AUCyber Limited (ASX:CYB)
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Earnings Call: H2 2018
Nov 20, 2018
Okay. We'll get started. Good morning to everyone in London, and good evening to those of you joining our webcast from Australia, and welcome to CYBG's full year results presentation for 2018. Us. I'll briefly take you through the progress we've made in our strategic execution.
Iain will then talk through our performance for 2018, us. And I will return with some thoughts on the opportunities ahead, and Iain will close with some guidance for 2019. Us. So our presentation is a little longer today because we're trying to do the stand alone performance and our initial thoughts on the combination. So if you bear with us, I'm sure we'll get everything covered for you.
Okay. So on strategic execution, before us. Ian talks about the specifics of 'eighteen in detail. And given we have new shareholders and analysts at today's presentation, I thought it'd be useful to provide you with some context us around our strategic delivery since the IPO. So following our IPO in 2016, we outlined a 3 year plan, which you're all familiar with, or most of you, us, where we promise to deliver sustainable customer growth secondly, to reduce our cost base and thirdly, to optimize capital us and all the while transforming our digital capabilities.
Turning first to customer growth. Us. We have delivered on an above market 6% CAGR in our mortgage lending over the past 3 years, and this demonstrates our ability to take market share consistently from other players. Us. At the same time, we're continuing to develop our core SME franchise with an above market 6% CAGR growth rate and are on track to meet our goal of £6,000,000,000 of lending over the 3 years to the end of 2019, so delivering against the promise.
Us. Our prudent balance sheet model means that we have funded the majority of this growth through customer deposits, building on our strong current account base us across both retail and SME and utilizing our diversity of funding sources. All of this growth has been delivered in line with our mid single digit guidance following our Capital Markets Day in 2016. And if I turn to efficiency next, us. We've committed to delivering over GBP 100,000,000 of net reductions in our total cost base by year end 2019, and we are running ahead of that target.
Us. Our cost to income ratio has therefore reduced from 75% to 63% over the past 3 years. And importantly, we expect this trend to continue going forward. Us. The success of the combined initiatives means that we've delivered a total return on tangible equity of 10.6% in 2018, us, and this is in line with the target we published for double digit returns.
We have also begun, importantly, our journey of providing a sustainable return on equity to our shareholders with our first two years of dividend payments. Us. In October, we also announced the successful receipt of IRB accreditation for both our mortgage and SME portfolios, us. And we still remain focused on further optimizing our capital position, and we will continue with the IRB application for our unsecured personal lending portfolio as well. Us.
From a performance perspective, I'm actually really quite pleased. We've managed to deliver on the majority of our targets that we published ahead of schedule. Us. And our successful completion of this stand alone plan has enabled us now to take our next strategic step of creating the 1st true national competitor. Us.
Back in 2016, we made the strategic decision to invest GBP350,000,000 in our IB platform. Us. We've already migrated around 2,000,000 retail customers onto the platform and we've had no migration issues and we expect our 2,000 SME customers to be on the platform by September 2019. This platform is open banking ready, us. Full open API capability, and this has enabled us to be the 1st in the market to deliver our current account aggregator service.
Us. We've also launched the B Store, which will in time contain a full range of products and services to support our customers, and we'll be seeking to leverage us, the much broader Virgin Group Companies as part of that proposition. We've already launched B Currency, the only live augmented reality app us via U. K. Bank, which enables customers to instantly convert currencies when purchasing items abroad.
Us. Our B Smart is coming next, and that's a utility price comparison app, and that will be launched quite soon. Us. And if you look at B, in over just over 2 years, it has grown to in excess of 190,000 accounts with over £2,100,000,000 deposits and a very strong NPS score. We've also signed strategic partnerships, large tech players such as PayPal on cards us on FinTechs such as EasyBob on SME and just last week, Salary Finance.
And I think what's important is these partnerships demonstrate both our willingness to collaborate with 3rd parties and the attractiveness of our digital platform in the marketplace. So when I look at the franchise in simple terms, We now have a national brand, a full suite of products, an integrated open API platform for 6,000,000 retail customers and SME customers and a proven partnership capability. We also intend to deploy a proposition which I think We'll be unique using other Virgin Group companies through our marketplace. And we are confident that we'll be able to drive growth across all of our segments and going to take market share as we have in the past. Us.
Frankly, when you look at this franchise, I think that our advantage is that we are more innovative and agile us than our large competitors and more capable of competing effectively than our smaller competitors. And I'll talk further about our growth ambitions in till towards the end of the presentation. But before that, let me hand you over to Iain, who will talk you through our stand alone performance.
Us. Thank you, David. Good morning. It's a pleasure to see you here this morning, and good evening to our friends in Australia. Us.
I'm going to run through the stand alone results for 2018, but I'll keep it brisk because I'm sure, like us, you're much more interested in looking forward than looking back. Us. Now before I get into the specifics of the 2018 performance, I first just wanted to highlight how the strategic execution that David spoke about us. Has translated into improved financial performance over the past 3 years. Sustainable customer growth has been a consistent feature.
Us. And while the income environment has been tough, we've outperformed on costs, delivering a 14% reduction in underlying expenses. Us. Taken together, our actions have driven a significant increase in underlying RoTE, hitting our double digit target a year early. Us.
Now I'm very pleased to be able to report a 13% increase in underlying PBT this year, us. And we continue to deliver improved business performance. Key contributors to the profit growth were increased net interest income, us. Commensurate with growth in our balance sheet, costs, which were 6% lower year on year and once again, us. Now in terms of KPIs.
Our net interest margin was 217 basis points, us. In line with our guidance of circa 220. We continue to improve the costincome ratio, which now stands at 63%, us with positive jaws of 5% in the year. And our underlying return on tangible equity was 10.6%. Us.
The strong underlying performance has enabled the Board to recommend an increased dividend of 3.1p per share payable to all shareholders. Us. Now before I move off this page, a few words on noninterest income as we don't cover it elsewhere. Us. After stripping out fair value movements, most of which are nonrecurring, and the £6,000,000 cost of the PCA campaign in October 2017, us.
Noninterest income is broadly flat year on year. And I think the key takeaway from this slide us. Our core business performance remains solid. Now turning to statutory earnings. Us.
After conduct charges and other items, we recorded a loss of £145,000,000 The charge for legacy conduct us. £396,000,000 includes the £220,000,000 we took in the first half with a further £176,000,000 charge us in the second half. £150,000,000 of that relates to PPI, and I'll talk you through the assumptions behind this in detail shortly. Us. The core message on PPI, though, is that we believe the endgame is playing out large as expected back in May, us.
But we've topped up our volumes to cover us out to the time bar in August 2019. The additional £26,000,000 charge for other conduct matters us in the second half. It relates to further costs in relation to the small basket of non PPI issues we've been managing. Us. Us.
And I can deal with any other items on this slide in the Q and A as required. We continue to see the benefits of our broad funding base and lower cost liability us. We increased our deposits in line with lending growth in the year. And stripping out the impact of base rate increases in November 'seventeen us. On August 18, we actually saw the underlying cost of deposits come down fractionally year on year.
And that's a great testament to our management of mix and pricing us when you consider that we saw strongest growth in our savings products. Our all in cost of funds last year was around 80 basis points, us. Up 5 bps year on year, and the net increase was driven by base and other rate hikes. Us. In line with our strategy to deliver sustainable customer growth, we've seen good asset growth in the year across all three of our asset classes.
Us. In delivering this growth, we have not compromised on our underwriting standards as evidenced by our origination KPIs. Us. In mortgages, our origination LTVs and LTI multiples have held steady or improved slightly. Us.
And in SME, our internal ECRS risk rating on new business is consistent year on year. Now as you know, mortgages started the year with a great tailwind from a healthy pipeline, but things slowed a little bit in the 3rd quarter us due to the impact of the changes we've made to our broker servicing model. Now these have been addressed, I'm pleased to report that Q4 volumes did bounce back as expected us. And if anything, we're a bit ahead of what we were expecting. The result is we've delivered 4.5% growth in mortgages, Getting on for double the market in 2018 while maintaining our discipline on margin.
In terms of mix, the home mover market's been flat, us. With growth primarily stemming from first time buyers and remortgaging. The buy to let market remains subdued, us. And the business being written in that space is predominantly remortgage. With base rate having been having increased, it remains very much a fixed rate market, us.
And we're seeing 5 year fixes growing in popularity. In SME, we had a slightly stronger second half given the pipeline coming into the period us. With above market growth of 6% in core balances for the year, and this is due to our consistent and disciplined focus on serving the SME market, us. And our specialist sector offerings resonate particularly strongly with customers. Now drawdowns were ever so slightly down last year at £2,000,000,000 versus us £2,100,000,000 in 2017.
And we think this reflects just that slightly lower confidence amongst our SME clients given the economic uncertainty us relating to Brexit. Unsecured lending grew by 4%, which is about £40,000,000 absolutely, us. And that was driven by growth in personal loans following the improvements we made to our capability that I talked about at the half year, basically enhancement of our SmartSearch capability for us. Aggregators and the launch of preapproved in app functionality. Looking into 2019, us.
The pipeline is solid for both mortgages and SME, and I would expect us to continue to take market share going forward. So us. We grew net interest income off the back of sensible asset growth, albeit at a lower margin year on year. The NIM at 217 basis points us. Was in line with guidance and consistent with the margin compression we'd flagged in the mortgage book.
In mortgages, the average portfolio yield was down 18 basis us. And that was really reflecting front book pricing pressure and also mix changes. The shift in focus from buy to letter origination to resi, us. The attrition in SVR balances that are now 9% of the book compared to 11% a year ago have all contributed to this. Us.
SME continues to do well. Stripping out the impact of rate increases and most of the SME book is tied to LIBOR, us. We've seen a few basis points of real improvement in average book yield over the last 12 months. Our SME business continues to be a good counterbalance us. Margin pressure on retail lending.
It brings better asset pricing and, importantly, a source of low cost deposits. Us. Retail unsecured is still a competitive space, and we've seen the average portfolio yield come down from almost 900 basis points to 835, us, although slightly less than the decay we experienced last year. So to summarize, retail pricing was disappointing, us. And that drove margin compression that we've offset with good performance in SME and some great work on the deposit side, allowing us to manage to our NIM guidance for the year.
Us. We delivered underlying operating expenses of £635,000,000 last year, ahead of market guidance. Us. I'm pleased to say that Project Sustain has been completed, delivering the promised run rate savings of more than £100,000,000 a year ahead of schedule. Us.
I'm also pleased that because we over delivered on gross savings, we've been able to reinvest a good chunk of money us into improving our customer and colleague proposition along the way. We'll see the full year benefit of the run rate from this year's Sustain initiatives us. Flow into next year's expense base. But now that Sustain is closed, our focus moves on to integration. Us.
Cost of risk ticked lower this year, down to 12 basis points, and all key balance sheet asset quality metrics are improved compared to 2017. Us. The key driver of the reduction year on year is that we saw lower specific provisions in our SME business. Now SME is always a little bit lumpy, us. And we'd expect to see next year's SME bad debt charge return to more normal levels.
Although given this is the point to which we say a fond farewell us. To IAS 39 and welcome in IFRS 9 from the 1st October, we may need to recalibrate what we think of as normal. Us. We've been soft guiding on the impact of IFRS 9 for the last couple of years. And today, we've published our estimate of the day 1 position.
Us. The details are given in the preliminary announcement on Page 43, but the headline is that we estimate an increase in provisions on day 1 us. Of £21,000,000 after tax, well within the previously indicated impact. The effect on capital is negligible us as we will benefit from the transitional relief offered by the PRA. Now looking ahead, we can't ignore Brexit.
Us. We've done as much work as we can to identify and mitigate areas of risk in our portfolio that might arise in an orderly Brexit. Us. We focused on customers in EU exposed sectors such as agriculture and those in all sectors us. That are exposed to the risk from supply chain disruption or other impacts from leaving the European Union.
And we consider that we're well prepared us to manage an orderly outcome. But the risk posed by a hard or disorderly Brexit is much more difficult to plan for. Us. We're taking another substantial top up to the PPI provision today, largely reflecting revised assumptions us. While PPI is disappointed once again, as I said at the beginning of my remarks, us.
It does feel like the end game is getting easier to call. When we discussed the provision 6 months ago, us. I talked about the key assumptions that drove the numbers: complaints volumes, up hold rates, the redress amount and cost to do. Us. Over the last 6 months, volumes, up hold rates and redress were pretty much exactly as we modeled.
Us. We said we expected to see 60,000 complaints, and we saw 63,000. Us. So what's driving the £150,000,000 additional provision top up is extra volume between now and the time bar us. Starting with volumes.
We'd assume that we would see complaints run at 10,000 per month on average us. To the end of the financial year and then step down once the CMC fee cap began to bite. We actually saw complaints tick up in our 3rd quarter us. With a weekly average of 2,600 and a peak in the month of May of 12,000, and we saw that as CMCs accelerating before the fee cap us in July. Since then, we've seen the weekly average come down, and the October monthly run rate us.
We've seen this reducing trend us. Despite further advertising bursts from the FCA and the fee cap only having been in place for a short time. Us. However, we've had another go at projecting how complaints run from here, and we think it's sensible to allow for higher volumes that we modeled back in April. Us.
So we've topped up to create capacity for 83,000 new complaints in the 11 month time bar compared to our projection of around 50,000 6 months ago. Us. And in effect, this more or less flatlines our latest experience. Us. We've also seen some unforeseen increases in overhead and indirect costs.
There's been a couple of things that contributed to that. We had some quality assurance rework in relation to the PDR and closed case remediation exercises, and we plan to do that over a longer period of time, us utilizing spare capacity in our Glasgow site. But the SCA wanted us to deal with these cases quicker, and so we kept one of our 3rd party sites open for a few months longer than originally budgeted. And in addition, the introduction of GDPR this year has added extra steps and costs to what we have to do to process complaints. So the £150,000,000 top up takes the provision level to £275,000,000 us as at the end of September.
Now I'm going to do something I've never done before on PPI and go a little way out on a limb. Us. I think this is the last material provision we'll be required to take on PPI, and I know you all want me to be right. Us. Underlying capital generation of 63 basis points compares with 13 basis points last year, us.
With improved gross generation, combined with lower drag from investment and asset growth. However, the key impact on capital and the capital ratio us. Has been legacy conduct costs, which absorbed 182 basis points of CET1 and reduced the CET1 ratio on a standardized basis us to 10.5 percent at the end of the year. As you're aware, shortly after the end of the financial year, the group received IRB accreditation from PRA us in respect of its mortgage portfolio and ahead of schedule also for the SME book. IRB accreditation delivered a reduction of over £5,000,000,000 in risk weighted assets, and resulted in a CET1 ratio on a pro form a basis at 30 September 2018 of 14%.
Us. Now as we've consistently stated, attaining IRB is a critical strategic benefit for the group. It puts us on a level playing field against our peers us. And eliminates a competitive and capital disadvantage. We're extremely pleased to have delivered on our promises here.
Us. And I guess that's a good point for me now to hand back to David to talk about the future.
Us. Thanks, Ian. So before I speak a little bit about the ambitious future, I suppose I should acknowledge as well as Ian the our current environment. It is a tough one. There's a huge amount of political uncertainty, as we all know, and the outcome remains hard to call.
Us. We talk about no deal as being a very bad outcome. I don't think we can say much more illuminating things than that. Us. Clearly, we're seeing and having an impact on the economic performance and outlook for the bank, and that's really a broad macro U.
K. Theme. And us. At the same time, on a positive note, credit performance has remained benign. Now having said that, us and looking past the doom and gloom to the medium term opportunities for us.
I'm going to be wanting slides like this rather than Brexit slides, I think, is going to be the way we go. If we look at the acquisition of Virgin Money, I think what we have now is genuinely a best of both leadership team us in terms of experience and a proven track record of complex multiyear transformation. We've also added tremendous bench strength from Virgin Money to our business at all levels. Us. Peter Bowell, formerly the Virgin Money CFO, has joined as our Group Integration Director and will lead the group ride integration program us covering every aspect of the bank, and we'll also cover the delivery of the RBS alternative remedies package schemes.
Hugh Chater, the Commercial Director from VM, has also joined our LT in his current capacity and has day to day oversight of the VM leadership team alongside myself. Us. Hugh, importantly, will also lead our commercial planning around the combined mortgage business as we move towards full integration. I'm also, given the circumstances, particularly delighted that Fraser Ingram has taken on the role of COO on an interim basis. Fraser and his team us.
We're the executives that built out our digital capability, and I look forward to working with Fraser and our new Virgin colleagues, who also have great expertise, to build on the great achievements of recent years. The combination of the expertise us. And the cultural similarities of both banks gives me a lot of confidence in our ability to deliver the integration plan over the next few years. Us. And we're already working jointly on quite a number of initiatives.
And frankly, I think we're making a lot quicker progress than I would have expected at this stage. Us. So while we have a lot to do to obtain our combined group license under Part 7, I'm very excited about the future of the combined our group and in particular the potential relationship with Virgin Group Companies. We have an iconic us. National consumer champion brand in Virgin Money.
It has a high awareness, 99% across the U. K. When you take that brand and you combine it with the technology platform and the capability we have built. I think you get a genuinely differentiated proposition in the marketplace. In addition, we'll be now able to offer a full range of products, as we've discussed us before and services to all 6,000,000 of our customers.
I mean for a practical example, we can offer a strong current account our position, which didn't exist before, with an exciting digital capability to the Virgin customer base and significantly increased product penetration as well as benefit from associated low cost funding. We can also leverage the Virgin Money Network, which doesn't do sales, as you know, to increase our overall sales ambitions on a national basis. Our SME franchise, as Ian has described, is primed to be scaled nationally through utilizing the RBS alternative remedies package schemes and the capability and innovation award at a Poulet level. And as I said, I think we're the only realistic challenger us. If you define that by someone who can break through the critical 5% market share threshold to provide a real challenge, I think we're the only credible challenger in that space.
Us. I think when I look at it, there's the expansion of our SME franchise, both in scale and geographically, as a key part of our strategic development over the next few years. And I think this will bring a lot of diversification and, in particular, funding benefits. Us. And this RBS package, I look at this as really the first step in our strategy before we develop a national technology driven strategy for SME us at Combined Group.
So when I stand back from what we've developed here with this acquisition, I think we have a unique advantage. Us. We have a national iconic brand that has ubiquitous recognition and does not have, importantly for me, a legacy banking connotation. We have us. Sufficient scale and products and services to be competitive, and we'll deliver those to 6,000,000 customers, as I said, and all of that through a national distribution platform.
Us. We have a brilliant digital platform and data mining capability, which will be deployed across our entire retail and customer and SME base. Us. We have an opportunity, as I said, to develop the whole SME platform nationally, a scaled national competitor with a great digital offering. Us.
We'll also be able to offer many of the benefits of the other Virgin Group products, which when we're developing our proposition model. Us. And what does that translate into? It gives us a low cost customer acquisition capability and uniquely we'll be able to acquire customers by tying all of this together with the Virgin Group loyalty program which is under development. This banking as a platform, as it's referred to, model us.
We'll all be delivered uniquely through a single brand, an integrated brand of Virgin. So unlike others who have friends and family that they have to get together, us. We'll do it through all one brand association. I don't think any other bank can replicate the innovation, the diversity of product us on proposition delivery that we can create through this combination. Effectively, when we stand back, we will deliver a technology driven us.
Integrated bank with a single brand with a single brand around open banking, and that's unique. So when I stand back, us. We're extremely well positioned to deliver on our ambition to become the 1st true national competitor to the status quo. Us. And I think that's real and tangible and we'll demonstrate it in the next year.
I'll now hand you back to Iain, who will talk you through our 2019 guidance for the combined group.
Us. So I know you're all aware that we only took control of Virgin Money 5 weeks ago. And being reasonable people, us. You won't expect us to have had enough time to develop detailed guidance by now. So we're going to come back to you in 2019 us with comprehensive medium term guidance.
However, I'm sure we'd be delighted if I'm going to say a little bit now us about how we expect the group to perform in 2019. Now before I start on the outlook for the enlarged group, us. I'll say a few words about Virgin Money's 3rd quarter, which concluded just before we took control on 15th October. Us. VM had a solid Q3, with asset growth, margin and profits in line with expectations us and the guidance given at the half year.
The margin compression that had been well flagged continued, and we see that coming through in the plan for the year ahead. Us. We're pleased to reaffirm the integration plan, cost synergies and cost to achieve that we outlined on 18th June. Us. Everything we've seen since 15 October has increased our confidence in the delivery of our plans.
Us. In addition to the announced synergies, David has spoken about the focus on growth initiatives as we bring the 2 businesses together. Us. I won't repeat those here, but I'll underline our confidence that this affords us a truly unique opportunity to deliver growth over the medium term us in what may be a more challenging operating environment. I want to remind you about the sequencing of the integration process us that will determine the pace at which we build out the growth opportunities and realize cost savings from the combination.
Us. A key gating item is the approval of the Part 7 transfer. Before Part 7, we need to maintain the separate integrity of the 2 banks us. With some regulatory restrictions on our ability to approach things on a combined basis, our target is to get the Part 7 approved towards the end of calendar OC19. And Part 7 approval allows us to bring all our customers' products and business under a single banking license.
From that point, us. We'll be able to rebrand and progressively offer our full product range to all our 6,000,000 customers on a single platform us and through a unified branch network. We planned the integration with the Part 7 in mind, and our guidance on cost synergies reflects this. Us. Our integration efforts in 2019 will be focused on planning and preparation, which will be considerable and on securing cost savings focused on third party contracts, us.
Property efficiencies and senior management headcount reductions. Us. The group starts life with a robust capital position. The CET1 ratio is 15.2%, us. More than 3.5 percentage points above the fully loaded CRD IV requirement, 11.6%.
And you can do the maths. That's about £1,000,000,000 and and a pretty strong starting point, which I hope you'll agree. Now what's not included is the impact of the IFRS 3 acquisition accounting adjustments us as that work is ongoing. Now this is important because it helps us deal with an issue that's become has been a matter of some interest and comment, us. The EIR accounting in the Virgin Money credit card book and the capital impact of any adjustments we might be expected to make us.
To the accumulated cards EIR asset, which stood at circa £190,000,000 at 30th June this year. Us. IFRS 3 requires us to bring the assets and liabilities, all of the assets and liabilities of Virgin Money, onto our balance sheet at fair value. Us. As part of that process, we'll eliminate the EIR asset completely and reset it to 0.
And we recognize the cards us. Portfolio on our balance sheet at its fair value based on the NPV of the contractual cash flows in the book without the requirement to estimate the benefit of material forward income us and include that on the balance sheet today. So the key thing to understand about the VM card book is that going forward in our hands, us. The book should not be as sensitive to the risks of EIR accounting in the way that Virgin Money was on a stand alone basis. Us.
We've acquired a more seasoned back book, but customer behavior is much better understood. And over time, front book origination will be less reliant us on interest free balance transfer offers. And we can set the income recognition assumptions on a suitably prudent basis. Us. Now coming back to IFRS 3 and the acquisition accounting.
The work's not complete, and we won't have a final answer until early 2019. Us. We expect that the net outcome of all of the puts and takes on the assets and liabilities, including the cards book, us. So how do we feel about capital? Us.
Well, as you know, we expect the group to be capital generative over time. So I guess the key questions will be where do we expect to operate from a capital perspective? Us. Does that result in excess capital? And if so, what do we intend to do with it?
So the board likes where we are right now from a capital perspective. Us. 2019 looks like an interesting year, both at a macro level and also for our business. We hope to get a sensible resolution on Brexit, us. But some uncertainty remains, and that's casting a shadow over economic growth prospects in the U.
K. And CYBG is sensitive to U. K. Macro, as you might expect. Us.
In our own business in 2019, we'll see the unveiling of an updated strategic plan, the commencement of our integration, us. The outcomes of the Williams and Glyn RBS alternative remedies process, and we'll see the closure of PPI. And that's really just to name a handful us. Facing into that from a position of capital strength seems to be the right thing to do. Us.
Importantly, the PRA wants us to undertake an ICAP assessment for the enlarged group, which we'll do in the first half of next year. Us. We don't expect that to throw up new risks of which we'll need to hold capital, but it is a key determinant of our capital requirement. So unfortunately, we're We're not going to try to answer those three questions definitively today. That will be determined over the coming 12 months, I reckon.
Us. Regarding the capital operating level, we'll target holding a sensible buffer over the regulatory minimum, and I wouldn't expect us to be out of line with our larger peers. Us. The answer to the other questions will be much clearer towards the end of this financial year. And finally, us.
A signal of the board's confidence in the strength of the business and its prospects, notwithstanding the macro uncertainty, us. It's a decision to pose an increased dividend this year of 3.1p per share and to reaffirm our commitment to progressive increases us. You will recall that we paid an inaugural dividend of 1p per share last year, us. And so that's a fairly material increase year on year. Before I guide specifically on NIM, I need to do a bit of recalibration with you.
The new group NIM is quite different from what you're used to seeing. Us. We've shown on the slide here the 2 heritage NIMs on a stand alone and comparable basis. And And so let me be clear about the basis of the Virgin Money margin figures. Firstly, they've been converted to a September year end.
And most importantly, they show the real NIM us rather than the banking NIM convention that was used. You can see the difference between the two heritage business models come through quite clearly. Us. Both businesses have been exposed to NIM compression over the past 12 months, largely due to the mortgage market dynamics us
of competitive
pricing and reducing SVR balances. The compression has been less severe in the CYBG heritage, us. Our NIM has been more resilient given our lower cost funding base, our slightly richer mix in mortgages and, critically, the benefit of SME. Us. Going forward, we'll focus on the combined NIM.
And in FY 'nineteen, we're guiding into a range of between 160 and 170 basis points. Margin compression in the mortgage portfolio is expected to continue. Us. And along with some upward pressure on savings rates, that will drive a reduction in the net interest margin. Us.
This is offset by growth in current account funding, helped by the RBS remedy package, which I'll talk about in a moment, and a positive contribution from non mortgage lending yields. Now the reason we're expressing guidance as a range this year is because we've owned the business for 5 weeks. Us. In addition to the overall economic uncertainty, there's a number of upside opportunities and downside risk that may impact our ability to land NIM on the head of a us. These risks and opportunities mirror what we're already seeing in our plans.
We've baked in some competition impacts, us. But we can't rule out further pressure. On the other side, though, we may see stronger results from Williams and Glyn switching than we have in the plan, us. And we will find opportunities for managing the combined balance sheet that are not yet baked into the guidance. Us.
Initially, we've put together 2 heritage plans that have been devised separately. Us. And we're confident that integrating the balance sheet management of the enlarged group will yield income opportunities. Us. Of course, the big unknown is what happens to interest rates, which no doubt will depend on the political outcome.
Us. So last or no, not last. An important point to make is we're facing the current period of political and economic uncertainty us. We have higher levels of liquidity that we might hold in different circumstances, and that, in turn, dilutes the margin. Now And we think that's the right thing to do for now.
And if we get a little more stability in due course, then we'll look at that again. Us. Before I move off NIM, there's a very specific point I need to address, which is MREL. There is a wide range of estimates out there us as to how much MREL will need to raise and its impact on the margin. Now we've got a slide in the appendix that talks to us in a bit more detail, but here are the headlines.
Us. Today, we already hold more MREL than our 2020 interim requirement. Us. The end state MREL requirement will be set by reference to our Pillar 2A buffer in 2021, and that's likely to be lower than it is today. Us.
We're planning on senior unsecured issuance of around £2,000,000,000 to £2,800,000,000 over the next 3 years us at a rate of 1 or 2 trades per year. And this issuance is factored into our funding and margin plans us. At prudent spread levels and doesn't present any concerns. Turning now to one of our strongest core competencies, us. Now we expect to make good progress in managing down costs in 2019.
We'll see the full year benefits of the final Project Sustain kids coming through. I will begin posting the initial synergy benefits from the Virgin Money transaction. So as ever, that demands that we set a target for the year. Us. Now in trying to establish a starting point for the group's cost base, I guess there are 3 components to consider: us.
The £635,000,000 we've reported today, the Virgin Money core cost base and the last publicly available consensus us. Estimate of that for 2018 was circa £350,000,000 and then also the cost of running the Virgin Money Digital Bank, us, which is expected to launch in 2019, and running costs were estimated at circa £35,000,000 incremental. Us. The VMD project is being shut down, and so that is no longer a factor. From the start point, us.
I've outlined that from the start point outlined, having avoided incremental costs related to vMDB and focused on integration, us. We expect to deliver a combined cost base of less than £950,000,000 in 2019. Us. So after a bit of a wait and a number of false dawns, the process for delivering the RBS alternative remedies package us is about to begin. Now it's worth recapping what the European Commission and U.
K. Treasury are seeking to do here. Us. It's all about competition, finding a way to move meaningful market share away from the incumbents and create additional investment capacity us. For banks such as CYBG to strengthen their competitive threat in SME Banking, and all applications will be looked at through that competition lens.
Us. And that's why it's necessary to focus on both material elements of the remedies package: incentivized switching us. And capability. I think all too often, people focus on the free money part, the capability grants. Incentivized switching delivers on the competition objective us because it is designed to cause at least 120,000 SME customers to leave RBS and go to another provider amongst a limited field.
Us. We expect to be a major winner in the incentivized switching scheme, which kicks off pretty soon, and you can see the key dates on the slide. Us. We've invested heavily to ensure we're ready to seamlessly onboard a substantial proportion of the 120,000 customers that are expected to move. Us.
We've built a dedicated switching factory in Leeds and recruited close to 50 new relationship managers, many directly from Williams and Glyn. Us. We have both a compelling proposition and the capability to give these long standing customers of RBS exactly what they need. Us. And as we said before, we think of incentivized switching as a really important source of low cost funding at scale.
Us. The pool of customers from which the switches will be drawn contains around £11,000,000,000 of deposits, us. And this is a number you weren't familiar with but RBS have allowed us to talk about. And RBS have been fantastic throughout this process in helping us get ready for the switching process. Us.
We therefore expect this part of the package to yield a couple of $1,000,000,000 of low cost liabilities for CYBG over the 2 years us. The scheme is expected to operate. Of course, what's hard to predict is the pace and scale of customer acquisition, given it's all driven by customer choice. Us. Part 2 of the package is the Capability and Innovation Fund.
As David said, we're a PULA applicant, us. Eligible for the largest grants, and the key dates in the application timetable, again, are shown on the slide. Coming back to competition, us. The authority's key objective. We think it's pretty clear that we are best placed to invest the capability money for the most beneficial impact on competition in SME Banking.
Us. The Competition and Markets Authority are clear that a 5% market share is the minimum requirement to disrupt incumbents us and therefore, to have that meaningful beneficial impact on competition. Santander and the big four banks are already well above that level, us. And then there's us. A 3.5% market share of business current accounts today, with the other potential applicants a long way behind, us.
We are the only bank that can credibly break through the CMA's 5% threshold and deliver the necessary impact on competition. Us. And we're ready to go on this, too. We worked through in some detail how we expect to invest the money and the growth that it will help deliver, us. And our application is ready to submit.
However, there is a small matter of convincing the judges, and so we haven't yet baked this element us. So there's a lot going on for CYBG in 2019, us. And so you'd expect a busy schedule for substantive market updates. In the first half, we'll get some clarity, we hope, on Brexit. Us.
We'll learn the outcome of the RBS alternative remedies process. We'll build out our integration planning, including the Part 7 and the rebranding. Us. We'll do an ICAP, and we'll complete our strategic planning for the Enlarge Group. And that will enable us to deliver a Capital Markets Day us.
In June 2019, to share the medium term performance targets for our business. And thereafter, things should settle down into a more regular reporting cycle, us. And we can all have weekends off again. Currently, we've no plans to move from a September year end. Us.
So taking a step back, here's how I'd summarize how we feel about the road ahead. There are lots of positive things to work on as we bring these businesses together, us. But they're going to take patient focused execution, and that's something that we've been quite good at in the last 3 years. We're very focused on what's in our control, and
us. And we have prepared as best we can
for what's not. And quite frankly, we're really looking forward to getting stuck in. So having provided a detailed update today And the promise of lots more to come. I'll end there and hand over to Q and A.
Us. Okay. Thanks, Ian. And we're going to handle questions in the room and then we're going to go to the us people who are on the phone. So starting with the room first and I think we have some mics we have right here.
Us. It's Arman Raghkar from Barclays. First question on net interest margin. Us. So you alluded to it, the guidance that you've given for next year.
Can I just ask what how many base rate hikes, us, if any, you have in your capital plans sorry, in your guidance? And on that theme as well, could you give us any color us. What benefit the combined group had from the most recent base rate hike? Can you talk about what kind of deposit beta you passed through? Us.
And any kind of numbers you can kind of give us on the benefit that you enjoyed there? And then the second question was about the mortgage market. Us. Just interested in, clearly, key source of margin pressure for the combined group going forward. And both CYBG and Virgin Money have us.
Basically lowered their market share of gross lending this year. Kind of interested in whether you see that materially recovering from here. Us. Just the kind of back of the envelope calculation I've done, I think you were somewhere probably about 5.5% market share last year us. Of gross lending, I think that's probably come down 1%, something like that this year.
Do you see that materially recovering from here? And And I guess what I'm trying to unpick is basically what kind of growth rate can we expect from that business going forward? Sure.
Us. So we have no base rate hikes in our plan for 2019. I think the first one we see next happens us sometime in the following financial year. In terms of deposit beta, we're pretty much in line with the other banks. And I think they've broadly talked about passing on about most of the last rate increase to depositors.
And we wouldn't be out of line with the rest of the industry us. In terms of mortgage share and therefore how that translates into growth, yes, you're right. Us. And that reduction, I guess, through 2018 largely came from the Virgin Money side. They grew very, very strongly through 2017 us.
And then in 2018, took a bit of a step back. So that's where CYBG broadly maintained its share of flow and us. A gradual tick up in stock by the end of the year. So as I say, it came from the Virgin Money side. Us.
Our view on where we expect to go from here, look, I think we're going to stay as simple as we can in what is quite a difficult market. We've demonstrated our ability to take share. I would expect that unless pricing was absolutely crazy, and it still us. Makes sense from a return on equity basis. We would continue to grow ahead of market.
Key question is us. What's market going to grow at? And I think that's what we've all got to guess. So really that us. What I'm saying is that the Virgin Money have taken a bit of a step back from their previous strong growth in mortgages.
Us. We've held our own, and I think we'll continue to take market share in 2019. I just don't know what that is yet.
Okay.
Us. We have one over here at the front. He's coming right here.
Us. Yes. It's Robert Sage from Macquarie. Just a quick one. Sort of looking at the expected margin decline next year to 1.6 to 1.7, down from 1.78
us. If you were to sort
of try to sort of look in terms of the primary driver, is it correct to sort of assume that it's largely mortgage market pressure on the asset a spread side that would be causing your view that this will fall. To what extent might it be sort of also attributable us. Well, the fact is, I think you referenced the sort of upward pressure on deposit spreads. But is it largely mortgages that we should be looking at there?
Us. Certainly, on the VM side, and we're still I'm looking forward to getting to a point where I don't talk about heritages, but it's early days. Us. So certainly, the bulk of the net interest margin compression from the VM heritage comes from mortgage market. Us.
Our own is much more balanced. We've got a broader business that allows some puts and takes us that help us to manage the overall net position. But yes, a lot of that pressure comes from mortgages. Us. The other opportunity we have coming into this is really to start working on the liability mix.
Us. Virgin Money, without a current account base and without SME, has us. Focused heavily on the savings market. We have the opportunity over time to sort of drive a more balanced position. Us.
And the other thing is liquidity. Liquidity is an important part of this. We talk about liquidity drag in our business. Us. And the group is in a strong liquidity position at the moment, which I think you'd expect given market conditions.
Us. Now just again to reinforce, our guidance today is base case. I can't emphasize enough us. Having been in charge of our new business in Virgin Money for 5 weeks, us. Our ability to influence that is something that we'll work through over time.
Us.
Any more questions from the room? We have up front here, and we'll come back in a second.
Us. Just a follow-up on NIM again. Just in terms of your assumptions on the EIR on the credit card book, us. Is your NIM guidance particularly for, Virgin Money on its own, predicated on the fact that there is going to be quite a lot of compression us. On the credit card margins as well, because of the way you're going to account for it going forward.
So has that had a bit of an impact? Or is it particular is it mainly still the margin side of things? Us. And secondly, on the SVR book, I mean, have you any idea at what rate the SVR book sort of contracts further from here In terms of it's obviously gone down from 11% to 9%, so that will obviously have another impact on NIMs as well going forward.
Sure. Us. So the group net interest margin is not particularly sensitive to EIR assumptions. What we're talking about us. It's over a much bigger income base in the enlarged group.
So not a huge impact there. And I think that gives us, us. As I said, the opportunity to be a bit more prudent on EIR. And then sorry, the second part of your question? Us.
Yes. So it's hard to call because it's so much driven by customer and competitor behavior. Us. Our base case is to probably for that to settle around about where it is now, but us. Who knows?
And I think you have to go back into history to sort of see that certainly in our case us. Something sort of sub-ten percent was a steady state.
Okay. We have one over here.
Us. Guillaume Desclayor from Thairobi. Two questions, if I may. The first one is on the comment you made on the broker our services adjustment that you had to go through Q3 that you were expecting like a slowdown in the volume, but actually it was quite us. So if you can comment a little bit further on that.
And the second question is on the IRB applications that you have in front of you. So you said The next one is the unsecured lending activity for CYBG. So it should happen within the next 12 months, I guess, something like that. Us. But the big then the next one after the part 7, you said.
You said us. End of 2019. So is it like a 3 year program for you to have an aggregated IRB application for the us. Thank you, Oliver. And to have a meaningful impact on your RWA in 2022.
Is it some The way we have to think about your LWA reduction going forward? Thank you.
The first part of your question? Us.
Just you've made a comment on the broker arrangements.
Yes. Okay. So us. We talked about at the half year that we had brought our broken mortgage processing onshore from India, us. And we'd experienced some operational problems in bringing that on board, which us.
Meant that our applications through the broker channel were much reduced. So we worked hard to fix those problems and to partner with our brokers us to solve those. And we flagged at the time that we thought we would see a difficult Q3 and return to growth in the Q4. We actually expected us our mortgage balances to go backwards in Q3. They were, I think, £13,000,000 us up.
So that was better than expected. And then we were back to normal in the Q4. So us. Really put that behind us. It was a frustrating episode, but put that behind us.
Unsecured IRB, and us. I guess that the relationship between that and integration. So us. Unsecured IRB, we now have to factor in our book, which the general expectation is that we would see us. An increase of a few €100,000,000 in respect of risk weighted assets, but nothing more than that.
Us. We also have the unsecured book in Virgin Money, which is also where we have an IRB application in process. Us. That's on standardized. And we expect to see a beneficial impact on RWAs from us.
We're going to sort of bring those 2 together because make sure that we've got a sort of coordinated us. And cohesive approach to the PRA on those. And I suspect that that process of us. Putting a foot on the ball means that we're probably later in the year in terms of submission of the application. I'm hoping that we're not going to see us.
A big impact on net RWAs as a result. And it's not dependent on Part 7. The IRB modeling process, we've got us. 19 mortgage models, and those really look at particular segments of the portfolio. Us.
Easy example is sort of buy to let or a current account mortgage or something of that nature. So they're much more us segment specific than entity related. So I think I don't know how many mortgage models Virgin Money have actually, but I would expect that us. We can bring some of those together where they make sense, and that's not dependent on a regulatory process in any way. But I think we'll continue to operate a range of mortgage models us that manage the different parts of our book.
So Part 7 and integration is not a barrier, if you like, to getting on with the IRB process.
Us. It's David Wong from Credit us. I just had two questions. The first is just a quick follow-up to your comment about the degree of control you've got over the Virgin Money business. So us.
Should we expect that basically for the large part of 2019 before these parts and transfers get affected that Virgin money still sort of remains slightly us. On its own as part of the combined group and you don't have full control you haven't got as tight a control over the business as you would us. Expect to have post integration. The second question I just had was on your mortgage distribution. Us.
I guess you probably still are primarily relying on brokers, 3rd party brokers to distribute mortgages. I wonder if you would hope to do more direct us. Distribution over time rather than relying on that 3rd party channel. Any thanks.
Great. Maybe I'll pick up on the control issue. Us. Just to be clear, the Part 7 requires you to run 2 separate entities for a period of time, but there will be levels of integration that we will negotiate along the path with the regulator. But in terms of specific control, I am the CEO of both legal entities with full regulatory responsibility, us.
The same for Ian as the CFO, and our CRO is now becoming the same. What that means is that think of it as having full control. Us. So we have full control of 2 separate entities that we're running in parallel. And if that makes sense, sounds a bit like an oxymoron.
Us. And then what we do is we at the group board level, we run a Virgin Money Board and a group board, but we bring it together. Us. And so our Chairman and myself and the rest of the Board members manage the entity as one. So that's the way to think of it.
1 group entity being managed, us 2 run separately but with full control at the key executive level.
Yes. And David, the only impediment that gives us until Part 7 is us. I'll give you a couple of live examples. We can't a Virgin Money customer can't walk into a Yorkshire Bank branch us and transact business until we get to Part 7 and we get on to a common platform. It's the customer side that we can't integrate.
We can do all of the functions. And as David says, we have absolute control over the business. Mortgage distribution. So us. At the moment, SUIBG is about 80% broker, 20% branch.
Virgin Money is 100% broker. Us. We are both heritage businesses. We're developing a direct proposition us through digital channels. And we're now able to combine our efforts on that.
So I think that's key. It's key us. A better customer experience and also to reducing cost to serve.
Just a subtlety to add there. In the When you think of the Virgin Money network, it wasn't a sales network. So they gathered deposits but didn't have a sales capability. Us across all the product suite. In my comments, we will deploy a full product capability through the full national network.
Yes, thank
you. Tramsel from UBS. Us. Do you have any expectation in terms of market share and how much you target to take from the RBS revenues and packages, the switchings ranging from 120 to 200 ks customers. Us.
And secondly, can I quickly follow-up on NIM side? Do you us. Understand what's driving the rapid decrease in the Virgin monies NIM in 'nineteen. Is it front to back book thing, us.
Yes. Good morning, Chancellor. So our expectation of share of the 120,000 customers, us. I wanted to avoid us getting dragged into a league table discussion, so I haven't put a number up there. But you can expect us to take us.
A significant proportion of the overall total. You think about how many meaningful banks are in that process, ourselves, Santander and a couple of others. Us. So that should give you a bit of an indicator. The Virgin Money NIM, there's a lot of us.
Sort of that snowball effect of business written in 2017 in a very competitive part of the mortgage market, then feeding us into 2018 2019's margin. So it's that sort of snowball effect of back book. I think that some of the us. Sort of taking the foot off the gas on front book in 2018 from VM will help a little bit in terms of stemming the decline. Us.
They did not grow as strongly in that competitive space, but it's back book related.
You have one just to the left here.
Us. It's Guy Stebbings from Exane BNP Paribas. First question was just on how you think about the relative us. Preference on growth between mortgages, unsecured and SME as we stand here today with a very competitive mortgage market, but given the economic uncertainty and how that might play through us. So how would you kind of rate growth between those three segments, if you like?
And the second question, us. If I can push you on material because you used the term not material for 2 very important items, the capital impact from IFRS 3 us. Any further PPI top ups. So people's views on what not material might be is could be vastly different. So any color you can give whatsoever around that?
Are we talking 100 basis points, Nothing more than that or anything else, that would be very helpful. Thank you.
Okay.
So the relative preference on us, Growth. It's a really good question. So without giving you us. Precise numbers because I'm going to fight shy of that. Our emphasis and again, this is all on a base case which says that us.
People stop messing around, and we get a sensible answer on Brexit, is that we would see much stronger growth us. Much more of a focus on growth in SME and unsecured and much less emphasis on growth in the mortgage market. Us. Both of SME and unsecured are better for the margin mix. Us.
And if I think about both of those businesses from a heritage CYBG perspective, well, clearly, us. We've made fantastic strides in SME from a place where back in 20 'fourteen, the business was mothballed. It's reinvigorated. It's got new people. We're us.
Taking market share from the likes of Lloyd's and Barclays and others, the biggest competitor we see in SME in the regions is actually HSBC. So we're taking share of the incumbents, and it's at good margins, good pricing. Unsecured, us. You know us well, Guy. We've not been particularly relevant in that market because of a lack of capability primarily.
Us. We saw some decent growth in personal loans in 2018. And I think unsecured through us. Our PL business and our things like the salary finance joint venture and others will just help underpin that. And again, us.
Much better margins in that space. On the VM side, well, we talked about a bit of a step back from the mortgage market. Us. And you'll continue to see growth in the cards business there. It's a really good business.
We've got to make sure we get the income assumptions right, us. But they're still stronger than you're seeing in mortgages. So hopefully, that gives you a bit of a sense of where we're placing our chips. But it is, as I say, us. Predicated on a sensible Brexit outcome.
Material. The way we think of material is it doesn't cause us to us. Break our stride. It's just how we think about the business. We're strongly capitalized.
PPI is has been a very painful episode for us. This business and primarily our former shareholders, but currently are our shareholders today. Us. As I say, it's something where we'll maybe have to deal with some last bits and pieces on closing out, but we don't see it causing an interruption in what we want to do. Us.
And similarly on the IFRS 3.
We have one over here.
Us. It's David Lock from Deutsche. I just have a follow-up on PPI. Us. Can you just give a just clarify a little bit?
Because, of course, the deadline is in August, and you quote all of the numbers about us. Kind of weekly customer complaints. But if I make a complaint or I make a claim on the last week, presumably, it's going to take a few months for me to actually get paid out. Us. And if you have a sudden rush of people in the last week, how long will actually the costs take to come out of the business?
So can you just give a bit of clarity as to us. That provision, what exactly is that? Is that to the August deadline? Or is it to a little bit beyond that?
So the way we think about the provision, David, is us until we're done. And we have us. A regulatory obligation to deal with claims in 56 days. So it's a 2 month process. So us.
And unless there is a deluge, and I don't think any of us is expecting a deluge of complaints us at the last minute. I mean, goodness me, how many people are out there that need to find out about PPI in the world? So us. Unless we have a deluge, we're well able to cope with those volumes within the 56 days. So when we sit down in 12 months' time, us.
We would expect to be able to show that us. Most people that we have on the pitch dealing with PPI are now doing other things.
Us. Maybe it might be time to go to the phones, and we'll come back in the room, if there's any
at the
end. So Andrew, do we have
calls come in? We have a question from Ed Henning of CLSA.
Us. A couple of questions from me. Firstly, can you just confirm in your NIM guidance that us. The potential change in EIR is actually in the guidance?
Us. Given that we stated a range, Ed, you can expect that any changes in income recognition us. On the cards book is we can absorb within that.
Okay. Us. That's great. And just a second one. David, you talked about, obviously, building out and needing to invest in the business and technology.
Us. Firstly, why has it taken it's taking so long to get the SME customers across the IB platform? And how us. Quickly, can you roll out if you've built a lot of the tech around SME and also the current accounts around B to roll it out with the Virgin brand name on it?
Us. Yes, Ed, it's really a question of prudence. So we've moved across 2,000,000 customers. And if you look at all the issues in the U. K.
And us around that. We decided to do retail first and SME second. We've built out that capability. And with 200,000 customers, we don't see that as a major Complexity. We will have all of that done during the coming year.
If you think about it, we can't really do integrated us. Offerings with Virgin Money until the following year, until Part 7 is done. So it allows us complete our exercise fully embedded us and then be ready to switch with into offering this product to Virgin Money customers in the following year. Us. Equally, we were very cognizant of the fact that the timing was fluid on Williams and Glynne.
And so the switching begins in 2019 us before our Part 7 is done. So we're having to move with another brand first. So we have a major conversion, which we'll be completing during the year on our own SMEs, us but at a manageable population. We will then have a large switching incoming activity on SMEs and then we'll be deploying significant new technologies further than those built us today with the funding, if we get the right level of funding from the category A. And then as we agree to Part 7, we'll be able to us, Lloyd, that rapidly into the Virgin Money territory.
So it's a combination of a series of activities, but underlying prudence, Ed.
Us. Yes. So but you've basically for a Virgin Money branded SME product, really it's not till after the Part 7. And is that the same for current accounts?
Us.
That's the same. Basically, what Part 7 does is protects against customer detriment. And what you have to do is convince the regulators that us. You have done enough to protect the customer, and the processes you've engaged in will guarantee that. So what we have is a us.
Peter Bowles, our Integration Director, is looking across the entire spectrum of activity in the bank, whether it's technology or it's just communications with the customers, every aspect of that us and then the rebranding process being done in the right way and that the plans for that are robust and coherent for the regulator and that we have proved that we're not going to do customer harm. Us. That takes usually 12 months, Ed. What we're hoping is that along the way we can make progress. So think of it as a pyramid, We can start slicing things out of that pyramid and executing them ahead of that as long as we can demonstrate they're not directly impacting the customer.
Us. So it's trying to get operational execution momentum. And then anything for the customer waits till post Part 7, Ed.
Okay. Thank you. Us.
Our next question today comes from John Cronin of Goodbody. John, please go ahead.
Us. Hi, guys. Thanks for taking my questions. The first question I have is just to understand better us. Your guidance on IFRS 3 impacts, I appreciate that that's preliminary and the work is ongoing and how that dovetails us with the NIM guidance in Virgin Money's case.
Look, I note your comment to the fact that the us. Dimination and margin on the credit card book for Virgin isn't a major driver of the NIM dilution. But just trying to understand better, us. If you take a if you effectively eliminate the EIR assets at acquisition, us. Then does your NIM implicitly continue to assume significant margin deterioration us.
In the credit card book for Virgin, even though that's not the primary driver of overall group NIM compression us. So look, I appreciate there's a lot going on there within that, but any more color you could give to Murray up the us. 2 on credit cards specifically would be helpful. And then look just secondly on the CET1 us. Guidance in terms of where you would like to be from a target ratio perspective.
I know what your comment around in line with larger peers. Us. Specifically, what should we be thinking in that respect? Is that 12% or is it 13% or us. Potentially even higher given the currently elevated P2A.
Thank you.
Us. Okay. So IFRS 3 and NIM, unfortunately, John, I'm not going to be particularly helpful. Us. We're not done on IFRS 3.
So there'll be a bunch of those fair value adjustments us that do feed through into the net interest income line. Us. We haven't yet those included those in guidance, and we'll talk about them when we come back in the Q1. Us. I'm not particularly concerned about it.
And again, I think I'll just stay away from worrying too much about us. EIR and its impact on margin. We get a back book that is us. Probably earning better today than the assumptions that were made sort of early on in terms of cash and therefore the bridge to us. EIR is much shorter.
So you're going to have to be patient with that. We'll come back on the impact us. Of all of those adjustments early next year. On CET1 guidance, I mean, I can't us. It's one thing to say where we expect to sort of target, I.
E, be above X%. And as I say, us. I can only point towards some of our larger peers and obviously make any adjustments for the fact that we're not a SIB and that sort of thing in terms of requirements. Us. But we are going to come back on our Capital Markets Day and give much more clarity around capital and the capital trajectory.
At the moment, We're going to sit on a big pile of capital, and we'll tell you what we're going to do with it in 6 months' time.
Us. Thank you.
Our next question today comes from Victor German of Macquarie. Victor, please go ahead.
Us. Yes, good morning. I apologize in advance. You've had a lot of questions on margins and I'm not going to break the trend here. Us.
I look at your CYPG guidance for margins and I know that you issued us. Emerald debt in September, which is obviously going to cost some additional money in 2019. Us. Yes, you're guiding to pretty much broadly flattish margin. In fact, it looks like margins are actually fairly stable in the brand.
Yes, Virgin Money contraction is us. 17 basis points, which is higher than previous year. And the base impact, given the base is different, it's effectively 12 us. I'm just hoping you could provide a little bit more color in terms of why we're seeing that margin decline. Us.
And is it sort of maybe some comments around the potential Emerald impact, potential TFS, us. Any sort of additional color you can give us on the trajectory kind of as we exit 2019, where can that margin can actually
go? Us.
Okay. So Victor, I'm not going to tell anybody about where we expect to go after 2019. We're very clear that us. After owning the business for 5 weeks and given all the stuff that's going on in the outside world, us. 2019 is as far as we're prepared to go today.
Now all roads lead to Capital Markets Day and those kinds of things us. We'll have a much clearer perspective when we get to June. So I know that's going to frustrate you. In terms of the CYBG heritage, us. Sure.
We raised MREL in at the back end of FY 2018. Us. But we are very confident about raising cost effective funding throughout us. So I wouldn't focus on a particular element of the funding mix in CYBG. We've proved ourselves pretty good at us.
Managing the different pressures in margin up until now, and I wouldn't expect that to change. Us. TFS refinancing combined group is probably going to we'll probably aim to refinance about €1,000,000,000 of TFS in 2019, us. And we'll refinance that from a combination of deposit and wholesale funding, all factored into our plans. Us.
The Virgin Money business and the impact on margin there, first of all, what I'd say was we knew that Virgin Money us was facing into margin compression. We factored that into our planning when we were constructing the deal. So us. Their business model is very different to the CYBG heritage. Us.
They competed in a much lower margin space in the market us and competed fairly strongly there and grew their book strongly as a result. And therefore, that has baked in us. Some of the spread compression that we're seeing. The Virgin Money funding model is also different to CYBG and a bit more dependent us. Refinancing savings year over year and being pretty price sensitive in that regard.
We're very confident that as we get to grips with us. The combined business that we'll be able to drive through a broader liability mix much more similar to what we have today over time, but it's going to take time. So I see this as an FY 'nineteen challenge for the Heritage Virgin Money business us. That we'll be able to work on through the year, I talked about what we might do on liquidity. I think some of the balance sheet management opportunities we have us before us will deliver stronger income.
So I'm pretty optimistic that us. As we put these businesses together, we'll drive to a much stronger position. But at the moment, us. What we're seeing in 2019 is as a result of how Virgin Money has built its business over the last couple of years, us. As I say, something that we were well aware of when planning the acquisition.
Us. Our next question today comes from Faheed Kunwar of Redburn. Faheed, please go ahead.
Us. Hi, morning. Thanks for taking questions. I had one question really. I mean, it's following on from the comments you made there, which I thought very important.
Us. Have you made any assumptions at all on any shift of the funding mix of Virgin towards kind of Clydesdale funding mix us. Within the 2019 guidance, I guess following on from that, should we think of 2019 really as a transitory year in terms of us. What the margins look like there are. I'm not asking for guidance post 2019, just an idea of kind of is this guidance It's really not the steady state of the combined entity, but more a factor of the way the Part 7 is working.
I asked the question, obviously, because the shares are down pretty significantly today. Us. And I imagine most of it is to do with what is the cost of your growth. So it'd be very useful if I guess we can get some color on in that 'nineteen guidance, us. Is there any revenue synergies or any kind of benefit from being a combined entity within that margin guidance?
Or is this all going to be a us. 2020 story in terms of the strategic benefits coming through on revenue and particularly funding for us for Virgin Money.
Thanks. So Fahid, I think you're spot on. There is for 2019, us. The biggest bit because we have to wait for Part 7 to really bring the 2 us. Customer businesses together and to start driving the revenue benefits from the combination.
Us. What you're seeing in 2019 is that really the 2 heritage businesses perform. And us. As I say, we reap what we sow in terms of the 2018 business feeds into the 2019 margin. Us.
So that's what you're seeing come through. We think of 2019 very much as a transitional year. Us. We'll have the opportunity on the income side, as I say, to get into optimizing the balance sheet. And I sort of keep saying that.
One of the things we've been pretty good at in CYBG is just making sure that we're very tight on managing our average our sustaining assets and picking and choosing our spots to compete. We would expect to do the same across the enlarged group, and us. We're confident that will have some benefit that's to come through. The key focus of The integration effort for 2019 is on costs and it's cost and some of the functions. The real opportunity us.
Revenue wise and growth wise, we'll start to see come through after that. So I think you're spot on there.
Could I ask one quick follow-up question us. On CYBG, I think current accounts is a really key part of this whole merger. But in 2019 for CYBG, us. How much did I think you talked about it briefly in the R and A, but how much did B contribute to the current account growth? And how much of the current account growth is from Clydesdale kind of time deposits going into current account as we've seen across the market?
And And the reason I asked the question is just to get a sense of how powerful a proposition B is when you do eventually kind of pull it into the Virgin Money customers. Us. Yes.
So the bulk of our current account personal current account, Res. So us. The current account growth includes business as well, but the bulk of our current account personal account growth came from B. And us. B has always been a mixture of retention of customer balances as well as delivering growth.
Us. And it's what we have said consistently and we'll repeat today is that the majority of the deposit growth is new to bank, us. So an important engine for growth that offsets some of the attrition we might see in some of our older current account proposition products.
Us. I think we have more on the line.
Us. We have a question from Chris Caint of Autonomous Research.
Good morning. Thanks for taking my questions. Us. I was going to have to come back to your NIM slide, I'm afraid. And I know you've taken out a few questions on this, but it's obviously of significant interest to all of us.
Could you us. Confirm what your exit NIM for Clydesdale standalone was for your 4Q 'eighteen. I think that was below the €215,000,000 you guide for 2019. Us. And on the 250 bps I'm sorry, the 125 bps NIM expectation for Virgin in 2019, us.
Can I be clear, is that post expected EIR changes or not? You've given us the specific NIM for Virgin us. Within the group, I appreciate your comments about, at a combined entity level, EIR changes not being a material driver. But is the 125 you're guiding us us. The Virgin 2019, inclusive or exclusive of any changes to EIR, please.
And it would also be great if you could us. Give us an exit NIM there, although I can understand if you're asking to do so. And finally, you're flagging liquidity pressures on NIM. Us. Some others have been flagging this with 3Q results.
I guess this is a largely optical or denominator driven impact on your NIM. Us. Just to allow us to contextualize that, could you give us a sense of what the combined group NII was for the period covered on Slide 23, please, us. So we can get a better sense of how much liquidity drag there might be for the combined business. Thanks.
Okay. Thanks, Chris. Us. So the exit NIM for CYBG in the or the sorry, the 4th quarter NIM was 212 basis us. That was diluted by wholesale issuance and other sort of non customer related us.
Bits of business in the Q4, and we'd planned for that. It's not representative us. Of the running yield, if you like. So that's why there's that apparent inconsistency. But we're very comfortable us with guidance versus exit NIM because, as I say, it was diluted by certain specific factors.
Us. The Virgin Money guidance for 2019. So it does factor in us. Some of the changes that Virgin Money were have put through us during 2018 and would have anticipated putting through in terms of adjustments to EIR, so taking some of the heat out of that. It doesn't reflect any further action that we might take, and I'm not saying anything about that today.
Us. There's a very sort of important commercial decision. We're not going to rush our fences on that in terms of just how we think about it. So what I would say is, us. Be comfortable that Virgin Money under its own steam was trying to take some of the heat out of that and therefore that is us.
Helpful and included in the 2019 guidance. But it doesn't include anything we might do, but I'm us. Pretty confident that we've got plenty of capacity at a group level to make the necessary changes and stay within our guidance range. Us. I'm not giving VM figures today.
So I'm afraid I can't give you an exit NIM, us. And I can't also give you the combined NII. We're going to have to wait for that. One of the things we will do in early 2019 is provide us. Some fairly detailed pro form a comparatives, so that that can be factored into people's expectations.
But us. We're not talking about VM numbers today.
Okay. If I could just
follow-up then on the comment you made in response to the first part of that question us. On the exit NIM, you're indicating that you don't consider that representative of the running NIM. Was there some kind of us. One off adjustment in the quarter that impacted your NII? Or is it to do with this liquidity drag, which you're assuming goes away next us.
Why is it exactly that you don't consider your 4Q NIM representatives? Because I think for most peers, us. People tend to look at the exit NIM as a steer for the next year. Obviously, you're talking about a subdued or competitive environment us. In terms of mortgages in particular, it does look like you're assuming an improvement there.
Was it a specific one off that you can call out? Or why is it that you think that, that was our representatives.
Because it look, this and this is the weakness in net interest margin, okay? And in some respects, it's useful. In some respects, it's not. It can be heavily influenced by the denominator. So if you increase your denominator by raising money in wholesale markets, And then you go walk over the road and put it on deposit at the Bank of England.
You get inflation in your average interest earning assets. You don't grow your net interest income. Us. So that's really a big driver of that. I guess, I actually can't remember as I sit here what our us.
3rd quarter net was, but it was higher than 2.17. So if you take I would resist focusing on a particular quarter's performance. Other than, as you quite rightly say, Chris, it is a bit of a steer. Us. And we're steering that we would expect to see our margin come down a bit over the next year or so.
But it isn't us. Representative of what we see as a whole year's performance. I mean, as I say, our us. The CYBG net interest margin in the Q3 of FY 2018 was a few basis points above the 2.17% we reported for the year. So us.
It's puts and takes.
Okay, great. Thank you.
We have one last one, I think, on the call, Andrew.
Us. We do. We have a final question from Aziz Khan of Morgan Financial. Please go ahead, Aziz.
Us. Thank you very much. Iain, you mentioned earlier look, I've got 2 questions on PPI. Iain, you mentioned earlier that The second half 'eighteen PPI experience was in line with your 31 March provisioning assumptions. But when I take a look at the data, us.
About twothree of that 31 March provision was utilized in the second half, which is a pretty high utilization rate. Us. So can you please reconcile that high utilization rate with your statement? And the second question is, can you just clarify whether the us. 83,000 future walk ins that you're assuming, are they the total number of walk ins that you're assuming?
Or are they just the walk ins us. Where you expect claims to be upheld?
Okay. So utilization rate was us. Higher because we were coming down to we're managing a higher rate of claims across 3 different sites. Us. We've now shut 2 of those sites and are processing claims entirely through our Glasgow operation, us.
And we're also processing fewer claims. So it's really about the downward trajectory. I would focus on us. What does the €275,000,000 we have in the provision and how does that translate? And we're actually allowed for us.
A little higher sort of cost per claim than we have up until now. The 83,000 is us. The number of people that walk through the door, if you like, and we have an uphold rate on those claims that has us. Come down month after month in the last sort of 12 to 15 months indicating that the quality of claims walking through the door has been much lower. Us and people that don't bank with us or have never had PPI.
Us. Okay. I think we'll move to the there's a question in the room just here now. So just at the back here. Us.
Put your hand up so either mic, and then we're done.
Jason Napier at UBS. Us. 2, and I'm afraid the first one is on NIM once again. The product slide on 12 was particularly useful, I think, Really useful, I think, giving us the yields on the CYBG books. Of course, there are annual numbers and they've changed.
And although I'm not a huge fan of quarterly anything, I I just wonder whether you could give us an indication of front to back book gaps just on mortgages for your business. So us. The MLR data suggests that the business done in the last quarter was at about 2.2%. The yield here is about 2.7%. Presumably your gap is narrower.
Us. And perhaps you could talk about whether there are any mix reasons why your portfolio might yield more than the sort of market average that's on mortgages? Us. And then secondly, turning to Brexit. The decision that you've taken to run a liquid balance sheet us.
Well capitalized bank into Brexit obviously makes perfect sense. I wonder whether you could talk to whether you're seeing any behavioral change or actions of that kind of nature amongst SME clients. Are they asking us. For bigger undrawn facilities to cushion themselves as their delayed CapEx or anything you can say about the real economy would be helpful.
Us. Sure. I'll pick up the real economy while you're Sure. You have some numbers for the first question. Yes.
The reality is, I think, us. Interesting with the, I suppose, SMEs. If they see a hard Brexit, all bets are off in their world, do they think, just in terms of being able to invest us and have clarity. This just puts a whole smorgasbord of uncertainty in the road of progress. So they're all agitating very strongly for us.
Whatever we have today, it doesn't matter. It's infinitely better than a no deal. So they're starting with that premise. But they're not expecting no deal. So what they're doing right now us is waiting for a decision, but that waiting is significant in terms of inertia.
So less in the credit or need to draw down on cash flows territory us and more in the capital investment profile. So we and I'm not just saying that's statistically. We do a lot of engagement around the us higher of the geography. And when you're talking to people, they're not only hiring and they're not spending, but they're fine with running their day to day business us across the location or locations they're in. So that's why it's translating into a more benign credit outcome.
It's because It's really about the investment or the hiring. So that's what's happening there. And then I think what you're seeing around the consumers, no particular stresses yet, us. But you're seeing, again, a consequent slowdown in spending and willingness to take on any more debt given the fears that have been created. So us.
It's that inertia activity across all sectors that we look at that is driving most of this. The housing sector is the same. Us. The number of houses available, and retention is the big strategy right now, which I think is well flagged. So again, same principle.
So I think what will be very interesting us is when you pick out all the uncertainty and get some outcome. And when that outcome is there and it's not a hard Brexit, us. I think there could be a relief rally and a little bit of a resettling of the economy. Certainly, some people are predicting strong very strong shifts in sterling after that, us all pointed towards general factors of more positivity because we're into a really negative dip just now.
So Ian? Us. Yes, Jason, I mean, I can't I'm not sure I'm going to give any numbers here, but you're right to observe that our own portfolio is a slightly richer mix us than the market average. I would say the Virgin Money attracts much more than the market average or is probably slightly more diluted. And us.
That's what you see, say, the difference in the heritage business models coming through in margin planning. Us. Our richer mix comes from certain factors that are probably going to be diluted over the next couple of years. Our us. Buy to let premium, for example, when we focused on buy to let business, particularly in 2014 and 2015.
That was at a significant premium to resi, and we've seen that mix gradually feed through. I think that's kind of baked in now. Us. We've been very focused on the first time biospace. And again, for reasons of standardized capital weightings and others, us.
We preferred the margin in that space. It's good business, but it's at a higher margin than others.
Us. Okay. Oh, we have just one more question here, and then we'll wrap up after this, and we can mingle a bit if you need. But everyone wants to get out IC2. Us.
Sorry, it's David from Credit Suisse again. Just a quick follow-up question on costs. If the income environment were sort of less supportive than you thought, how much us. How prepared would you be to sort of grip the cost base tighter for this year is my question. Us.
And I get always there, present to reinvest any gross savings that you extract us. Into either the to protecting the franchise or to counter things like wage inflation, which I guess in the U. K. Is probably running at around 2.5%, 3% now. Us.
So just curious on how you're thinking about the flexibility to manage costs for 2019? Many thanks.
Yes. Us. Thanks, David. So I think there's plenty to go for in the cost base. Us.
As ever, the art to this is making sure that you approach it at the right pace us and in the right sequence. So there are some things we just can't do until Part 7 and until a bit later on. Us. But we're definitely looking at opportunities to accelerate savings. And I think it's a good It's a helpful hedge against income weakness.
So look, I think there are opportunities there. But we don't want to throw the baby out with the bathwater.
Us. Okay. I think we're going to wrap it up there. But thank you to everybody on the phone for participating and in the room, and we'll call it. Thank you very much.
Us.