Also within the commercial business, our net CRE exposure continues to reduce. It’s now around £10 billion with an average interest cover ratio of 3.3x and average indexed LTV of 46%. Meanwhile, the portfolio is well diversified across sectors with only 14% of exposures relating to offices. Moving on, I’ll turn to Slide 24 to look at the below-the-line items and TNAV. Consistent with our objectives, there continues to be convergence between underlying and statutory profit. Restructuring costs were £154 million in 2023. This includes integration costs for Embark and Tesco, but it also reflects a significant one-off cost to ensure business continuity following the administration of a key supplier. Volatility and other of £152 million includes the usual items for fair value unwind and amortization of intangibles.
It also includes modest positive volatility, mostly driven by lower rates in the fourth quarter. Statutory profit after tax of £5.5 billion resulted in a return on tangible equity of 15.8% for 2023. Tangible net assets per share at 50.8p were up 4.3p in the year, including 3.6p in Q4. The increase was driven by profit accumulation, a lower share count and a reduction in the cash flow hedge reserve as the yield curve fell. Based on our current economic expectations, we expect further TNAV growth in 2024 and beyond, driven by much of the same factors. Turning now to capital generation on Slide 25. The group remains highly capital generative. RWAs were up £8.2 billion during 2023. This includes a £5 billion increase relating to CRD IV, of which £2 billion was taken in Q4.
Regulatory pressures were offset by NPV positive balance sheet management, including securitizations. Beyond that, lending and operational impacts increased RWA. The implementation of CRD IV is ongoing. We expect a further RWA increase of about £5 billion, phased between 2024 and 2026, subject, of course, to further PRA review. And in this context, we continue to expect RWAs to be within guidance of £220 billion to £225 billion at the end of this year. Lending growth continues alongside active balance sheet management to offset regulatory pressures. Capital generation in year was 223 basis points before 50 basis points of regulatory headwinds. Net of that, capital generation was still strong at 173 basis points, in line with guidance and driven by robust profitability.
The impact of the higher remediation charge in Q4 in this context was more than offset by the one-off write-back in the same period. The group’s strong capital position and capital generation enables the Board to announce a final ordinary dividend of 1.84p per share, making a total of 2.76p. The dividend is up 15% on 2022. And alongside a buyback program of £2 billion means the group will distribute a total of up to £3.8 billion. This, as you know, is around 14% of our current market cap. As shown today, the Board is committed to a progressive and sustainable dividend and an additional excess capital distributions. It’s worth noting that in Q4, we also made a £250 million further pension contribution. This closes off the remainder of the deficit and means there will be no further deficit contributions in the current triennial period till December 2025.
Our year-end pro forma CET1 ratio of 13.7% remains strong. As you know, the Board continually reviews the appropriate capital target for the group. Based on regulatory, economic and business considerations, including our risk profile, we’ve now determined that 13% CET1 is the right target. As before, our target continues to include a management buffer of 1%. To be clear, this change in target is a positive development, indicating the strength of our group. In order to manage risks and distributions in an orderly way, we expect to pay down to circa 13% by the end of 2026. This year, we expect capital generation of around 175 basis points, as previously guided. Looking further forward, we continue to expect capital generation to be greater than 200 basis points by 2026.
So let me bring this together on Slide 26. We are, as Charlie said, progressing well towards our ambition of generating higher, more sustainable returns for shareholders. For 2024, we now expect the margin to be greater than 290 basis points. Operating costs to be around £9.3 billion and the asset quality ratio to be less than 30 basis points. We also continue to expect the return on tangible equity to be circa 13%, RWAs to be between £220 billion and £225 billion, capital generation to be around 175 basis points and to pay down to a 13.5% CET1 ratio. In the medium term, we remain confident in delivering our vision of higher, more sustainable returns by 2026. We are retaining our medium-term targets, specifically, cost-to-income ratio to be below 50%.
Return on tangible equity to be greater than 15% and capital generation to be greater than 200 basis points. In addition, and as mentioned, we now expect to pay down to a circa 13% CET1 ratio by the end of 2026. In sum, we look forward to continuing to deliver for our shareholders. That concludes my comments. Thank you very much for listening this morning. I’ll now hand back to Charlie to finish up.
Charles Nunn: Many thanks, William. So to summarize, the group delivered a strong performance in 2023, in line with expectations that we’ve laid out, aligned to our purpose of helping Britain prosper, we have continued to proactively support customers and meet our broader societal objectives whilst successfully executing against our strategic plans. In addition, despite the external headwinds and uncertainty we faced in 2023, we’ve taken actions to deliver robust financials and increased capital returns. We remain on track to meet our 2024 and 2026 strategic targets, which will support the delivery of higher, more sustainable returns and capital generation. Thank you very much for listening. That concludes our presentation, and I’ll hand over to Douglas, who will lead the Q&A. Douglas?
A – Douglas Radcliffe: Thank you, Charlie. So moving to questions. [Operator Instructions]. Okay. So let’s begin. Let’s start with Alvaro.
Alvaro Serrano: Alvaro Serrano from Morgan Stanley. I’ve got a question on motor finance and one on margins. On motor finance, I realize there’s still a lot of uncertainty, as you pointed out, William, but can you help us reconcile why you think £450 million is enough? I realize some estimates out there point to £1.5 billion, £2 billion. And — so what’s the difference in view there? And also, how does that fit in with the Board approving the £2 billion share buyback and basically the lower capital ratio that the bank needs to run with? How can you square that? And then the second question on NIM. How do you see the year progressing? You previously talked about a trough in margins in Q1, Q2, is that still the case? And you pointed out you expect the mix shift in deposits to continue. There’s central bank data points to more stability, so why use that still expecting that mix of change?
William Chalmers: Sure. Thanks, Alvaro. Shall I take those, Charlie?
Charles Nunn: Yes.
William Chalmers: Thanks for the question, Alvaro. I’ll take them in turn. First of all, on the motor point. As you know, in this context, as acknowledged by the FCA, the extent of misconduct and customer loss, if any, remains unclear. We believe that we have complied with all the relevant regulations in the relevant dates. So that’s the backdrop. In the meantime, we’ve had 1 financial ombudsman judgment, and we’ve had a series of county court cases, most of which have actually decided in our favor. When we look at the review therefore, we welcome it in order to get some clarity on the situation. You asked about the £450 million provision. In that context, there are 2 components to the £450 million provision. One is operational and legal expenses and the other is redress.
Both of those 2 are encompassed within the £450 million. The redress is built upon a variety of scenarios, various scenarios, which in turn are built upon various inputs to those scenarios. So for example, time periods, how far back does this go? 2007 being 1 example, but other time periods could be taken into consideration. Likewise, what are the commission models that have taken into account? Likewise, what is the relevant benchmark for compensation should redress arise? Should it be a 0 commission structure or should it be a reasonable commission structure? Likewise, what type of redress measure might the FCA want us to consider? Is it proactive or is it reactive, response rates, not hold rates. These are all variables that feed into the various scenarios that we’ve constructed off the back of which we have positioned our £450 million provision.
There are, as you can see from my comments, quite a few uncertainties, and we’ll obviously update on those as the situation develops. But I would note that when you consider it against other numbers that might be out there, there are a number of quite important dependencies. So for example, whether it is a 0 commission number that is taken as a benchmark for any potential address, whether it is a reasonable rate of commission makes a big difference to the ultimate provision that might be necessary for redress, cutting it by more than 50%, for example. So there are some important dependencies in the numbers that are out there. Secondly, you asked about how that all squares with the Board approving the £2 billion buyback and indeed, the capital ratio reduction to 13% by 2026.
I would say both are an expression of the Board’s confidence in the business. We’ll talk more about it, I’m sure, but when we’ve looked at both and in particular, when we’ve looked at capital ratios, we’ve looked at both the regulatory outlook, we’ve looked at the business risk reduction that has been embarked on over the last several years and indeed, we’ve looked at retaining our buffer for uncertain economics. And all of that adds up to the 13% CET1 target ambition that we have. So both of those 2, the £2 billion and the target reduction of 13% are expressions of confidence in the business. Moving on, you asked about the margin. The margin, as you know, we have committed to is circa — is greater than 290 in the course of 2024. When we look at the performance in 2023, we delivered on guidance greater than 310, delivered at 311.
But the relevant number is the quarter 4 closing rate of around 298. So when we look at the trajectory going into 2024, we expect what will very likely be a gentle decline in the first half of 2024. And I’d underline the word gentle, nothing like what we saw in Q4. And then we expect that to gently increase in the second half of Q4, certainly — in the second half of 2024 certainly by the end of the year, certainly by Q4. So what you’re seeing, therefore, is a closing rate — closing margin of 298 in Q4 of ’23, and expectation for 2024 that we will see a gentle decline in the first half, a gentle incline in the second half as I say, certainly realized by Q4, if not before. What’s going on kind of underneath the hood there, a couple of points to make.
One is we do expect to see, as your question alluded to, Alvaro, some continued deposit churn over the course of the year. Two is, we do expect the mortgage refinancing headwind to still be there over the course of this year. But in both cases, in deposits and in mortgages, we expect each of those headwinds to gradually abate over the course of the year. And we can talk more about the reasons for that, but they are at least, in the mortgage case, very mechanical, and then deposit case, rely upon the kind of rates trajectory, the rates outlook that we’ve described to you. And then finally, offset against that is the structural hedge, which cumulatively gathers pace during the course of the year, and all of that nets out to greater than 290 for the 2024 margin outlook.
Douglas Radcliffe: Well, let’s take the next question from Joe.
Joseph Dickerson: Joe Dickerson from Jefferies. Two things from me. First, on the severance costs that you have. Could you try to quantify those or express them in materiality terms? And then is this just a present part of your cost base? Or at some point, will this abate and become a tailwind on the cost base? That’s question number one. And then number two, just on the cash flow hedge reserve. I think off the top of my head looking this morning, it’s about £3.8 billion. How do we think about the sensitivity around that and how that comes back? Because obviously, the 15% return on tangible number by ’26 is very different if the TNAV is that much higher. And I’m not sure that TheStreet estimates have that quite right.
William Chalmers: Yes. Thanks, Joe. Just to give you a couple of numbers on each of those. Severance costs, first of all. We always have an allowance for severance costs within our overall cost budgets. We had it in 2023, we again have it in 2024. What is different is that in the final quarter of 2023, we actually took a bit more severance than we normally would do. And likewise, when we head into 2024, the same is going to be true. Now in 2023, we were able to offset that against various other mitigants within our overall cost profile. In 2024, it’s tougher to do so again. And that’s the reason why we’ve moved from the £9.2 billion that we described to you before as the ’24 cost guidance to £9.3 billion that we’re describing to you today.
So I won’t put a precise number on severance, but that is the principal driver between £9.2 billion to £9.3 billion. It’s increased severance above and beyond our regular severance budgets. It’s worth saying before leaving the severance topic that, as you can imagine, we subject that to pretty severe business case tests. And so any severance that we deploy, we expect to get benefits out of it. Now you don’t typically realize those full benefits in year. You would expect to see them in the years thereafter. But as you know, a big part of our story is around operating leverage within the business. As the headwinds abate as strategic initiatives come in, we hope to deliver a flatter cost base going forward. And that in line with lower investment levels leads us to predict the returns that we’re predicting for 2026 and have, as I say, full confidence in.
So the severance has business cases. The business cases are relied to the profile of operating leverage that we expect to deliver over the course of ’25 and in particular, in 2026. Cash flow hedge reserves, you mentioned. You’re right, cash flow hedge reserve is around £3.8 billion right now. The pace of it or the movement, I should say, in the cash flow hedge reserve is, as you know, very interest rate dependent. There are 2 things that go on there. One is the valuation of the existing stock of derivatives against which structural hedge is positioned. And then second is, as the derivatives mature, I mentioned £40 billion of structural hedge maturities this year. So you get a repricing on a mark-to-market basis of new derivatives that come in.
Those 2 compress the structural hedge — sorry, compress the cash flow hedge reserve and indeed lead to TNAV growth. We saw a bit of that through the course of ’23. We saw a good part of it in the course of Q4 of ’23. We do expect to see more of it in the course of ’24. I think we’ve given a PV01 of around £12 million or thereabouts, 1 basis point move leading to about £12 million cash flow hedge reserve adjustment. That, in turn, leads to expected TNAV growth over the course of the year. We ended up ’23 probably a touch higher than we expected to end it up on TNAV per share. That will carry through into TNAV per share build for cash flow hedge reserve reasons, but also for the other reasons I mentioned in my comments, over the course of ’24.
Charles Nunn: Joe, just one thing on the severance because obviously, William covered it well. We should expect an ongoing baseline severance, as you say. Why an increase this year, which is kind of your question? I think it’s because as we’ve got into the strategy, we’ve seen additional opportunities for efficiency and to provide reinvestment into areas that are going to drive the growth. So it’s really a demonstration of our confidence around what we’re doing. And you should expect the baseline level, but this is really a demonstration of this year. We think we can do a bit more.
Douglas Radcliffe: Let’s move to the front row now. Rohith.
Rohith Chandra-Rajan: I had a couple, please. The first, actually, just sort of following on from the cash flow hedge question. But just CET1, the move to 13%. Can you give us a little bit more in terms of your thinking behind that? And then how also that factors into the TNAV for 2026, presumably that takes about £1 billion off, so you’ve got cash flow hedge build and then you’ve got £1 billion less from a lower CET1 ratio. And then how in turn that feeds into greater than 15% RoTE? My read of your guidance is you haven’t changed the — more than 200 basis points capital generation. So it’s not a comment on earnings. It’s just a change to the denominator. That was the first question. And then the second question, just on average interest-earning assets. So at 453 in Q4, 450 for 2024 on average. What was the jump-off point for ’23 and what are the headwinds in ’24, please?
William Chalmers: Yes. Thanks, Rohith. Rohith, there’s sort of 3 questions there in a way, actually. CET1 reductions, first of all, it’s worth me just starting off with the point the CET1 target ratio from 13.5% to 13% is a very positive sign for the business. It’s a positive sign, we believe, for all stakeholders, clearly for shareholders but also for customers. It allows us to price product, for example, more efficiently. Why have we gone there? As you know, the Board when it looks at the target CET1 ratio looks at what capital is required to operate the business, to grow the business and to absorb stresses the business might encounter. When we’ve looked at the business, we’ve looked at 3 things. One is business risk reduction.
As you’ll be aware, over the course of the last 10 years-or-so, but particularly in the last 5 years, this business has materially reduced the risk that it’s exposed to. You can see that evidence in the CRE exposure, for example, I made a comment in my earlier script. You can see that evidenced in the runoff of the legacy mortgage portfolios, for example. You can see that evidenced in terms of some of the metrics around the business, whether it’s LTVs, interest cover ratios, secured backing for the SME portfolio and so forth. And you can also see it manifested in regulatory assessments, the ACS performance from about a year ago. So significant risk in business — significant reduction in business risk as evidenced by the statistics that we will give you, but also testified to by things like the ACS test.
