NatWest Group plc (NWG) Earnings Call Transcript & Summary

Thank you, everyone. Welcome to the European Track of the Barclays Global Financial Services Conference here in New York. I'm Amandeep Rakkar, I lead coverage of the U.K. banks research team at Barclays. I'm delighted to be joined here this morning by Katie Murray, NatWest Group CFO. Katie, thank you very much for your time.

Lovely to be here. Good morning, everybody.

Cool. So to kick in -- to get into things, many U.S. and international investors with us today will be worrying about an uncertain macro backdrop in the U.K. and the implications for its banks. Given your unique vantage point, I'd be interested in your assessment of the operating environment, how would you characterize the outlook for your business?

Look, I think it's important to -- first of all, kind of just confirm the business is performing well in this environment. We structured it so that it can perform well in both sort of higher and lower rate kind of environments. We still haven't maintained our guidance of this 14% to 16% royalty in terms of what we believe we can deliver. But certainly, there is a lot going on in the macro. We can see that inflation has remained a bit higher and a bit longer than people expected it to. But I think what's really important against that is I will say, wage inflation is kind of slightly above and that's causing different challenges. But it means from a kind of cost of living and an impairment perspective, actually, our balance sheet is relatively secure because they -- although people are seeing increases in rates, they're also -- that's been paid for by their wage inflation. So there is the kind of inflation angle. Interest rates, you all watch it closely. They've gone up significantly and very quickly. In our own models, we had them going up to 5.5% at the last rate hike, they actually went up to 5.25%. The next meeting of the MPC is on the 21st. We'll see what we do there. And I think certainly, the narrative is and the market expectations is maybe the rate rises aren't over, but we're getting to the end of those rate rises. So whether there's another 25 or 50 basis points to come to over a couple of hikes. But I think for us, as I look at macro, we feel comfortable, we're able to deal with it. We've had very good performance in the first half of the year. We continue to perform well. I'm very comfortable about the maintenance of that 14% to 16% royalty number.

I guess, recent developments on the senior management from CEO departure, the recent appointment of -- recently announced impending appointment of a new Chairman, interested in any reflections around the impact on the management team, the business, is there a chance of a shift in any strategic direction from?

So I think what's really important to say is that the transfer over to Paul Thwaite was incredibly well managed. It was known and that he would be the succession candidate, if there was any need for a short-term success to come in. And that was something he was aware of, the Board was aware, we all aware of. So that I think was really helpful and important. And I think from a strategic perspective, he has been intimately involved in the development of the strategy that we announced. He is a fully fledged CEO. If he needs to make any strategic changes, he must look at them and propose them and Board will ultimately kind of confirms in the set strategy. So -- but I'm not concerned about a change in direction, if anything happened, it would be some kind of tweaks around the hedges. So very much, I'm part of getting to where we are today and I'm very much part of the delivery of that. And what's been really interesting is for the business because Paul is very well known. He's been with the business for 20 years. He's worked here in the states, he led the C&I business with Robert Begbie, very well known in the organization. It's been pretty seamless in terms of actually the transfer from one to the other, mainly because he has been such a big part of things. The search for the new Chairman was already announced. It was all very much underway, so it's progressing kind of as planned. And then when Rich, who I met a couple of weeks ago is in place, he will then take your views to what to do around the CEO in the longer term. But for the moment, Paul is very much behind the desk and driving the business forward as you'd expect him to.

I guess a related follow-up question, it's a key question that we get from investors that we speak to is the kind of extent of government involvement in the running of the business or that relationship, noting that the U.K. government still owns a significant chunk of the share base. I mean, is there anything you can kind of shed the light on there in terms of that relationship?

No. I mean I think this is the fifth time we've done this conference together in terms of that piece. And what I can absolutely say is, kind of hand on heart is throughout that entire time. When I meet our UKGI on a monthly basis, they haven't been involved in the day-to-day running of the business. They'll have some views on Rainbow, but you would expect any major shareholder to have some views on Rainbow as well. So kind of typical, and it's always been very comfortable to be able to make that statement. Nothing has changed. And since the moments of late July, I think what investors need to see is the comfort that, that really is the case. But certainly from what we're experiencing on the ground, I think the particular circumstances, which we can all kind of recognize, but they have always wanted to make sure that they were independent and very much decorated entity on my agenda. Just to give you a kind of point of detail, the very first, NatWest agenda says, please do not pass over any insider information in terms of that piece. So I think it's really -- they do want to be a kind of [indiscernible]. I think the job that Paul and I have is to make sure that we're building a business, it's delivering to our 14% to 16% return. We're managing a 13% to 14% to enable them to do their continued sell down, which they've been very public about doing, and we are very keen that they continue to return us into private ownership.

I guess turning focus to revenues, NIM, key driver in the investment case, domestic U.K. banks, I guess, pressure in recent quarters has seen a lowering of market expectations for net interest income. And that's primarily driven by rising deposit costs. Can you talk about the major drivers of revenues from here? And in particular, we might expect some stability in net interest margin and income in the coming periods?

Yes. So I take you to kind of what we talked about when we met at the end of July, we've got the target of around GBP 14.8 billion for the year in terms of income. NIM is certainly one of the main KPIs. I would say though, for us, it's an output rather than the original driver. I'm very comfortable to take which are income accretive and royalty accretive, but could be NIM damaging in terms of that piece because I feel actually in the raise that, that's very important. And I think actually, the deposits are a really good example of that. As we've seen money is transferred from kind of instant access in current accounts into term, obviously, we've tried to make sure that it will go into our term accounts rather than others. So while that has an immediate kind of impact on the NIM, it's more valuable for us to keep them on balance sheet than it is to not offer that product and have them go elsewhere. But do you think it's important when we look at NIM is to understand is, it is a very important KPI, but for us, it's a bit of an output of the actions that we take rather than the kind of solid drivers. So then when I look at what's kind of driving that kind of NIM. So obviously, what's happening on deposits, we were stable at the end of Q2, what we said was to kind of stable from there onwards. I think what's really impressing is the shape of those deposits. We think that they're now 11% kind of fixed versus things we're at -- 4% or 6% when we've kind of started. So that piece, obviously, has as an impact on it. So the timing of rate rises. I mentioned earlier already that we thought it would be 50 basis points in August, it turned out to be 25, that has a little bit of a -- I mean that's a short-term impact in NIM bit. The timing is as they may happen, what pass-through decisions that we make as that kind of comes through. And then also what's kind of happening in the mortgage market. You know that we're in this kind of period of transition where we had written mortgages at very high rates in kind of 2020 and '21, and they're kind of all kind in the final stages of rolling off. But we can see that kind of working its way largely through the book by the end of this year. There'll be a little bit into early next year. So that kind of sort of balances down. So what we sort of said was that we'd take it to of around 3.15. That does mean that in Q3 and Q4, you'd expect the NIM to be lower in the second half than the first half, the average down to 3.15. So I think it's important not to be surprised when that comes out to be the case. But I do think what's really important is the management of income and the management of the ROTE, is in that you're managing the whole balance sheet and all of the activity that we do, not just the net interest line.

I mean deposits are a key source of market focus at the moment, key sensitivity for earnings. We're seeing deposit costs rise, I mean a backdrop of rising competition political pressure, evolving customer behavior, in particular, mix shift, the transition from noninterest-bearing current account, things like term deposit. History suggests we potentially have some way to go on that transition if we look at pre-financial crisis, for example, what -- where do you think mix can settle from here?

For me it's one of the most interesting questions. And I think, particularly in the states, you've also had different behaviors because of the kind of the prevalence of money market funds. But as I look at it, if we think of our noninterest-bearings or NIBs and our interest-bearing with the IBs, we were 40, 60 for many quarters. And it seemed it was really stubborn, they weren't moving. And you kind of felt that it didn't feel kind of quite logical. In last quarter, we went to kind of 37%, 63% in terms of NIBs and IBs kind of balance, and that was the beginning of that transition. I would expect that transition to continue. And if I look at the assumptions we made for the end of this year and as we look forward to our 2025 guidance that we are expecting that to continue to move. I think what's really hard is to where does it land? And I'm not convinced that history is the best dictator of where it would land. It's what we would we look at all the time to try to kind of get there. But I've been surprised that -- how slowly they had moved to date, getting up to 11%. And then what I'm really interested is if we have only 1 or 2 base rate rises to go, does that mean it starts to stabilize as well and customer behavior kind of stables out? Then you balance with all customer behavior lag, so there's still more to come. I do think what's going to be very interesting, and we'll see, I think, some atypical behavior where in the past, we've seen kind of pass-throughs much more linked to the base rate rise. What we do know is that many of -- ourselves and many of the peer groups have got significant TFSME, which was some funding that was given during COVID into banks to repay and that repayment starts in 2024 and goes on, I think, out to 2028. And I think as people are trying to secure some of those balances, you'll start to see some changes, I think, in terms of how they do some of the pass-through. And some of them, I think, will be quite short term. They'll be looking to raise particular amounts for certain periods and then it will kind of moves itself out. So I would expect it to be a movable road from the back side as we move forward from here. And I think customer behavior will be very intriguing. One of the debates that we have, and I know you have it as well a lot is, if you haven't moved now and is already 5.5% available, what percentage are you waiting for to move your excess funds. And I think it's interesting. And then to think of you get the best returns if you're willing to tie your money up for a year. People when we particularly see this as an SME market, they really value liquidity, and actually the tying up of fund for a longer period of time is something that they value far less. So I think there's a lot of twist and turn that we have made. We think, pretty prudent assumptions in terms of where we think it will go. We're not at the point of where it got to a history yet, but we continue to watch and we'll update those assumptions as we move forward. But I do think it's one of the things -- it's the hardest to know at the moment in terms of that piece. And clearly, the financials of a current account or even a incident access account versus the term account are quite different. But to make sure you kind of have that balance. So we were very pleased to see kind of stability in volume. And obviously, term accounts are very valuable to us from a liquidity perspective. So although there might be a smaller margin on them, they are very valuable asset for us and the liabilities that we are holding on our balance sheet.

I guess just to round up the discussion on deposits. The FDA's implementation of consumer duty at the end of July, most notably a 14-point action plan on cash savings. Interested in your thoughts on the extent to which consumer duty might affect your business, the industry more broadly. Is this the kind of thing that could see pass-throughs rise, these cuts?

I think what's important to see, obviously, as a large kind of high street bank. It's something that the outcome for our customers, something has been key to us all along. So we probably expect to see lesser impact on our institution. It's going to a big program for us as we've kind of gone through to make sure that we've got the right things in place. What we don't have is a history of back book versus front book pricing or things like there's some very small pieces in some kind of remote parts of the bank that we need to deal with, but they're actually immaterial in terms of that -- piece of that, I think, is very helpful as we move kind of forward from here. I think while it's gone in place. The Board itself has tested, it's all up and working only a year from now. So we still got a huge focus in terms of actually are we in the right place. And I think the FDA is also working at what it means for them. We have seen other players in the market. Make some significant changes to their fees, I mean, across different aspects, not just in banking. So that obviously shows that -- it's a piece of legislation and guidance that's needed to make sure that you kind of get to the right place. But at the moment, we're obviously taking very seriously, we have a significant project led by one of our senior executives on the ground on doing that, but we don't see it having a particular impact on a day-to-day basis.

Great. Remote shift to the ARS questions. We have the remote handsets on your desks. We've got six of these questions. I'll do a couple now and then we'll do some later. Question one, please do participate if you're in the room. So what would cause you to become more positive on NatWest shares? Number 1, better NII. Two, better fee income. Three, better cost savings. Four, better asset quality. Five, distribution. Six, reduction in U.K. government stake. Seven, clarity on UK macro.

A pretty emphatic point, isn't it? So we're here in terms of the responses. Look, I think any business in any country, stability and clarity on politics and macro is clearly -- it's very impactful. And then I need to make sure that I do the best I can on numbers 1 to 5 because those are things that are far more in, far more in my control.

Yes. Question two, what are you most concerned about at NatWest? 1, weaker earnings. 2, weaker capital. 3, low distributions for reg risk. 5, political risk. I guess that's in the context of a subdued share price for U.K. banks. Again, political risk, followed by weaker earnings. Question 3. How are you thinking about NII into '24? Number 1, growing driven by loan growth. 2, growing driven by hedge, NII flat, NII falling, given deposit headwinds. NII falling, given other headwinds. Structural hedge, kind of neatly brings me on to this topic, I guess...

To the perfect segue.

Perfect segue. I guess NIM is going through a period of adjustment right now. We've got to catch up on deposit costs. I guess you've alluded to the fact that mortgage margins are source of margin compression at the moment. Structural hedges are significant tailwind. Balances are shrinking, I guess, in part because things like current accounts are shifting. But this does look like a pretty substantial multiyear tailwind. So how are you thinking about the hedge? And does it give you confidence around?

I mean certainly, we've talked very openly about the strength of the hedge and the strength of that tailwind that it gives to you. So I mean, at the moment, the hedge is GBP 202 billion. Royalty GBP 1 billion in the quarter. What we've guided to is that by the end of the year, it will go to GBP 190 billion. Now for us, we do it very mechanistically. If we look at the last 12 months of deposits and then kind of calculate what the type of the hedge would be. So you can see -- what we need in terms of that piece as we go forward, would be 1 quarter of stability and 3 quarters of falling. So the fall in the hedge is very -- is kind of very predictable. I think what's really important, though, to remember is that GBP 40 billion matures in every single year. At the moment, we're putting it on at around 4.4%. Earlier in the year, I was talking about 3.3% and 3.6% and now is at kind of 4.4%. Interestingly, what rolls off in '24? Is it 80 basis points and what rolls off in '25? Is it 50 basis points. So there's a huge natural kind of benefit to that. So even though I have a falling volume. If we'd see that deposit stability and the stability needs to be both in volume and shape. So if they were all to move, it would not obviously all move but into term, then that would have an impact as well in terms of what you were hedging. That certainly gives us confidence as we move forward from here. And just the mechanics of it that -- given the lower rates, but the significantly -- sorry, given the significant improved rates for the lower volume, it's a nice strong tailwind and a very important part of the shape of our income as we move forward over the next couple of years.

I guess the size of the hedge has increased quite significantly since 2019, kind of in line with deposit growth on the balance sheet. I guess now we're entering into a period of monetary tightening deposit outflows and mix shift. Should we expect the hedge to go back to kind of pre-COVID size in terms of notional?

Yes. I probably like in my answer, that a little bit in terms of, do you go back to the same level of term deposits? I think it's important to do is to remember in terms of the hedge what we actually do with it. So we are predominantly hedging current accounts and to a much lesser extent, instant access in terms of that piece. So what we can see is that as people continue to keep good funds in the current account that we kind of -- you could see that can still obviously decrease in the hedge. So what we really need to answer that question is actually the monetary tightening, we can see impacts to commercial banks much more and actually which to our customers are being impacted by that, not necessarily immediately, but over time as well and how that kind of flows through. So I think we haven't made any type of public statement as to where we think the hedge might land over the next couple of years. I think the deposits and the shape of those deposits, I did say earlier that we've been relatively conservative around the movement to terms. So I still expect it to shrink a little bit, but we're comfortable with the benefit that we have in that '24 and '25 rate increase. But really, the shape will be very interesting for us.

Yes. Mortgages, feels like a difficult backdrop for mortgages in the U.K., demand is subdued, volumes are relatively weak at system level and spreads are low, competition remains intense in that space as ever. You actually seem to have done a pretty good job of navigating that in the last couple of quarters, but interested in what your take is in the outlook for the mortgage market here?

Yes. I mean, look, you have -- if we think on mortgages, it came off such highs in sort of '20 and '21. And I think that '22 actually surprised there for a little bit to the upside in terms of the strength of the continuing mortgage book. So it's definitely much lower in this year. We have been pleased, and you can see from the recent market data that we've gone to kind of 12.7% stock shares. So that kind of points to up from when we spoke before. So we have -- we view mortgages really importantly as a really important growth area for us. We do know that they are -- in the U.K., we have a kind of a 2- to 5-year kind of model. There's something that the 2 and 5 years is very much the initial relationship. We have sort of 7%, I think our attention is at the moment. So therefore, 3/4 of them you keep on for many, many years in terms of many renewal periods. So they're very valuable both in that first moment, but also as they renew as we go forward. It is challenging. There's lots of competition. People ask me a lot, does the market behave in a very rational way. I think it does over a year, but you can see movements in 1 week or this week as we all kind of try to manage our flow, manage our balance sheet, make sure we're using the hedges we've got in place in the right kind of way. We've always talked about, we like to write the book over time at a kind of 80 basis point piece. When swaps move up very quickly, you can see that, that can fall and then we kind of work to how we kind of get back to that kind of around that 80% kind of level. So definitely under pressure at different points in this year. But I think, again, it's one of those things that we look at a lot is very much its income and its royalty impact and very comfortable with what we're writing at the right level in terms of the royalty. So again, a really important product for us. It is challenging. We've invested hugely. We invested in our relationship with the brokers to make sure it works well. And at the moment, we're kind of comfortable with the performance we see in that, what we see is a major -- a continuing growth area. I think when I was here a number of years ago, I was talking about 9.7% or 9.8%. That's a huge move in terms of the size of that market over the last 5 years. So I mean significant continued growth in the book, and that's we'd expect to continue going forward.

I think you alluded to Q2 this idea that the negative mortgage margin churn or the headwind from mortgage margin pressure is something you'd expect to kind of be a feature for the coming quarters, but thereafter, maybe we pass this headwind.

So as I kind of look at that, definitely sort of Q3, Q4 is in the future, but Q1, it kind of starts to diminish. I think. And you can see that at the moment in the book, if I look at our published numbers for Q2 for group if there was any kind of 1 on 1, it has fallen 15 to 18 basis points each quarter for the last number of quarters as we've seen that kind of churn. When you get to the kind of 1 on 1, and you think, well, Katie, you talk about over time, time to write to 80 basis points. Ultimately, those things would vary. It's a bit simplistic because there's SCR on Barclays and a lot of other things going in there, but we're definitely reaching the end of that the level of pressure that we've seen in the past and which is good to see.

Asset quality. Clearly, many of your customers are facing a pretty significant step-up in borrowing costs, most basically your mortgage customers and with rates set to be higher for longer, the kind of asset quality outlook is uncertain. It's a key feature of the conversations that we have with investors. It's a remarkable observation so far how benign things have been. I mean, how sustainable is this level of credit performance? And are there any particular areas of stress that you're observing in your portfolio?

I mean, first of all, I would say no, there aren't any particular areas of stress. We have obviously spent -- we spent an inordinate amount of time looking at this. And if I think of it in two different buckets. If I look at the retail side, our mortgage book is now 66%, 5-year. And so when I look at wage growth, and it's not just wage growth in 2023, it's wage growth since 5 years ago when you took that mortgage out. And 5 years ago, we think that wasn't very much but actually 1%, 2% for 3 years and then now 3% and now are kind of 6.5%. So you've had pretty significant wage growth in those 5 years. When I tested your mortgage at the time that you took it out, I tested your rates that were higher than the rates that you're paying today. And so therefore, what we can see, we've done a huge amount of work with the economics team. Actually, the wage rises people have seen, and it's true for 2 years and 5 years are bigger than the wage rises that they're seeing in their mortgage. And I think it's important to remember that they are multiyear, so therefore, you've got multiyears of wage increases. So therefore, that gives me some comfort. I think the most important thing for mortgage is actually, are you employed? If you are employed, you will have the benefit of wage rises. Now people have taken different paths over those 5 years and people wages will have gone down for different kind of personal reasons. But we know in this for history, that's a really good example. We know that people will move hell and high water to pay their mortgage. So while they might be suffering challenge as well in cost of living and they're free basket and things like that. We know that -- as we look at it, actually, they're more comfortable. So that's why I think we're not seeing a particular issue on the retail side. If you look at the commercial side, the economic touch point is neat. There's lots of different things going on within there. What we have done, as you know, over many years with our commercial book is to try to make sure that we moved out with some of the more risky aspects of the balance sheet. We try to make sure that we trade debts that are in trouble before they get into trouble to kind of protect us from any of those kind of impairments. We spend -- I mean, I get a weekly report from the credit team and the credit officers so we kind of talk about the funnel. What I would say we're seeing as many things bring into the funnel, as we saw in 2019, that's unchanged. But what we're actually seeing is them recovering back out of the funnel as well. And I think that COVID in many ways, was a fantastic learning experience, particularly for the small and medium-sized businesses as to how they could manage those things and the kind of pressures well. I think in the U.K. press, we love to talk ourselves down. And then we kind of in some of the ways, we forcefully say actually the economy is doing a bit better than we kind of realize. And we can see that when I go out to visit customers and I talk to them and they say, "We're doing okay, but we're a bit worried about the other guys." And so they're doing okay. We're watching it very closely. We've got a lot of work that we do. We try to preempt people before they come into problem. And at the moment, we are -- rate for the -- it was 12 basis points, I think, cumulative up to Q2 might be 14, forgive me. So I mean, really very low and we'd have to see rates move significantly or if situation has changed quite a lot to get into that 2023 guidance as we move to the second half of the year. So at the moment, we're comfortable. We did add a bit more on to our PMA, the kind of post management adjustment that we make, about GBP 0.5 billion of that has kind of protection against things going. So the balance sheet is good. It's performing well. We spent a lot of time making sure we've got a strong balance sheet in that space. We are worried that things will get harder. So that's why we put the PMAs in place, and we'll just continue to look at them as we move forward. But at the moment, I'm not seeing any particular signs of stress in any particular areas.

Commercial real estate has historically been a big part of your balance sheet, much less so now. But it is a market focus, people do worry about commercial real estate.

I think we've changed our commercial real estate book so dramatically. It's less than 4% of the book. It used to be 20%. It used to be loan-to-value in excess of 100%. I think it was 120%, it's worse. It's now about 47%. What we've also done is changed a lot of where it's invested in terms of that. So we've got more in kind of the manufacturing kind of level. If you're trying to buy a warehouse in the U.K., it's almost impossible, sort of thing. So -- and that's kind of where we're investing. So it's to make sure that you're looking at the right kind of piece -- is an area that we spend a lot of time on, and we will continue to do so. But it's not one that would have given us the worries that we have done in the past, mainly because we have shrunk it so significantly. Looking very much working with kind of prime developers invested in the areas that we feel are the right areas as we move forward in there. That's not to say that there isn't anything in the group that we wouldn't rather not have. But in the rounds, we're very comfortable with what we've bought and the size of it and relative to the total book is something that we are comfortable with.

Okay. Great. Maybe we'll shift back to the ARS questions. How do you think NatWest will perform versus market expectations for capital and dividends? One, beat expectations, given better earnings. Two, beat expectations given the lower cap requirements. Three, missed expectations, given weaker earnings. Four, miss expectations given higher reg requirements. Half of the room thinks you'll beat expectations, given better earnings. I might actually ask a question then on the outlook for M&A across your business. So I don't want to be too leading in the way that I ask the question.

Don't worry. That's a question we are well used to. You can ask anway you like.

I guess, around your fee income and ambitions at a group level, I guess, the net interest income tailwind has been so strong, but the balance of revenues has shifted towards net interest income. I think you've been pretty clear for a while now that growing fee income is a strategic priority for the group. And hopefully, that's driven by growing fee income rather than losing net interest income. But the kind of growth rates that you need to deliver in order to rebalance fee income suggest that it might have to come from upside. Do you share that view? I mean can you deliver on fee income in-house? Or do you need to...

So I think when you look at our fee income over a multiyear basis, you'll see that we've got a very nice CAGR that's coming through. The challenge is, and I do think it's one of the things and Alexander and I have always been very public a lot of before. Actually, it is misshapen. We are too dependent on net interest income. It's an absolute reality. When I look at it, 20% of our income is noninterest income, it moves sometimes 30%, depending on what's happening on the top line. So to see -- even though we've seen nice consistent growth in there -- if I look at where our investment is in a huge amount of our management effort is around how do you grow that line? How do you make sure the product that we have in there is better, utilized across all of our different customers and things like that. You're going to just get that kind of 2% to 3% to 4% CAGR, which is fine. But the problem is you're not going to change it from kind of being 20%, 25% of the balance. So we've been always very public that when we look at acquisitions, it is something we're more interested in things that can move that noninterest line. I do think though, as we look at it's very important for our investors. We're an entity that's delivering 14% to 16% earnings where our price to book is now, it's relatively hard to make the case of some of the very big kind of wealth acquisitions. So we do look at things. We're quite interested in buying kind of books of business. You've seen the acquisitions we've done to date have been very much around kind of capability. So we do have an active team. I spent a lot of time with them. We do look at it if the right opportunity came up, we would certainly seek to add it. And that is the thing I think it would pivot that number. But in the meantime, it's very important that a significant share of our investment portfolio goes into continuing to develop that kind of growth within that noninterest income line. But I would agree to change it significantly. It's M&A, but I'm also very clear on the commitments and the conversations we have with our investors around returning capital and the hurdles that we would be making as part of any of those acquisitions.

Yes. Maybe wish you through the last couple of ARS questions. What do you see is the biggest risk to NatWest earnings? 1, rate cuts. 2, competition. 3, cost inflation. 4, loan losses. 5, government or regulatory intervention? Competition. Competition followed by government or regulatory intervention. I guess it has been a concern for European bank investors. You've seen speculation around bank taxes in places like Italy and Spain. I seem to get regular incoming from various people telling me that a bank tax could be coming in the U.K.

I think it's really important to remember that the U.K. already has 2 bank taxes. So it's not an area that hasn't already been accessed. So we have the bank levy, which we pay in Q4, which cost us around GBP 100 million, very much depending on deposit levels. But think of it around sometimes a little bit higher, really lower in terms of that piece. And then we also have 3% surcharge on our corporation tax in terms of that piece. So I -- personally don't feel that, that's -- we already are in that position. We -- it's not something that we expect, we would see more of. I said it earlier, my job is to make sure that we deliver the right investment case. But I think it would be -- the government also recognizes they do need to have a very working banking system as well. So I think we've already been taking for that. I mean -- I think competition for deposits. I think that's a real. I mean just -- I do think we'll see some atypical behavior. And all of these things are things I spend a lot of my time on. That one is probably the one that kind of more impacts than others because of the TFSME and things like that. So let's see how that kind of flows through. I can see the benefits coming through, certainly in the medium term, on our income of the hedge and how it's going to deliver and also on our kind of continuing growth that we see in the AIA, but the competition and deposit piece is probably one. We spend a lot of time modeling what it might do, but it's comfortable, obviously, on our 14% to 16% return.

Question 6. Final one, just returning to the theme of acquisitions. How would you view significant acquisitions at the group level? 1, very positive given potentially high return on investment. 2, marginally positive. 3, margin negative. 4, very negative. 5, prefer the capital back to shareholders. The response is -- main answer, main response there is prefer the capital return to shareholders.

And what's interesting is if I take the very positive and marginally positive, it kind of outstrips that. So for me, what that tells us is if you do something, make sure you do it wisely. And we've got the right returns so that we continue to while you could see a short pause in the capital return, it's something that comes back on play. So actually, if you take 1 and 2 together, that's interesting to see, and we continue to look excepting we know what our commitments and our expectations on us are.

Yes. I mean, I guess, while we're on the topic then around distributions, you're very capital generative bank now. I guess it's moved away from a return of surplus to -- driven by the underlying profit of the business, which I guess is a good transition. How do you think about the priorities for capital returns, things like buybacks, you've done specials historically?

So I mean you're absolutely right. We -- over the last couple of quarters, we've generated kind of 50 basis points of capital a quarter. There are movements that will come through as while 3.1 kind of drips in. Post [indiscernible] we're always worried about if I go back to my comments earlier when we were on impairment that it's sometimes hard to kind of guess where that number is. But the kind of RWA movement will have some impact on that. We've been always been very, very clear. 40% dividend return and then the excess over that, our first priority is the direct to buyback. The next priority would be and in-market buyback. You'll recall, I think it was summer last year that we did a very large special because we didn't want to toggle the U.K. government back over 50% ownership. They're at 38.7% today. So that's not something that we're so worried about. So you can think, well, that would become less likely. But I think the kind of the dividend and the direct to buyback things are our real priorities. And then obviously, we also use a lot of our excess capital to invest into the business, and it's very important that we continue to do that as we move forward. But I think we talked about M&A, but we've been very clear that the capital we generate, our preference is to return it to our shareholders and to use it to continue to bring down the ownership structure of the bank and from conversations with shareholders, that's very strong feedback that we get as well.

We've probably got just enough time if anyone had a question on the floor, please do put your hand up, happy to kind of -- be able for Katie. And on the final question then, just on the cost base, I mean inflation has been running higher than expected. I can't imagine it's easy to control the cost base in this environment. I mean how are you doing it? And...

So you're right in your imagination. So GBP 7.6 billion what we said we'll do for this year. We'll be there or thereabout. So I'm probably chasing 10 or 20 around the building at the moment to kind of make sure we hit the numbers. So GBP 7.6 billion and that's an important number for us. It's helped by what's been going on elsewhere to a little bit of benefit in that piece. But look, it's really -- it has just been really important that as you manage the impact of kind of the wage inflation that you also manage the size of your workforce in terms of that piece and how you kind of marry both those things together. So we've made investments where we really need to in the right kind of specialist kind of areas, whether that's in data and tech and kind of managed elsewhere. But it's really, it's something that we've done cost takeout in NatWest for the last 15, 20 years, very kind of significantly over the last decade. It's something that is part of the DNA. It's an annual kind of cycle we're in the conversations as we are for next year. What we did indicate this year is that because of inflation, we will be going up rather than down. And I think as we get into 2024 and then into 2025, we've obviously got a commitment there around a 50% cost income level. So it's still a huge focus. There's only three ways to take out costs. It's people, processes and kind of technology, and we try to work on all of those levers. What's been really pleasing for me is the amount of the activity we do now that is just digital straight-through processing. And that's been really fundamental to make sure that -- our sales have done that way. Credit cards are open that way. Mortgages have managed that way. And I think just continue to take that through every single process. We have both external to our external customers, but also internally. And I think we still got more we can do in that space.

Okay. Great. With that, we'll bring the session to end. Thank you very much, Katie.

Lovely. Thanks a lot. Thanks for your time this morning. Take care.