Royal Bank of Scotland Group Plc (NYSE:RBS) Q2 2016 Earnings Conference Call August 5, 2016 4:30 AM ET
Howard Davies - Chairman
Ross McEwan - Chief Executive Officer & Executive Director
Ewen Stevenson - Chief Financial Officer, Executive Director
Andrew Coombs - Citigroup
James Invine - Société Générale
Rohith Rajan - Barclays
Raul Sinha - JPMorgan
Michael Helsby - Bank of America Merrill Lynch
Robert Noble - RBC
Christopher Cant - Autonomous
Fahed Kunwar - Redburn
Martin Leitgeb - Goldman
Good morning, and welcome to our half year results. And my most important role is to ask you to switch off your mobiles. I was going to begin by apologizing for a rather complex set of results. But then, I realized that complex results are what keeps bank analysts in business. And so, you can look forward to an exciting Friday afternoon analyzing it.
The results demonstrate the underlying strength of our core business, generating solid operating returns in a currently low interest environment. It's been an uncertain time for banks throughout this year. Even before the referendum vote, there were, of course, signs the global economy was slowing and that lower interest rates were going to be with us for longer.
It's too early for us to predict the full impact of the leave vote on the economy and, therefore, on our own financial performance. We're monitoring our own customer activity closely and also, market indicators, and we'll have more to say about that later.
The action that's been taken over the last few years to de-risk the balance sheet, to run down non-strategic assets and focus on core target markets is positioning us well to deal with the current market uncertainty. And we're pleased that the difficult decisions taken earlier by management at a different time are giving us strength today.
We continue to work our way through the various legacy conduct and litigation issues we have to deal with. We've made a provision in this quarter in relation to the 2008 rights issue litigation and have announced an agreement, in principle, to resolve the U.S. RMBS investigations of the State of Connecticut Department of Banking. But the investigations by the Department of Justice and various other state attorneys general continue.
On Williams & Glyn, the board has taken the decision to stop work on the plan to stand up and IPO a new bank and to focus on alternative options. We concluded that the technology risk and the associated implications are now clearer than they were at the end of the first quarter. And that, combined with a more uncertain economic outlook and even lower-for-longer rate environment, undermine the standalone viability of the entity and meant that we could no longer prudently continue with the current plan. We're in positive discussions with a number of interested parties around an asset sale, and we'll update the market as and when there are further developments.
The deadline set by the European Commission for the end of 2017 as part of the State Aid obligations remains in place. The board remain confident in the fundamentals of our strategy and in management's demonstrated ability to deliver it. We aim to produce a lower cost, lower risk, higher return business focused on retail and commercial markets in the UK and Ireland, and in Western Europe.
I'll hand you over to Ross and then to Ewen, who will give you more detail, and I will return to open the Q&A. Ross?
Thanks very much, Howard, and good morning, everybody. Thanks for joining us for our first half results briefing this morning. I will start by giving you the financial highlights for the first half and then, explain how we're positioned given the uncertainty in the market. And then I'll cover the progress against our plan and give you an update on conduct and litigation. As usual, Ewen will walk you through the details of the financials.
The fundamentals of the plan remain the same, to deliver a sector-leading lower cost, lower risk UK bank with solid returns from great businesses. We have strong positions in each of the markets that we like in the UK and the Republic of Ireland and Western Europe, and we see long-term, good prospects in each.
We are halfway through our five-year plan. The core bank is generating £1 billion of pre-tax profit per quarter, and is returning 11% on equity. Costs are lower and still falling. Our capital ratio, above our target, and we have a much better risk profile than probably ever before. We're better for our customers and we are winning more of their business.
The UK is our home market and banks reflect the economies they serve. We know that an economic slowdown as a result of the leave vote will have an impact on us. But, I think, it's too early to assess what that fall impact will be. What we do know is that the UK economy starts from a position of relative strength with good fundamentals, and we like its long-term prospects. If a slowdown does occur, our funding, capital and liquidity strength means that we will be there to support the UK businesses and households when they need us.
We expect competition to increase, and we are constantly sharpening our focus on excellent service so that customers choose us over the competition. A great service experience is the key to delivering sustainable returns, especially in more uncertain economic times. We are positioned to deal with the challenges that the leave vote presents and to help customers take advantage of any opportunities that may arise.
And above the macro uncertainty, we continue to deal with outstanding legacy conduct and litigation issues as prudently as for our shareholders as possible and, at the same time, improving the core bank for our customers.
Let me give you more of a sense of how we did this quarter. You can see that our underlying performance is solid and we are continuing to take costs out. The headline figure marks the strong underlying performance of our business, which made an adjusted operating profit of £716 million in Q2.
We made an attributable loss of £1.077 billion for the quarter, driven by the various conduct and litigations issues, which I'll touch on in a moment.
Our six franchises, the core franchises that we're concentrating on, delivered an adjusted return on tangible equity of 11%, a solid return in the current low interest rate environment. We generated £1 billion of adjusted operating profit in Q2, adding to the £1 billion operating profit delivered in Q1. And we continue to focus on becoming simpler. We've taken a further £404 million of costs out of the business in the first half of 2016, and we're on track to meet the £800 million goal we set for this year.
And our capital position is strong. Our common equity ratio is at 14.5%, above our 13% target we've set for 2016. And we're ready and willing to lend, and we are clear on the business we want to write. We've seen another strong quarter of growth with net lending up 7% in our PBB and CPB franchises from the end of 2015. And so, we are on track to exceed our 4% target that we set for ourselves.
I always wanted to give you an early indication of what we've seen since the EU vote in terms of customer activity because it's the customer activity that reflects what this business is. We saw an initial slowdown in mortgage application to 15%, compared to the three weeks prior to the referendum, which has now stabilized. Some of this drop is seasonable, with July traditionally being a quieter month, probably around 4%. Consumer spending levels have remained fairly stable at an average of £230 million of debit card spending per day through June to the 10th of July. So, no real change here.
Corporates are still doing business and our flows have been solid with stable levels of commercial banking loan applications or renewals submitted in the three weeks following the referendum. We also see opportunities within our CIB franchise, particularly in currencies and rates. Volatility in markets helps this business and we've seen this over the last two to three months.
We will continue to monitor our customer activity closely. I've been commit to this being long-term trends, we acknowledge that the economic outlook is more challenging. However the quality of our book is better than it has been in recent years. And Ewen will take the time to walk you through some of the relevant exposures later.
I've shared this triangle with you many times because it's our plan on the page. We're committed to our long-term goals. But with the increasingly uncertain economic outlook, we recognize that it's now going to be more challenging for us to achieve these by 2019.
The early action we've taken to restructure and refocus our business on our core markets and dispose of any assets that didn't fit with that model is standing us in good stead today. That plan is broken down into three clear phases. In the first phase, we worked to clean up the balance sheet, getting the capital ratio up and costs out. We're now in the latter part of Phase 2, transforming the core business and working through our outstanding conduct and litigation issues.
We now need to focus on moving to the next phase of the plan, to become number one in our chosen markets, generating sustainable profits for the cost-to-income ratio at or below 50%, and a 12% return on equity. And, as I mentioned earlier, with an increasing uncertain economic outlook, we recognize that it may now be more challenging for us to achieve these by 2019.
And, as I said, we continue to work through our outstanding issues. Today, we have taken an additional £450 million PPI charge, primarily as a result of the new guidance given on the deadline from the FCA last week.
On RMBS, the investigations by DoJ and various other state attorney generals, continue. We are announcing today that we have an agreement in principle to resolve the U.S. RMBS investigation of the State of Connecticut Department of Banking, and we are negotiating the settlement documents.
The settlement amount is fully covered by an existing provision. But to be clear, this is only one part of the outstanding RMBS claims. We've also made a provision today relating to our 2008 rights issue shareholder litigation. I have no further update to give you on the FCA investigation into GRG.
And on Williams & Glyn, as Howard mentioned, the board has taken the decision to stand down the current plan of action on separating the business. We've made good progress on standing up the required technology with more than 90% of the required 625 applications successfully delivered.
As part of the planned divestment of Williams & Glyn, we assess the financial viability of the future bank in the face of changing market conditions. And our goal was always to deliver a standalone bank that generated acceptable returns to future owners, and was a solid sustainable addition to the UK banking market.
Williams & Glyn, unlike any other challenger bank in the market, was to be stood up as a full service retail and commercial bank with all the operational requirements that that entails. The mix of the business means that it needs to scale up significantly to generate acceptable returns. That was the plan.
W&G needs scale to succeed. It is now clear to the board that Williams & Glyn would now be unlikely to grow its balance sheet to the extent necessary to deliver returns above the cost of capital within the next five years.
The technical and financial complexity of delivering this program means that it had exceptionally high hurdles to clear, which is why we opened up a second track of the program to look at the possible trade sale at the end of last year.
The business we are divesting remains attractive to the right owner, with the right scale, and we have had been positive at preliminary discussions with interested parties. We will update the market as soon as we have anything further to disclose on these discussions. And this is a hurdle we have to clear, and we are working our way through the issues as prudently as we possibly can.
As we progress through our plan, we're becoming a simpler bank. We've already reduced complexity for our customers, a key driver of hitting our 50% cost-to-income ratio target. And over the last two years, our London property footprint has shrunk significantly. CPB and CIB are now fully active in only 13 countries, down from 38 two years ago. We've fully exited six including Russia, Kazakhstan and South Africa in this half alone.
And we've simplified our product range. Offerings are down from 416 to 333. We've kept the number of registered companies by 40%, and we have retired more than 100 of our major legacy systems since January 2014. We know we still have more to do but, I think, this is good progress.
The investment we've been making in our core bank is starting to deliver, and I'd like to touch on a few highlights. Digital Solutions are helping us to provide a simpler and faster service to our customers. Our business line application process has gone from 11 days to less than 24 hours on average, and the introduction of electronic signatures has reduced the mortgage switching documentation process from seven days to less than two.
We are the number one supporter of businesses in the UK. And last month, we launched the £1 billion NatWest lending fund and the £100 million Royal Bank of Scotland fund so we can support even more smaller businesses. We will see a further three business accelerator hubs opened on the next half of 2016, reinforcing our support for the new businesses across the country.
Our mobile app is one of the best in the market, and we were the first bank to be accredited by the Royal National Institute of the Blind, something that we're very proud of. Our reward current account offering customers 3% cash-back on household bills continues to grow well. It now has 815,000 customer accounts compared with 202,000 at the end of 2015. This is helping us to retain and deepen relationships with our most valuable customers.
Customers are changing the way that they bank. Digital transformation will help us build a simpler bank, improving customer experience and driving cost reductions. We've seen a year-on-year increase of 25% to 4.1 million active mobile users, with 30% of the logons to our app now using biometrics.
Customers who transferred money using our app on average, six times a second, during the first half of 2016. Since Q1 this year, customers have been able to apply for unsecured products via the mobile banking app, and so far, 69,000 had benefited 10% of our total applications.
And I'd like to now touch briefly on our Net Promoter Scores. Year-on-year we have seen improvements in NatWest Personal and Royal Bank of Scotland Business, Rol, RBS, Commercial and Mid-Corporates. Royal Bank of Scotland Business has also narrowed the gap to number one for the zero to £2 million turnover customers in Scotland. We have still a lot more to do to demonstrate further progress and being better for customers though.
Our core businesses have delivered an average of £1 billion adjusted operating profit for the last six quarters across NatWest, Royal Bank of Scotland Coutts, Ulster and the RBS brands. Our priority in this business is to reduce costs while investing effectively to grow high-quality returns.
It's clear that some of our franchises still need to do better. These are the ones we are repositioning for greater returns. In Ulster Bank, Gerry Mallon joined us as the new CEO in June. His focus is on driving a strong and profitable bank, recognizing the need to reduce the cost base. We want to increase our mortgage market penetration and improve our capital efficiency in Ireland.
In Private Banking, our CEO, Peter Flavel, has been in post a few months and has already made progress in reducing the costs. His focus is to meet more of our customer needs from lending and investments, working closely with PBB and CPB to develop referrals. Peter and his team are also working to relaunch the private banking proposition.
And finally, in CIB. Adjusted operating costs are down £22 million in this quarter, and they will continue to fall. CEO, Chris Marks' priority is to continue to reduce costs and to stabilize income. Results have bounced back from Q1 and this business has been profitable in Q2. CIB are also starting to work more closely with the Commercial Banking to deliver for our large corporate customers.
We've continued to grow our businesses in our chosen markets and the investments we're making in our front line, advisers and relationship managers is starting to pay off. Total loan growth in our PBB and CPB franchises are 7% in the first half of the year, surpassing our 4% loan growth target for 2016.
PBB UK delivered a 5% net lending increase in the first half. And performance in the mortgage market continues to be strong, with lending up £3.4 billion in Q2 despite a slowdown in June as buyers awaited the referendum outcome. Our share of new business is 12% compared to the stock share of 8.6%. But our story on growth is more than purely mortgages-related.
Our unsecured lending performance was positive, with gross lending in personal loans up 18% on first half of last year. We remain committed to entrepreneurs in the smallest businesses and our gross lending to small business was up 50% on H1 of last year. And our Private Business customer loans were up 5% this half.
Our Commercial Business delivered positive net lending for the sixth consecutive quarter, underlining our position as the biggest supporter of British businesses, and lending balances were up 9% this half alone. Our plan is paying off and over the first half of this year, we were the fastest-growing large bank in the UK, growing customer loans by over £20 billion this half alone.
To summarize, our core bank delivered another solid performance this quarter, and we continue to work through as outstanding legacy issues are within our control. Our capital and liquidity positions are strong. Our costs are coming down in line with our plan and customer service is improving. There is much more to do but we are making good progress.
The referendum result has created uncertainty and could potentially make some of our long-term financial targets more challenging to achieve by 2019. However, we are well-positioned to deal with the challenges the industry faces, ensure we can get on with the job on hand, supporting our customers and delivering value for shareholders.
I'll now hand over to Ewen who will take you through the results in more detail, and then Howard will open up for questions. Thanks.
Thanks, Ross. So, three messages for me today. Firstly, despite the attributable loss, a good set of results for the core business. Secondly, post the referendum, while the credit outlook has weakened, we've substantially de-risked our loan exposures over the recent years. And thirdly, in this new environment, while tougher with lower interest rates, weaker growth outlook, we consider ourselves relatively well-positioned to continue to capture profitable market share.
On this slide, I did want to spend a few minutes talking through Q2 results by franchise. Overall, as I said, a good set of results for us, progress against all of our financial targets that we set. Central to our equity story is the left-hand side of the slide as strong and growing core bank. Across the six franchises, on a combined basis, £3 billion of income. And for the second quarter in a row, over £1 billion of pre-tax profits and a return of 11%.
As Ross highlighted, growth in the UK continues to be well above market, that's both in absolute and relative terms. And this volume growth is having a significant shift in our balance sheet towards higher-yielding PBB and CPB customer loans. Underlying like-for-like income across PBB and CPB was broadly stable. On H1 2015, we had a much better quarter in CIB, and we had positive JAWS across the three divisions. We remain on track to deliver our cost target this year, and that's despite some recent adverse FX movements.
Turning to each of the franchises in more detail. UK PBB continues to do very well. Another quarter of good volume growth. Mortgage flow share of 12% representing annualized growth of 13%. The adjusted ROE was 24.2%, and the cost-to-income ratio, 58%. As you've seen today, we've taken a further £450 million of PPI provisions. This predominantly relates to the new FCA consultation out on Tuesday, and is my second attempt in recent months to do a full and final settlement for PPI provisions.
Post the EU referendum, we think the UK PBB should continue to be well-positioned. We expect to continue to capture share in mortgages with plenty of funding capacity given our loan-to-deposit ratio of only 92%. Ulster Bank Republic of Ireland was impacted this quarter by a conduct charge of €118 million. This relates to expected settlement costs of an industry review of advice given to track our mortgage customers.
Underlying this was good new business volume growth, the continued rundown of the track of mortgage book, further proactive management of the NPL portfolio and progress on operating cost. On a like-for-like basis, operating costs were down 2% in euros on a year-ago. With our new CEO in role, Gerry Mallon, and as the only banking group with large banks in both Ireland and the UK, we believe we are well-positioned to continue to capture share in Ireland.
Commercial Banking had its sixth consecutive quarter of volume growth. It's adjusted ROE of 6.6% this quarter was impacted by one larger, single name impairment charge. It's cost-to-income ratio was 59%. We are confident that this franchise, the clear number one commercial and corporate bank in the country, is well-positioned to continue to capture profitable share.
Private Banking. It's beginning to turn around. Peter Flavel, the new CEO, has been in role now for several months. Ross and I, as you know, have been talking consistently about our expectations on returns out of this business. This quarter's 10% adjusted return on equity is a positive step towards this. The improvement was already driven by just simple operating leverage, keeping income flat and cutting costs. However, I do recognize that as a deposit-rich franchise, net interest income will be pressured in the coming quarters.
RBS International continues to perform well in each of the four markets, very high market positions and attractive profit streams. In Q2, an adjusted ROE of 15.7% and a cost income ratio of only 35%. Post the EU referendum, we don't expect any significant customer disruption to this franchise albeit similar to Private Banking. It will face the same net interest income challenges given its low loan to deposit ratio.
CIB had a much better quarter than Q1 which as you know had a very tough start to the first six weeks of the year. Adjusted income was up 46% on Q1 and up 18% on Q2 of last year. Cost continue to come down, 12% lower than a year-ago. And the franchise made a small profit. And adjusted return of equity of 3.5%. And a cost income ratio of 76%.
Loss of pass-boarding rights may create some cost fragmentation for us. But equally we can see opportunity post the vote. With the largest UK Corporate and Commercial Bank, we have natural flows and FX, rates and financing as a result of this with an expectation of more FX and interest rate volatility.
I've talked for several quarters now about our strong funding position. We remain very liquid. We remain structurally underweight of our natural customer loan share in the UK. This is progressively getting addressed. UK, PBB and Commercial Banking have significantly revamped their service and product offerings. Our back office delivery has materially improved with much greater capacity to handle higher origination volumes. And as a result, we're growing comfortably ahead of market growth rates at the moment. You can see on the slide compared to a year ago, while overall interest earning assets are down 5%, we've had a 6% increase in interest-earning assets in our core bank.
The yield on this new business is significantly higher than the yield on both the excess liquidity we're holding, and lower-yielding capital resolution assets that we're running off. So our NIM has now improved by further 6 basis points this quarter, and 8 basis points over the last year. That's despite an ongoing mix shift within PBB towards secured, and within secured, are biased towards fixed-rate lending. With the loan-to-deposit ratio of only 92% at the end of the quarter, we think we can continue to grow above market growth rates for a number of years.
With the outlook now for a tougher income environment, we know we need to be relentless on costs. We think we're building up a pretty credible track record of delivery on this. Over the last 2.5 years, we've taken out £2.5 billion of cost or 21% of our cost structure. That's a compound annualized reduction in nominal terms of 9%. But we recognize that we need to continue to target this sort of reduction for a number of years until we get our overall cost structure back to what we consider to be acceptable and competitive levels.
We've been told by some people that we've done the easy cost cutting, and that it will get harder from here. I personally don't agree with that view. We still got a lot of latent cost opportunity across the bank. We've got firm plans to take it out in addition to the longer term opportunity to re-engineer the cost base area of technology.
Another area that I think we've done a very credible job on is reducing our legacy exposures. These continue to get cleaned up and reduced. We've exited over £121 billion of legacy RWAs over the last six quarters. RWAs in our legacy portfolios are now down to just £55 billion. That's 23% of total RWAs.
When I stood up here at the end of 2014, it was around 50% of our RWAs.
This quarter, we've completed the sale of Private Banking International. The residual operational risk, RWAs of Citizens are now off our books and capital resolution reduced RWAs by a £3 billion to £5 billion.
In achieving this accelerated runoff, we've also significantly de-risked as a result of this. But a combination of the new outlook and relatively unfavorable FX over the recent weeks does mean that we expect the run rate of runoff on capital resolution to moderate during the second half of the year. So, we've adjusted [audio gap] (30:49) target to £30 billion to £35 billion from the previous guidance of £30 billion. On disposable losses, there is no change to our previous guidance.
We do believe that we're going in to a tougher environment but equally, we are relatively comfortable with our exposures and our core credit books. We've got a very well-diversified portfolio, given our strengths in both retail and Commercial Banking in recent years and personal banking. We've strongly prioritized secured lending over unsecured. And in Commercial Banking, we've had conservative risk appetite limits so we've not allowed ourselves to get overly exposed to any single sector.
In recent weeks, UK commercial real estate exposure has received a lot of attention from the investment community. In short, we don't feel overly exposed. Given our history, we've had a cautious new business risk appetite in the sector, and we've dramatically shrunk our legacy exposure. We're the largest commercial bank in the country, so you would expect us to be one of the largest commercial real estate lenders.
Our total UK exposure is now down to £25 billion, and the average LTV is 53%. We're also not overly exposed in the residential mortgage sector. Overall, it's only 44% of total customer loans. And within this, buy-to-let is only 14% of total mortgages, well below market averages. The average LTV for the total mortgage book is 59%, and the average LTV of Q2 originations was only 68%. This is in line with the average LTV of new originations going back to 2014.
Similar to our commercial real estate exposure, our book has been heavily tested under recent Bank of England stress tests and has performed relatively well under those severe modeled scenarios. On legacy credit exposures at the end of 2013, our risk elements in lending were 96% of the bank's tangible equity. At Q2 this year, this was down to 29%. This is a result of a very deliberate and sustained commitment to derisk our legacy exposure together with a progressive improvement in the core lend books.
We've still got a few pockets of high-risk elements in lending such as in Ireland and in capital resolution. But overall, we're in solid shape to deal with the downturn on the credit cycle.
Given the recent shift in market outlook, I wanted to give you some thoughts on the new environment. Our medium-term targets of 12-plus percent return on equity, a sub-50% cost-to-income ratio, it's really too early to give you a revised guidance. But we recognized that reaching these targets by 2019 is now uncertain and is likely to be more challenging.
On volume growth, we think our growth will now moderate across PBB and CPB from the very strong growth that we've seen in recent quarters. But we still expect to grow ahead of market while remaining within our risk appetite limits.
On NIM, we've put into the back of the slide pack a breakdown of our non-interesting-bearing-demand deposits, some £85 billion at the end of the second quarter, which, together with our equity, means that we have around £125 billion of zero-interest-rate funding for the bank.
So, on the longer term, as our hedges progressively roll off, a 100-basis-point negative shift in rates, without any management actions to protect asset-side margins, would reduce income by just over £1.2 billion.
On non-interest income, we remain more positive. The final impact of the change in interchange fees will flow through this year, and we remain positive on the outlook for trading income in CIB. A weakened net interest income outlook means that we need to - reinforces the need to be relentless on costs. As I said earlier, we think we've got the discipline and drive to continue to deliver on this.
On impairments, we do expect the cycle to now weaken as a result of this. I think you should also anticipate a modestly higher day one impact from IFRS 9 compared to what would have been more benign modeling assumptions.
On Capital Resolution, much of the remaining wind down is relatively insensitive to the changed environment. So, over the medium term, while we're signaling caution in relation to the 2016 RWA targets, we don't believe at stage we need to change either the assumption that we're going to be in a position to wind up Capital Resolution at the end of 2017 or the £1.5 billion of total disposal losses to that point.
On pensions, while our current defined benefit pension liabilities are substantially hedged for interest rate risks, we recognize that in this very low interest rate environment, changes in discount rate assumptions could lead to higher levels of actuarial deficit at the time of the next triennial valuation. But as a reminder, post the accelerated contribution that we made in Q1 of this year, there's no further top-up contributions required until Q1 2020.
So, to summarize, we've got a strong and growing core bank delivered again in Q2 over £1 billion in operation profit, adjusted return on equity of 11%. PBB and CPB are capturing share, much better customer servicing, better product offering and resultingly, income has stabilized across these two franchises. CIB recovered strongly from a weak Q1. And overall, costs continue to come down.
Legacy exposures continue to get cleaned up and reduced. Capital Resolution, RWAs down by further £5 billion this quarter. And Legacy RWAs have now been less than a quarter of our overall RWAs. And on conduct issues, these are getting progressively settled or provided for.
The EU referendum does create new uncertainty for us and other banks, but we feel we're robustly positioned for this both defensively and offensively. Defensively, we've materially derisked going into the cycle. Our legacy credit portfolio is much reduced, much more seasoned, and our legacy rundown has well progressed. Offensively, we've got six strong customer franchise positions, each well-positioned to capture market share and collectively producing attractive returns.
So with that, I'll pass back to Howard to host some Q&A. Thank you.
Thank you very much. Ewen, we will no doubt get some up here on the screen, but I'll certainly begin with people in the hall, if you could say who you are. Yeah, first one here. I'm putting - I'm saying you, yes. Give your name and designation.
Q - Andrew Coombs
Thank you. Good morning. It's Andrew Coombs from Citigroup. I have three questions all relating to the net interest margin. And first one, just as an insider, will be on Ulster Bank. The asset rate there has actually come down quite meaningfully Q-on-Q, 2.33% to 2.07%, interested in the rationale behind that. Then two more, two bigger questions I guess.
The first one, if I look at your UK PBB margin, that's actually improved dramatically Q-on-Q. It appears to be due to quite a rapid decline in the customer funding rate. The first part of my question there will be does that mainly relate to the cut you put through in your main variable savings rate products to 25 or to 0.25% during the quarter? And if that is the case, how much flexibility do you have to cut further in a lower rate environment on that product? And then my final question on TFS. Given that you haven't re-tapped the FLS, given that you have a deposit overhang, would you look to use TFS?
Do you have nothing there, Ewen?
I'll spread them around later.
On taking the last one first, Andy. On TFS, I mean, we'll obviously look at it. I mean, as we clearly said today, we're extremely liquid with a 92% loan-to-deposit ratio. We haven't had any difficulty lending, given the growth rates that you've seen in first half. So, we welcome the package of measures. But I think it's more directed at other banks other than us. But if there's an opportunity to use it, we will.
You are right on PBB UK, it's mainly because of a cut in current deposit rates. On the asset side, I think we've continued to see a migration from standard variable rate to fixed rate. Standard variable rate is now down to 12% of the book. Actually, for the first time, we've actually seen some growth in some of the other portfolios as well. Unsecured has started to recover and Business Banking is back up a bit.
Is there an opportunity to cut rates further in PBB UK? I'm sort of looking at less at the moment, but yes would be the answer to that. But obviously, I mean, so far, you can go towards zero. And then Ulster, look, I mean, I think Ulster, it's a euro-based bank that's beginning to feel the meaningful effect of interest rates in that environment.
Okay. So, to your right immediately, with no jacket. We don't discriminate sartorially here.
Sorry about that. A little bit warm in here. It's Tom Rayner from Exane BNP Paribas. Maybe I can have three questions as well, please? First one on the structural hedge. Ewen, you gave some sort of figures in your speech. I mean, it looks like a potential headwind of about 30% of core profits, and you said ex-management actions. I wondered if you could talk about what the management actions might be and how effective they might be in offsetting what could be quite a big headwind.
Second question was on the litigation provisions. I don't know if you can say how much of the other litigation provisions do relate to the 2008 rights issue because, again, just trying to get an understanding what your assumptions that you're making when you take that provision. Are you assuming that you're going to lose any court case?
And then my final question on Williams & Glyn. I just wondered if you could remind me the status of the convertible bond, how old is it and how that may affect any discussions with the third party? Thank you.
Okay. The first one is Ewen, the second one is Ross. Third one, I don't know if I have a bidder.
Unidentified Company Representative
I could say Ross as well.
Look, on the structural hedge, we have a hedge today. We've got £122 billion. So, that progressively rolls off over the next five years. So, you'll see a progressive impact through the P&L over that period.
In terms of management actions, well, it's not a sort of complex, I mean, growth asset side margins, on the liability side, repricing down towards zero. I think, increasingly, you've seen a structural shift in terms of, yeah, we've started with things like the reward account. Well, we've now got 800,000 customers paying us £3 a week - a month for that account. We've got about one on five of our current account holders now paying us fees.
And then on costs, I mean, it just continues to sort of emphasize the need to be relentless on cost reduction. But I think - having said all of that, it does feel that, given this interest rate environment for the UK banks, will drive us to structurally lower our profitability for a period for the UK banking sectors.
Let's move on to the litigation decision. We have put numbers in the accounts here that would be fit. So, we're not going say what the numbers are because we are having a negotiation with the litigants.
You'd normally do get through a process of mediation before you hit the court because often the first question you get asked when you get into the court from the judges, have you been through some form of mediation.
We went in good faith into that mediation. We didn't get a resolution. But having gone into that, we didn't need to make a provision. We haven't disclosed it for obvious reasons. We would like to have solved it, didn't get it done and it does now look like we'll head into the courts and it will be a long one, which is a shame, but never mind.
On the convertible bonds, that's about - our behest is to win. We can convert that and we'll take that timing over the next few months to work through that one. It's not part of our capital stake.
And it doesn't have any impact on our ability to sell the business. They've been good and supportive investors about that.
And just to remind of why it was there, they posted a question out there. I think it was a very good strategic move to have an initial investor in an IPO. You immediately had 30%, 35% of the float taken away, which means you get down to below 50% very, very quickly. So, I think it was strategic. It was a great move, but obviously now unnecessary. Now, our next is....
Next. Immediately to your right. Yeah.
Thank you. [Indiscernible] from Bernstein. Two quick questions. Ewen, on mortgage RWA density. It seemed that go up from 7% to 10% in the last six months sharply. If you could say what's driven that. And secondly, if house prices come down probably, say, 10%, so what kind of RWA migration would you see? So, that's number one.
And the second one is on your PVA deduct. The PVA deduct also in terms of capital, that's increased in the quarter. So, what's driving that? That'll be all. Great. Thank you.
Okay. What deduct has come...
Sir, your prudential value adjustment?
Right. Okay. So, look, on RWA density and UK PBB, there was some modeling adjustments during the quarter which was the main reason for that summer in the back, you can see the breakdown of that. It was about £3.5 billion, I want to say, of RWA because of modeling changes.
Probably, the best way to look at stress sensitivity on RWAs is to actually look at the recent PVA stress test where, I think, you sort of get to numbers of about 15% increase in RWAs as in 2018 as a result of those stress assumptions. And then, you can sort of adjust accordingly depending on how severe you want to stress our numbers.
Look, on the deduct, I think that's mainly driven by a pretty severe shift in interest rates in the last few days of the quarter.
Directly behind you. Then, I'll come to - Yeah. Thanks.
Hi. Good morning. It's James Invine here from Société Générale. I've got two please. The first is on CIB. Ewen, you sounded a bit more optimistic about the trading revenue in CIB, but you still want a lot of the balance sheet to come out of that business. So, I think it's about 20% of risk weighted assets and 40-odd-percent of funded assets. So, I was just wondering, how much of the revenue in the first half that we saw is attached to those assets that are going to be disappearing?
And then the second question is just on your continued equity issuance to pay the pref dividends. Is that linked to the Williams & Glyn situation or that is just your own conservatism on capital? Thanks.
On the second one, we have agreed with the BRA that we will continue to issue £300 million of equity issuance until the point that we have the ability to return to capital distributions. So, you should just assume that that's going to be a continuous feature of our equity issuance through to the point of distributions again.
On CIB, you're right that the target is to get down to £30 billion of RWAs versus about 36% in Q2. I don't think the revenue base, they'll be as - I mean, our forecast, medium-term forecast, when we've talked about £1.3 billion of revenues last year and the assumptions that we need to get back to cost of capital returns are based on very modest income growth of that £1.3 billion. It's mainly - the CIB return story is mainly a cost-cutting story.
But in terms of what those asset have generated in the first half, do you have a number on that?
Yeah. I'd have to get you the detail afterwards.
Chris has got them.
Chris, do you have any on-hand detail on that?
Well, maybe because it's actually - there's a pretty detailed plan to what [indiscernible] by industry measures. And a lot of the movements [indiscernible] more clear basis.
Movement of the derivative book to a more clear basis. There's still capital tied up in unclear derivatives that will change over time. So, we've got a pretty granular plan about how the current balance sheet, current capital consumption and current leverage of the book - the business consumers moves to the target and state model. And it doesn't involve an erosion of future revenues or capacity for future revenues.
I'm going to take one from the webcast. Given Brexit and the resulting impact on Ireland, what are your thoughts on Irish reserve releases?
So, look, the - I mean, as you've seen in recent quarters, I think Irish reserve releases have been slowing down. I'm not sure that Brexit has any undue impact on that other than whatever your views are on the impact on Irish real estate valuations. But I think increasingly, Irish reserve releases is less and less of a feature of our equity story.
Thank you. Yeah. In the middle here. Thanks. Was it [indiscernible]? Thank you.
Thanks. Good morning. It's Rohith Chandra-Rajan from Barclays. A couple for me as well, please, if I could. First one on Williams & Glyn. Clearly, there's quite a significant change in the plan. It looks like you're halting the program, but there's no change to the restructuring charge expectation, I think, you previously said about £50 million a month, and restructuring charge in the quarter was, I think, £187 million. So just curious as to why you're not expecting a change in restructuring charge and what the plan is from here.
And then, also, if you're expecting there to be any renegotiation with the EC in terms of structural timing. And the second one, just a quick one, if you could update us on US RMBS whether discussions with FHFA or DOJ have begun and what your expectations are on the time line there please?
Jon, deal with the first one of that.
Unidentified Company Representative
I'll have gone back and say giving you a bit of a break. First off on DOJ, no news on that one. Still obviously communication but there's no negotiations going on whatsoever on the charge of the price. Still feeding information, so as Howard said, there's no update on it.
We did have one settlement that was disclosed around Connecticut, which is a smaller settlement, so we're pleased to get that one tidied up, but nothing else on RMBS from either FHFA or DOJ. So, those are still sitting there. And we do know that others are talking, but we've always said, we're probably the last in the list given the court date times that we've got. I think we're 17 out of 17.
Williams & Glyn, we haven't done any re-planning since the board made the decision to actually halt option 1. We will do some planning around the numbers. There will be obviously some costs outstanding down the program, and we'll also look at the cost of ongoing of moving towards the trade sale, as opposed to an IPO which will be moving through. And we haven't had any conversations with the European Commission about changing these with the timing. We're still working towards the end of 2017, but we've had put in our disclosures that this could be a problematic time for us. So working through those.
Okay. I've got one more from the webcast. On mortgage lending, is LTV your main criteria for mortgage lending? Do you have other criteria, for example, linked to the borrowers' available net income? Do you want to do it or do you want to [indiscernible]?
Both. We have maintained in our mortgage lending, along with other lending related to income, actually quite a high level of interest rate expectation from customers not the 2% or 3% or 4%. There's always been a quite a large buffer on top of that that we measure. Their ability to pay is north of 2%, so it is LTV. It's the quality of the asset and it's the quality, ability of the individual to pay both today and in the future based on what we know. So, we've been very strong in that.
And we haven't changed that at all as well. I'm looking at less. I'm not aware of any changes over the last even three years.
Stayed up quite [indiscernible].
Hi. Good morning. It's Raul Sinha from JPMorgan Cazenove. If I can have a couple, please. Just the first one for you maybe Ross. On the broader impact on margins on RBS, often measures that were announced by the Bank of England yesterday. If you look at what the Bank of England seems to be suggesting, they are trying to imply that the TFS is - the scheme is constructed such that the negative impact of the rate cut on the banks should be offset by obviously the chief funding available. Now, I think that statement is valid at the industry level but, clearly, that might not be true for individual banks.
So, I was just wondering, to get your thoughts on, given the fact that you're the largest commercial lender and you've been growing your mortgage book significantly and, obviously, liquidity position, does that sort of end up at the more negative end for you?
And also on the corporate bond scheme, obviously, do you expect that to lead to spread pressure on the corporate side?
I'll pick up the first one. Certainly, we have worked this through the system. We have to see what impact. As Ewen said, we're at a 92% loan-to-deposit ratio. So, we're well-funded for lending. So, we just have to work through how this comes through into our funding. I think there are really positive moves because government accounting basically said there's money to lend, stop saying there isn't, let's get on with the job. And the other that I think very positive thing he said yesterday was we are not going negative because that has been, I think, major concerns for banks and probably yourselves.
So, I think some two very clear signals here. Hit the flow through. If we can use it, we'll use it. And if helps us - well, the aim is to help bring down the cost of funding, and I'll take those as positive. We just haven't worked those through our book yet.
Okay. Just another one if I can.
Maybe for you on the credit environment and impairment outlook. For a long period of time, over the last sort of 12 to 18 months, you've had releases and very little impairment. But for the last two quarters now, you've taken the provision charge in shipping. This quarter, you've had oil and gas. In your outlook statement, you make a relatively cautious statement about the large single NIM exposures. So, would you encourage us to start thinking about a more normalized level of impairment going forward? And can I ask if you have an idea of what that might be for RBS in the near form?
That's an excellent question. We've had long debated what normal is and I don't think we have a view on what normal is in this interest rate environment. I mean, if you look at risk elements in lending for the last couple of quarters, I think the core books have basically stabilized. They're not improving, and they're not deteriorating.
If you look at the impairments that we had in Q2, they were largely in areas that we're already under stress. Oil and gas, metals and mining, shipping. So, it's really sort of too early to see the direction of travel and new areas on the book. I mean, the other place you can obviously look is the Bank of England stress test at the more extreme end and work back from that. But we're really struggling to say what is normal. Do we expect them to [indiscernible] a bit higher, yes. But we're in a very abnormal interest rate environment. So, we're not sure we're going to back to historical precedence, provides much guidance to people.
Thank you. Yeah. In front. Thanks.
From HSBC. In the past, you've talked about RBS being a business with about £12.5 billion of revenues and is about £6.5 billion of cost by sort of 2019. I appreciate the revenue outlook is going to be weaker. Could you, maybe, update your expectation for the cost figure or, perhaps, explain how the cost base could be pushed lower from £6.5 billion?
Yeah. I'll pick that one up. We are - look, we have been working towards getting to £6.5 billion. And we've got a pretty clear plan on how to get to that with income being under more pressure. My executive team are working through the plan now for a lower cost base for the organization. We haven't finalized that. We're in the early stages of it.
I think you'll probably see something from us in the first quarter of next year before we come out and make statements on that one. But we have been working towards the £6.5 billion. And not just on the last month but over the last six months, we've been working through. Interest rates are going to be lower for longer and we need to adjust it.
And I think that we have got is you're seeing a lot of significant changes in customer behavior and banking as well that we need to actually take into consideration. So, a lot more customers both in the business scenes and in an individual scenes wanting to just do things on the mobile phone or online which actually has quite a big impact on how you structure yourself. And we're having to think about that from front to back of the business. And our Chief Operating Officer is working with the business as how do you process accordingly electronically. So, there's big changes from the customer end that we're also looking at. And I think we'll have some significant impacts on our cost structure going forward and then, of course, technology to help.
Thanks. Yeah. Let's go here.
Thank you. It's Michael Helsby from Bank of America Merrill Lynch. I've got two questions, please. First on - you mentioned the reward current account, and I must admit it is fantastic and I'd recommend everyone to get one.
Can we get that on video, please? Just get that and we got to play on national TV for you.
Really, it's good. I guess because it's so good, as a customer, I feel the benefit because the rewards outweigh the fees. But from an analyst's perspective, I worry about that because you're talking about the offset from the fees. So, I just want, in an aggregate level because I appreciate maybe I'm a bit different than everybody else from that perspective, what - is - does it wash out and do the fees cover the rewards?
Yeah. I think it's embarrassing for any analyst to confess not to being a good customer but a partner.
It's a great question. The answer is fairly simple. So, the answer is twofold. One is when people take out the reward account, what they end up tending to do is keep much higher balances in their current account and they tend to use it a lot more. And that means they get even more familiar with the bank and they tend to like some of the things that they see. And then, generally, they end up buying more products from us.
We've now had it out for actually almost a year. And what we're seeing is that the percentage of people who are taking additional products is higher, a bit higher than we expected. So, it is actually meeting the goals that we had. And then the good news is we don't have any interest on that account, but one or two of our competitors do. They might be thinking about that.
Thank you. Sorry.
Yeah. You said there was a second one.
Second question is just on your approach to the mortgage market because you're putting up some blistering numbers at the moment, and I think one of your competitors - clearly, with a lower interest rate environment, and it's a low risk book, one of your competitors is hoping that the price dynamics might change i.e. prices might go up.
What we're seeing in the market post-Brexit is that prices are coming down, and banks - because it's the lowest risk lending that you're doing, the appetite to do more mortgages seems to be going up as well. So, I was wondering if we could get your perspective on that from a new business perspective but also from - I saw Barclays - I was going to - [indiscernible] yesterday what your approach is going to be on that one. Thank you.
I'll take that up, and then we'll see the delays current interest in our 9x9, but it's been interesting. The ones that have kept their price, this process is actually still higher than ours, considerably higher than our 4%. So, that's just another advert for why should we be doing business with us, not with somebody else. But we will going to be reviewing all of our pricing over the next week or so as things flow through.
We have been very cautious in the mortgage market. Ewen gave you the loan-to-values. We haven't changed any of our policies for chasing. What we've been doing is building distribution. We've been doing it for four years now. And that's been our strategy, build distribution, get your people really skilled and qualified, and work with a broken back, and bet away.
I think there will be more competition in this marketplace. I can't see prices going up particularly with the moves we made use today by the Bank of England. I think you are seeing them wanting to put money into the marketplace and to keep things coming down. So, I think you're going to see more pressures here. We just need to make sure that we don't chase these things down ourselves. I know Les has been doing some technical pricing pieces in certain segments of the marketplace. But we do like mortgages. As long as we don't end up on the same mess that the industry ended up 10 years ago.
I might just add that the board through the Risk Committee, with the help of their Chief Risk Officer, keeps an eye on the progress of this and make sure that we are not growing out of appetite. We are currently within the board's defined risk appetite.
I think that's really important.
And the other point, Michael, I mean, when you describe it as blistering growth, we had 12% flow share. Current account share is 16%. I think that's more a statement about the lack of growth of some of our peers rather than our growth.
And the other thing we have had - we had a 92% loan-to-deposit ratio. So, we are open for secured mortgages as long as they're good, secured mortgages.
Yeah. The next one there, I think.
Hi. It's Robert Noble, RBC. You increased the estimate of your interest rate sensitivity on a decline of 25 basis points. So, I was just wondering what drove the increase in your estimate for a rate cut there? And also what value of loans on your balance sheet are variable rate? Thank you.
Variable home loan rates are 12%. They're on an SVR. The bulk of them are on a fixed rate and is a small portion, I think about 9% that are on a tracker type arrangement.
So, the bulk of our lending is on fixed rate and most of that is on [indiscernible].
Yeah. On that specific question, I need to - we'll need to get IR to come back to you. But the numbers that I'd focus on, and I think you should focus on is the overall £122 billion of structural hedges we've got on. And that progressively rolling off over a 5-year period. So, I would actually focus less on that table because it shows you just the one year impact. And we are into an interest rate environment now with I think you're going to see the full impact roll out over five years.
Thanks. I've got one more from the webcast and I'll come back. Williams & Glyn. Does the new plan for trade sale involve higher or lower exit costs than the previous plan?
So, look, I mean, as someone said earlier, I mean we have been spending £50 million, £60 million a month. There's probably around about £200 million of break costs associated with what we announced this morning. There will be incremental costs involved in a trade sale. If you think about, - ultimately there's two ways to separate out Williams & Glyn. One is to put it on to its own separate platform and sell the platform. The other is to migrate the customers unto someone else's platform. That still involves quite a bit of complexity and quite a bit of cost. So, I wouldn't assume that the overall timetable has changed materially.
I think probably what has changed is probably the point of getting to certainty as probably being brought forward, because it's not dependent on a back-end weekend when you need to migrate the customers on to your own system. But the overall timetable to completion probably hasn't changed materially.
Yeah. In the middle there. Can we have the...
This way, sir. Thanks.
Good morning. It's Chris Cant from Autonomous. I just wanted to come back on this point about your loan to deposit ratio being quite low, and your ambition to essentially fill that gap with lending growth. Obviously, that's going to be more difficult in this environment. I'm just thinking about how this interacts with your ambition to improve your Net Promoter Scores. I know the disclosure you've given today quarter-over-quarter shows a tick down in Net Promoter Scores for a number of your brands. And I'm just thinking about how that's likely to trend if you're forced to try to price away liquidity. Because you can't actually deploy it into lending, is that going to constrain your ability to improve your relationships with customers? Thanks.
A good question on the Net Promoter Score. Most of the drop was in our business banking area are nothing small until we've changed the model there, which will embed over the next 6 to 12 months. It was interesting. We changed the model in the mid-market commercial space. Our Net Promoter Score changed while customers actually got used to the model. And now, it's the highest in the marketplace, I think, number one in customer set for that mid-market.
We expect that to bounce back also in business banking as the customers get used to a model which is quite different, but very open for them to make the phone calls anytime they like and get somebody. So, I think, there's a piece of work going on in our customer service delivery and model change that's hit our customer service scores more in line with [indiscernible].
But as long as our pricing remains, I think fear in the marketplace, I think it doesn't impact so much to how the customers feel about us. When you get out of [indiscernible] with pricing in the marketplace that they start to worry about you and not be as happy. But it's really service delivery that they like which hits your customer service metrics.
We're running over time, but I've got a couple more I'll try and get in. One over there, and then I'll come back to you.
Hi. It's Fahed Kunwar from Redburn. Just a couple of questions on the core Tier 1. So, just following up on the RWA inflation of £3.9 billion, and it's quite big and we haven't really seen it from your peers either. I mean, is there a further impact here from the consultation paper put through from the PRA? I think it was last week on mortgages.
And the second point, which is a clarification, the pension hit. So, I'm going to say, it's top of the 2020. But can we expect another kind of, in the next few quarters a rate, a hit from a reduction of discount rate? And is using the EBA stress test hit a decent way of flexing how big that hit could be?
So, on the second question, no. So, legally, we don't have to agree further top-up contributions with trustee until after the next triennial valuation. The next triennial valuation is at the end of 2018. We then have a 15-month period to conclude that renegotiation which takes us until Q1 2020. That is very, very limited ability of the trustee in any point in that period before then to come back and ask for additional contributions. So, for modeling purposes, you should assume that there's no impact until Q1 2020.
On the £3.9 billion of RWA inflation, it wasn't related to the Bank of England paper. We're still sort of working through that. We do think there'll be some modest RWA inflation that will come as a result of that. I think, overall, it's probably within the balance of what you may see come out of Basel 3 plus 4 anyway in the next six months, so...
Okay. We have to take the last one here. Thanks.
Yes. Good morning. Martin Leitgeb from Goldman. Two questions please. The first one just a follow-up on your comments on competition mortgages and also you're more cautious outlook for volume growth from here. Is the tone in volume growth mainly driven by expectation of system loan growth to slow down somewhat in light of the referendum outcome or do you see the risk that your share of flow, which you say it was around 12% over the last couple of quarters could come under pressure as probably more people, more companies get access to cheaper funding via the TFS?
And the second one is just briefly to touch on credit risk in light of the expected slowdown in economic activity. Obviously you provide good disclosure in terms of your mortgage book and also commercial real estate. In terms of SME book and - how should we think about the resilience of that book to a potential slowdown? Thank you.
I'll do the first one. Our estimations around the mortgage [indiscernible] and we're at system loan growth as oppose to us losing share. I think we've built up the distribution to continue to do pretty well and work above our system of share. So, it is more of system growth that we saw coming off. And even on the credit risk, it sort of relates back to the other question that what do we see that...
Again, the best thing to look at is the result out of the Bank of England stress test results last year. What you see in these sort of noncommercial book is the absolute level of non-CRE commercial losses in line with Lloyd's and behind Barclays despite us being a bigger lender to the commercial real estate sector. But you can look at that and then do your own adjustments.
Unidentified Company Representative
I think we better wind up, but, Ross, just a couple of points before we finally close.
Sure. Thanks very much. I think the results here showed that we are making good progress working through the litigation issues, and transforming the bank back into a really good customer bank. We have been generating £1 billion of profit per quarter pre-tax for the last six quarters. So again, a really strong consistency there. And we are showing growth in the quarter for this bank, which is what we are set out to achieve. But it has to be good, solid, long-term growth as opposed to growth at the expense of our risk factors.
We are stronger. We are showing resilience even as things do slowdown in the marketplace. And we've got good funding here to actually keep going in the market. And we, as I say, we are the fastest-growing large bank, which is something that we found ourselves looking at saying, we're the one growing this marketplace. If you contrast that three years ago, we were the ones being criticized for not being there and not being there for customers in lending. So, I think you are seeing a stark difference between the bank we were and the bank we are. We are very focused, UK, Republic of Ireland business with good offshoots in Western Europe.
So, I think we still have things to do and we now got the conduct and litigation that we've been trying to be as open with you about what those issues are and we still have RMBS. We've add on that list 2008 rights issue. We add on that list GIG. We've had on that list all of those Brits pensions and things. And we're quietly ticking off these things. So, were getting there.
Thank you very much for your time.
Unidentified Company Representative
Yeah. Thank you for coming. Thank you for your questions. Look forward to reading your verdict. That's my exciting Friday night. Thank you.
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