Yes. So if I look at the coverage piece there, I mean, 31%, it really will be mixed. We have had a small amount of write-offs in the period as we do the normal kind of cleanup, but nothing else within there. The other thing, of course, to remember is that the BBLs kind of come through there, and they kind of base or mess up your numbers a little bit just because of the way that they’re dealt with. And so then the question I always ask is, well, the BBLs are all on guarantee, they kind of flow through, but they can make a little bit of noise.
So what about the associated lending on the BBLs, and that’s in the report as well. And you can see that that’s performing very well.
Operator
Our next question comes from Ed Firth of KBW.
Ed Firth
I just had two questions. The first one was on cost but not about next year’s target. I guess I was thinking more conceptually about the variability you have in your cost base because — and I guess the context of that is you’re clearly hugely benefiting from higher rates, but one’s got to imagine that at some point, the central banks will finally crack inflation, and we’ll start to see rates coming down then. And I guess then a lot of NII will start working into reverse. So I’m just trying to think of that cost base, if as we go through next year, we start to see rates coming down, is there quite a lot of flexibility in that cost base?
I mean, is there sort of a chunk of investment spend that you could say, well, look, we could delay that? Or is the sort of cost drag? Is it all about wages and salaries, which I guess will then be baked in sort of add in an item? So that’s the first question.
And then the second question was, I’m still sort of struggling a bit with savings rates and what you pay on savings, et cetera. So if I look today, your interest in access saving, you’re paying 50 basis points on your main account. And I guess, based on your comments, you’re assuming that goes to — if we have a 2% rise, you’re going to knock that up to about 1.5%. But I mean, if I look back in 2005, ’06 when rates were last at the same sort of level, you were paying 3%, so double effectively on savings. And I get the answer about your customers are financially unsophisticated, a lot of them are elderly, et cetera, so they don’t all move on to the rate.
So you can charge less. I do understand that you can’t pay less and still fund the business, that’s fine. But in terms of your conversations with regulators and politicians about withholding taxes, et cetera, I’m still struggling to understand why you think that is a sort of a fair rate for an oligopolistic supplier, I guess.
Alison Rose
Okay. Let me try and answer that. So a couple of things just on deposits. sort of liquidity and funding position is fundamentally different to previous cycles. At the moment, if you look at sort of Bank of England data as well, looking at deposits, there is £300 billion more deposits sitting in household accounts and £25 billion less debt.
So deposits are inflated. I wouldn’t describe my customers as elderly, vulnerable or unsophisticated at all.
What I would — and what you’ve seen with where we’re directing deposits, we’re directing them in a way to help people save, use digital regular saver. We have a strategy of encouraging more and more people to save, to build up resilience, and we’re offering competitive rates. So I think, firstly, it’s very different to previous cycles. Secondly, I would say we’re making sure that we’re passing on fairly. And thirdly, there are excess liquidity hangovers as a result of COVID.
And fourthly, behaviorally, customers are wanting to stay in liquid positions. I gave the example of our business accounts. At the moment, we’re offering some of the fixed — best fixed deposit rates in the market in terms of them wanting to fix their deposits. And on the whole, businesses are wanting to stay liquid because it’s largely transactional balances that they’re keeping in place. We will continue to manage our liability strategy in a way that is very competitive and also very targeted and also making sure we’re passing on in a balanced and fair way to our customers.
So hopefully, I’ve answered a few of the questions — your questions. I disagree with some of your assumptions. And our customers are actually very sophisticated. And one of the reasons we’ve undertaken 600,000 financial health checks with our customers and nine times out of 10, when we do those, we save our customers’ money because we help them sort of reorganize their budget and their balance sheet in a way that’s really helpful for them. I was looking at one earlier this week where a customer was paying £2,700 a month on various credit cards.
They’re now paying £400 because of the actions that we’ve taken. So we look at it across the whole budget.
On your cost questions on variability, of course, we obviously have A lot of our costs are on staff, making sure that we’re looking after our colleagues, we’ve put through this year, the highest pay rises that we’ve done in five years, and we put an exceptional pay rise in at the half year as a permanent pay rise to help people Obviously, with our investment, we are increasing automation in our business, our straight through processing that gives us a degree of flexibility in our cost base. And obviously, we have significant investment as well that we can be flexible and agile with. There are fixed costs in our business, clearly, but we actively manage our cost base.
Operator
Our next question comes from Jason Napier of UBS.
Jason Napier
Two quick ones, please. The first is could you just be explicit in the Bank of England rate that’s assumed in the 14% to 16% royalty target for next year?
And then secondly, thank you for Slides 12 and 14, the breakdown of sort of the NIM walk and the deposit betas on the interest-bearing base. I guess there’s more uncertainty in some investors’ minds around the durability of the tailwinds from the commercial book, in particular. I wonder, is there a difference in the benefits of the hedge as pertains to that block in particular? Certainly feels to us like the retail tailwinds are in train given the size of the hedge and the rates that you’re putting on there. But I just wonder whether the same could be said for the tailwinds on the commercial piece, which in the last couple of quarters has been just as big for the firm as the retail side.
Alison Rose
Katie?
Katie Murray
Yes, sure. So if you look at the 14% to 16% when we set that target, we had set it with a 2% and flat at that point obviously is at half year. we’re not upgrading the target today, but what we have said is we are increasingly confident in our 14% to 16%, and that’s really because of the strong tailwinds that we’ll get and that significant movement that we’d expect to see in terms of the revenue — sorry, the cost impairment guidance and that positive jaws that we’re expecting to see coming through.
When I look at the hedge, I guess, the way I think about it is that there is £11 billion a quarter, so about £40 billion a year that kind of rolls off on that, and we’re continuing to invest that piece. And I would say that the tailwind is across both retail and commercial in terms of that piece. And given where the rates are and given what — the low level of what’s rolling off and what we’re putting on and then this kind of caterpillar effect that we’ve talked about in the past, that obviously gives us a strong tailwind as we go through, which helps support our increasing confidence on the royalty.
Jason Napier
I don’t know whether I want to be able to do this in an erratic way, but can I come back to the RoTE question, please? The market this morning says that the Bank of England is going to 4.9%. Can you hit the bottom end of your range at the 2% rate number that you had used? Or can you say that you are or aren’t using 3% or 4% as your new terminal range?
Katie Murray
Beautiful tap there. Look, I think you’ve got to remember that — and you know this, so don’t — you want to remember when inflation is rising, that’s what’s pushing interest rates up. So those two things are not happening in absence of each other. So what we’ve seen happen since the half year is our inflation expectations go up. You see that in our economics.
We’re always a little — we always kind of work a little bit lower than market implied because market implied often has a frothiness that doesn’t come through. So clearly, as we work through that, when we came out in the half year, the 14% to 16%, we were comfortable. Since then, the rate guidance has improved. That’s naturally had an impact on the inflation aspect of things. But look, we’re increasingly comfortable about that 14% to 16%, accepting we already were, I guess, June and since then the — rate on the rate side is obviously more positive.
Operator
Our next question comes from Alvaro Serrano of Morgan Stanley.
Alvaro Tejada
Two questions. One on the structural hedging on provisions. Structural is really a follow-up. My recollection was that you and other banks in early ’21 were doing shorter durations because obviously, back then, we’re flirting with negative rates. And the question really is, if we’re doing shorter ranges, I think it was two years, is there an outsized rollover of the structural hedge next year that we should take into account, which obviously could increase, step up the contribution of structural hedge a bit faster than the sort of caterpillar effect that you often refer to?
And the second is more conceptual on provisions and the sequencing of provisions. You obviously reiterate your guidance of less than 10 basis points this year, which suggests provisions will be down in Q4. Is this about you intending to use the PMAs up in Q4? Because obviously, if you’re guiding to between 20 and 30 next year, sense counter in to, I would have thought in IFRS 9 world, you would be front loading. And it seems like any macro updates that you might do in Q4, you don’t expect it to lead to any top-up.
So just a bit of color on the provision side, what to expect.
Katie Murray
Yes, sure. So if I take your hedge question, first of all, we’ve got a very consistent on the duration of the hedge, slightly shorter than three years. That hasn’t particularly changed. You will recall in the first half of this year that we did do a review of the behavioral life piece, but that’s going to come out in the same kind of time line. I do recall the kind of shortage durations, but it’s not something that would have any particular impact from the 2021.
So if we look at provisions, we’ve obviously — we’ve done a fairly significant move in our weightings in this quarter that’s caused us to recognize some additional provisions there. I think Alison and I have both talked a lot about this morning we’re just really not seeing anything in the book. So IFRS 9 does talk about front loading, it does have to have the evidence of deterioration in terms of that front loading.
I’ve talked about the PMAs. They’re there because we do believe that things will continue to decrease. We’ve done a lot of work to support them in terms of looking at different cohorts of customers, whether it be retail and who’s going to be more impacted and things like that. We’re not looking or expecting to release them significantly in the next quarter. I’ve always said that the release of them will be — would be gradual as we see it coming through.
So I think let’s wait and see how we run our models through, but comfortable with the guidance we’ve given you — to you based on what we’re seeing on the book today and the economics that we’ve — the update on the accounts we shared with you this morning as well.
Operator
And our last question comes from Omar Keenan of Credit Suisse.
Omar Keenan
I just had three questions, if I may, actually. So firstly, I just wanted to ask about deposits. I appreciate your comments on deposit migration being limited. I was hoping perhaps you could give us some idea of how deposits are changing in October? Are balances growing again after the seasonality points that you made on the third quarter?
And are you seeing any changes right now in terms of terms and mix? And if not, do you have an idea as to what level of interest rates might start to induce changing behaviors? So that was my first question.
My second question was just on the structural hedge. Could you just give us maybe just a bit of elaboration on what buffers you have on modeled deposits? And then just lastly on RWA rating migration. I was just wondering if you could perhaps give us a sensitivity on RWAs if house prices were to fall by 10%? And also maybe just give us some help with how to think about rating migration in the corporate book.
Alison Rose
Great. Thank you. So look, on deposits, what are we seeing? No real change. We’ve seen a little bit of reversal of commercial outflows in Q3, but nothing else of note.
So deposits remain pretty stable. I mean I think I’ve talked previously about — and obviously, there are inflated deposits. I talked about the £300 billion more broadly across the economy. We’re not yet seeing the cash burn or the rundown of deposits or particular switching of deposits out of interest in noninterest into interest-bearing. So at the moment, there is a preference, I think, for people to stay transactional and liquid.
I think — I don’t think it’s as simple as saying there is an interest rate level that would induced change of behavior. It’s interesting, the dynamic we saw around retail deposits where people use their savings accounts for potentially paying for holidays and yet transactional balances have gone up. So I think there were a couple of behavioral dynamics as we’ve been going through financial health checks with our customers, what we have seen is people using their balances to pay down credit card borrowing, which is we have a very small unsecured, but as we look across order balance sheets, people are paying down their credit card debt, building up buffers of savings.
So I think as cost of living squeeze continues to bite with higher costs and inflation, you might see people use their transactional accounts to manage that sort of expenditure. But we’re not seeing significant increases in debit or credit card spending. So I don’t think it’s as simple as interest rates. So we’ll keep a close eye on all those elements of behavior. Katie, do you want to pick up the others?
Katie Murray
I’ll take the structure hedge in the RWA. Omar, I didn’t quite catch your structural hedge questions if I answered the wrong question, jump back in and correct me. In terms of — as we look at that, we don’t share the buffer with you in terms of how — exactly how much we hold back, but we do take a conservative view on the eligible balances that we do hedge. We hedge the proportion of a kind of a 12-month rolling average to make sure that we don’t have any exposure to our short-term variability of balances. So things started to move and very comfortable that wouldn’t cause us a problem.
And the other thing to remember is the product hedge turns approximately £35 billion to £40 billion per annum. So if we did need to readjust because of customer behavior, we’d be able to do that very easily. So I’m not concerned on that side.
If I think of RWAs, so the house price moves are important, obviously, in our book is 54% loan-to-value, so we can sustain a 10% movement in terms of the security on that book, even the new business has got an average of 69% loan-to-value. So kind of comfortable in that kind of range if you saw that. We start to see procyclicality in RWAs when we actually start to see actual defaults. So one of the things on house prices, although it might move, it doesn’t necessarily move in terms of defaulting on that piece because actually, your mortgage is on an agreed two- or five-year rate. And so therefore, the house price move might cause some anxiousness around the dinner table, but it doesn’t actually make any real difference on your cash flow.
So we need to start to see that cyclicality.
What we’ve actually seen over the last number of quarters is positive procyclicality. We saw that again this quarter of 0.7, 0.1 from retail and 0.6 in terms of C&I. The thing I think to think about as you remember on RWAs, we do expect a further reduction this year for UBIDAC. I’d hope to see about €4 billion of RWAs coming off in the quarter. And then obviously, what happens on lending and market volatility could move that in the other direction as well.
Omar Keenan
Okay. So if I’ve understood things correctly, so in October, corporate deposits have been stable and actually some of the outflows have actually reversed and come back in. And then — okay, great. And then just on the RWA migration point, so I guess house prices, if they were to fall 10%, it does not affect LGDs and networks model, so we would…
Katie Murray
It wouldn’t have a particularly significant effect. It will clearly move it around is bit, but it’s not something that we’re already concerned about.
Operator
I now like to hand back to Alison for any closing comments.
Alison Rose
Thank you. Well, thank you very much, everyone, for joining the call and for your questions. Look, I think Katie and I are very pleased with the results that we’ve announced a day for the quarter, it’s another consistent delivery. We’ve seen income growth, good performance for operating profit. We continue to grow our loan book with responsible lending, 5.4% increase in loan growth.
Our CET1 at 14.3% is moving towards our year-end targets. And our book is well diversified and strongly secured. We’re not seeing any signs of default in our book. Obviously, we’re being very proactive with our customer base to support them.
We continue to meet our cost reduction target for next year and remain very confident about our 14% to 16% ROTE guidance for next year with very strong tailwinds going into next year as well. So good strong, continuing performance, delivery of strategy, as you would expect, we’re mindful of the environment, both in terms of our customers and various fiscal events that are coming up, and we’ll look forward to updating you on our guidance when we talk to you in February. But hopefully, you can see strong continuing performance and resilience in our business.
Thank you very much.
Operator
That concludes today’s presentation. Thank you for your participation. You may now disconnect.
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