OSB Group Plc (OSB) Earnings Call Transcript & Summary

Good morning, everybody, and thank you for joining us today for our brief, but hopefully reassuring third quarter trading update. I'll start by giving a short introduction, and then April and I will handle any questions that you would like to pose to us. I'm very pleased though OSB has had a strong third quarter, both operationally and financially, especially given the challenging environment we all face. We continue to support our borrowers and deliver very high levels of service. We continue to lend, albeit with our controlled risk appetite, and applications are strong across our Kent Reliance and Precise buy-to-let and residential brands, with total applications at around 65% of pre-COVID levels as we remain cautious with criteria offered in our more cyclical market segments, such as development and asset finance and commercial property. The net loan book was up 8% for the first 9 months of 2020, excluding restructured asset sales that we did in January. Our loan book is performing well, and there has been a slight improvement in arrears in the third quarter. And the level of active payment holidays has reduced to only 3% of the loan book by value as of the end of September. I'm pleased to say very low arrears levels for those borrowers due to resumed payments. We've made good progress with continuing the integration of the OSB and Charter Court businesses. And I'm pleased to report that the new holding company that we previously delayed because of the onset of COVID was approved by shareholders at a general meeting recently. I'm also in a position to reiterate our guidance that we gave at interim results. We expect underlying net interest margin to be broadly flat for the first half of 2020, and underlying cost-to-income ratio to be marginally higher than in the first half. We also anticipate double-digit underlying loan book growth for 2020, excluding the impact of those structured asset sales. Although we must be cognizant of the potential impact of the latest lockdown on timings of completions and redemptions for the rest of the year. I can also say that the Board firmly aspires to return to dividend payment and will assess the dividend for 2020 at the year-end, taking into account the macroeconomic situation at that time. Overall, even though we are facing uncertainty stemming from numerous sources, COVID and the associated measures and restrictions, including extensions to the furlough scheme and payment deferrals and, of course, the continued Brexit negotiations, we believe though, that the group is well positioned with strong capital and strong liquidity positions and a strong secured balance sheet and excellent risk management capabilities. That's all from me by way of introduction, and we'll now throw open to Q&A, which April and I will happily try and answer for you.

[Operator Instructions] Our first question comes from James Invine from SG.

Two, please. The first one is thanks for reiterating the guidance you gave at H1. April, I think at that stage as well, you mentioned that you thought the Q4 margin would be back in line with last year's margin, which was 266. I was just wondering if that is still your view? And I'm just asking that in the context of the Bloomberg consensus, it seems to be in the kind of 245, 250 area. And then the second question is just on the split of the loan book. So we can see from your disclosures that Greater London is just over 40% of your loans. I was just wondering if you could give us a little bit more granularity. So how much of that is zone 1s and 2, those sorts of areas. And I ask given the rents in those areas are getting hit very hard at the moment.

Yes. Thanks, James. I'll let April tackle -- sorry, April. I was going to say, I'll let you take the one on guidance, and then I'll talk about the loan book split.

Okay. So yes on them, I think I've said that we entered this year in Q1 with a strong NIM broadly flat to the prior year. If you exclude the one-off EIR gains that we actually booked last year, taking that aside, broadly flat. Q2 and Q3, I said, were impacted by the delays in passing on the full base rate cut to retail savers. And also some high liquidity that we were prudently running in those quarters, which we have been utilizing, whether that was the second order impact. And you're quite right, I expect Q4 to return to the broadly the same levels as Q1, and that's still my expectation, now that we have done our back book reprices on the easy access savings books in both banks. So yes, I think things are panning out some to date as expected.

Okay. And then, yes, on the loan book split, I mean, it's a good point, you're quite right that the kind of Central London zone 1, 2 stuff is clearly where the pressure points are in terms of some of the big chrome and glass type developments that rely on pretty hefty rental payments. We're not an inexpensive buy-to-let lender. We're a specialist buy-to-let lender. You would really struggle to get a loan through us to buy something in Central London that would hit the kind of rental yield recover -- required to give us the rental cover calculation that we would want against the interest payment. And as a function of that, what you should read into our Greater London book is it's much more kind of Greater London than it is Central. I was once in a meeting with a shareholder and I joked about, you wouldn't find me lending to a buy-to-let landlord who wanted to buy something high up Heron Tower and the shareholder actually had a property in Heron Tower that he was renting out. So it was a bit agreed by that. But that's not our market. Our market is kind of 2-bed flats in Chiswick and family homes in sort of north-south, et cetera, London, that's our landlords' target market because that's where they generate enough rental yield to make the kind of hurdles that we require. So we're pretty sanguine about our exposure to Central London 1 or 2, but exceptionally low loan-to-value. And I think that's probably the way to look at it.

Our next question comes from Benjamin Toms from RBC.

I've got two, please, if that's okay. Firstly, on the dividend. So you made your stance quite clear in the release. But can I just clarify on a specific element, which isn't mentioned there. If the regulator makes an announcement similar to earlier this year that large U.K. banks can't pay dividends, but remains silent on the smaller U.K. banks, would this in itself stop you from making the payment? And the second question is more broad. Lloyds in their call a couple of weeks ago suggested strong demand for mortgages has been driven by both reduction in stamp duty, but also a structural change in retail behavior with COVID-19 leading to people caring more about having a nice house with space they can call their own. I'm just interested on your thoughts on how that structural change, if true, could play out in the buy-to-let sector? Could the demand this generates for residential mortgages cannibalize demand for buy-to-let mortgages, in your view, with the potential for the population to move away from a renting mentality?

Yes. Yes. Thanks, Ben. I think both good questions. That last one, a really interesting point. But let's just tackle the dividend piece first. I mean we were not a lender. Clearly, that was instructed last time not to make a dividend payment. But if we think back to the timing that we were all in, there was so much uncertainty. We've never seen a lockdown situation like it before. Nobody really knew. I think I used the phrase at the time when we put over a full year results out, nobody really knew if the world was going to hell in a handcart at that point and how government would react with stimulus and how people generally would cope with it. I think we're in a very different position from that now. It isn't my expectation. I don't think that the PRA will dictate to the larger banks around dividend payment. I think it's a matter of the capital that any one bank has on board and the ability to distribute that capital accordingly and still maintain good buffers. As we said in the release, we aspire to make a dividend payment. We think that's the right thing to do for shareholders. If some of the larger banks have told they can't, I don't think that is a reason for us not to. As we've said, what we'll do is we'll review our capital position and our capital plan against what we see in the macroeconomic forecast going forward, and we'll use that as the basis for our dividend decision. So hopefully, that covers that one. I mean Lloyds is right, there are some structural changes, but they're not just -- in my opinion and from the knowledge that we're picking up from around the market, they're not just actually in the private rent -- sorry, in the owner occupied sector. I mean, yes, you're right, people are reevaluating if they want to move out of kind of smaller apartments maybe and get something with a patch of grass out of the back because when you're locked in your property for such a long period of time, it gives people the opportunity to do that reevaluation. But that's actually fueling movements around in the private rented sector as much to a certain extent as it's fueling the resi market. Obviously, the resi market has that additional stamp duty play, which is definitely providing some stimulus on the purchase market at the moment. I worry a bit about how some of the very mainstream residential lenders are coping with the service volumes. Many of them have said that they're struggling with it. And we know the conveyancing community and land registry and whatever have got their backs to the wall to a certain extent because volumes are high. I hope in some way that the government find a way to extend the stamp duty moratorium or at least do something on stamp duty post March, but we'll have to watch that carefully. I think people will always need accommodation and not everybody can buy accommodation, we know that. The size of the deposit is actually even bigger now as a requirement than it was pre-COVID. So that does preclude a lot of people from getting into owner occupied. If you look at the jaws of how homeownership versus the private rented sector have changed over the last decade, it's been a massive widening. First-time buyers are getting older and older because of the size of the deposit and the house price versus wages debate, and people are using the private rented sector to provide that flexibility of accommodation. And I don't think there'll be enough of a structural change to change that, coupled with the fact we just don't build enough houses for everybody to buy one. And actually, the building industry is a little bit further behind than it was pre-COVID because of a big period of lockdown. So I'm sure it will make changes both in the PRS and in the owner occupied sector, but I don't see the jaws crossing back the other way anytime soon.

Our next question comes from Gary Greenwood from Shore Capital.

I've got 2 questions, if I can. So the first is just on your modeling assumptions for bad debt. So I think you've said that you've not materially changed those. A thing to recall you had quite a big fall in house prices in -- for 2020, which obviously doesn't look like it's coming through. So just in terms of thinking about sort of modeling assumptions, provision releases or not, do you just roll forward that assumption on house prices into next year? How does that work? And how do you sort of think about the sort of balance on retaining provisions versus releases? And then secondly, just on the deposit repricing. I just wanted to confirm whether or not you've sort of completed the deposit repricing exercise that you're going through?

Yes. Gary, I'll tackle the deposit repricing one quickly because that is a quick one. I mean, yes, we have -- we've completed that all the way through. So we're up to date. We think the market is pretty much up to date. We talked at the interim point around the pressure coming from NS&I in terms of the rates they were paying to gather deposits. So we weren't out trying to compete with them in the instrument access market. We were rather choosing sort of 1 and 2-year bond funds at that point. But we all know that NS&I have done what typically they've demonstrated in the past, which is their rates this month are all coming back down to a pretty derisory amount again. And we've got to be careful. And I think other deposit takers have to be careful not to be too far off the best buy table because you'll have attractive run of cash coming back out of NS&I that we don't need to fund our plans. But the short answer is, yes, we've completed that sort of pass on exercise now. On the modeling one, obviously, I'll hand over to April for that.

Thank you, Andy. Yes, we -- you picked up correctly. We really didn't see any significant movement in the economic outlook when we came to review various economic forecasts in September versus June. And we didn't really see the need to make any other model adjustments or staging criteria adjustments either. But it's been a bit of a roller-coaster, I think, with good news followed by bad news followed by good news. So what we're doing is really awaiting the next suite of outlook, which incorporates further government stimulus and also the potentially very positive news about a vaccine. So these are kind of -- and possibly Brexit as well, which was in our downside case, a hard Brexit, but not in our base case. So there are a number of drivers there that we'll have to kind of see how they play out as we head into the sort of closing stages of next month. But what the economists generally have been doing, as you've alluded to, is kick the can down the road. And that's in fact what they did for us at the end of the third quarter, which is they weren't backing off from the kind of the worst impact of the pandemic on the economy, but they were just assuming it happened later.

Just to be clear, April, what flexibility do you have in terms of deciding those provisions? I mean how much of it is sort of mechanically driven by the models? And how much of it is your subjective overlay? So if your models were saying you need to release a provision, which is I know what I saw during the third quarter and later offset that with a subjective overlay, are you in the same sort of situation whereby if that was the case and you felt like you wanted to remain cautious, you could do? Or are you mechanically forced to release provisions up and when?

No. I mean you always have the -- I mean first of all, one of the biggest inputs of course is where you decide to put your economic scenarios. And we don't just slavishly follow the first -- what we're given by one economist. So we're always looking much more broadly than that. So there's quite a bit of judgment and comparison across different sources before we set those. Yes, then an answer comes out of the model. But yes, we're not -- we've never ruled out a post-model adjustment. I think it were -- the situation at Q3 was very, very modest in that sense. A very, very minor release suggested, which we didn't take, nothing like the kind of numbers you saw coming out of some of the larger banks.

Our next question comes from Aman Rakkar from Barclays.

Just a clarification question, actually on -- so you made a commentary around applications running at 65% of pre-COVID levels. So when I look at some of the kind of high-frequency buy-to-let application data that we track at a system level, but it looks like we're not far off at a system level running kind of at pre-COVID levels. Although within that, I know purchasing is up and remortgaging is probably down 25%. But you're running at 65% of pre-COVID levels, which suggests to me, you are operating quite defensively in this market right now. So I guess, one thing I was interested in is to what extent are you in control of originations running at 65% of pre-COVID level versus perhaps some kind of different demand? I'll just -- I'll squeeze in another one in there. Sorry to cut question there, Andy. And on net interest margin, so I guess, really encouraging to see that you think 265 for Q4. I think you briefly historically intimated about TFSME being one of the levers that you could pull in Q4. I guess what would be really interesting is, could you give us an understanding of the kind of quantum of TFSME you're looking to draw? When you're looking to draw it? How much of that benefit is going to come through in Q4? And you support the 265 -- I guess, what I'm really getting at here is, when we're thinking about next year and the puts and takes on NIM, is there a funding cost opportunity to realize here that can support you? And if you're able to kind of highlight any downward pressure that we should be thinking about, that would be really helpful?

Okay. Thanks, Aman. And I'll talk about app volumes. And then April, I'm sure, will talk about NIM and TFSME impact. Remember, the 65% that we're at pre-COVID levels is at a group level. So that is the total originations that we were doing pre-COVID, which included development finance, asset finance, commercial real estate, group finance, et cetera. And those are the lines where we have really tightened our criteria hard, and I make no apologies for that. Now it's not the time to be pumping money out the door with a fair degree of uncertainty when fundamentally is liquidity in U.K. housing sold that drives the repayment vehicle on those loans. So that's where we're really constraining overall volume. What we said in the release was in our core Kent Reliance and Precise mortgages, buy-to-let and residential brands, application volumes are very strong. We have curb criteria and put pricing up a touch across buy-to-let and residential. Actually, buy-to-let in Kent and Precise is running at now on pre-COVID levels and residential is as well. This is application volume in total across the group. And we've always liked the credit in buy-to-let because of the optionality that we have as a lender in the event of a problem with the landlord. Our cost of funds is much cheaper than theirs. We can rent a property out as the receiver of rent in the event of a problem. And obviously, still make the piece, wash its face. And in the residential market, we're enjoying volume in that at very, very sensible loan-to-values and good margins as a function of just that increased demand, particularly in the purchase market that you mentioned. So I think you have to look at it in the round because you're right. If you look at the totality of the system at the moment, buy-to-let would suggest it's pretty much back up at pre-COVID levels. It is, and we're not really a drift from that in our core brands, either. It's the other areas where we're really constraining [ release ]. And I said, I make no apologies for that. We're building a pipeline. We're happy with the level of pipeline that we're going to be building and taking into next year. We're happy with the returns and the risk-adjusted returns that we're making on that pipeline. And because of the adjustments we've made on funding costs, et cetera, the back book is a very big animal that spins off a significantly strong return on equity. So I think our cautious approach is absolutely right at the moment given the degrees of uncertainty that still exist in the market. April, do you want to talk about NIM and TFSME?

Yes. I mean I think what we would likely do with TFSME is actually draw down as late as possible in order for the 4 years to last as long as possible. So if we have tranches of the original TFS in small tranches that are kind of getting close to maturing, we'll draw down sooner. But I think our plan is to sort of back end that to get the maximum benefit. And I guess, what you probably saw with it previously was the afterthought was we could use it to refinance all of TFS and also the amount of Index Long-Term Repo that we have from the Bank of England as it's a more favorable rate slightly than that. I think what we've seen is now opportunities for net new lending, which means that within our encumbrance constraints, we should be able to fund some of the net new lending this year and first quarter of next year, albeit probably not drawing down until next year. But the way we would normally think about it is, we tend to -- what we have to manage within an encumbrance limit to 30%. And therefore, it's only a portion of that net new lending that we can actually fund in this way. The bulk of our lending is always funded with retail savings. So certainly, I think more of the drivers for Q1 in next year, probably Q2, Q3, Q4 more, and it is on the margin beneficial to NIM because a greater proportion of our funding will come from the store. But the key thing, unfortunately, is as always our encumbrance restrictions. But we continue -- we continue to sort of try and manage that encumbrance. You saw us do a couple of largely internal securitization trades in the Canterbury program. That was in order to transition mortgages into AAA notes that we could then place with the Bank of England for more favorable haircuts. So we continue to do things like that to kind of manage within our encumbrance limits as best as we can.

Perfect. Andy, just to return...

[indiscernible] about any potential drag. So I think the -- right now, things are looking good in the retail savings market with NS&I out of the picture and slashing their back book rates so soon after gathering in the funds. I think there's an element of having to make certain we don't become overly liquid. And that's a very positive situation now. When you see the chance to announce further extensions to the furlough, it may will be -- NS&I will be back in the game at some stage, Q4, Q1, and we may see a temporary disruption of the savings market again by them. There's been a lot of lobbying by the industry, not least the building society association U.K. treasury to say that they need to understand the impact they're having on smaller deposit takers by pricing aggressively in the way that they did.

Aman, sorry, you have to come back.

Yes. So sorry, just -- April, it doesn't sound like there's too much downward pressure that you'd be calling out next year.

I mean I think it -- no, I mean I think the old sort of change in the mix of the asset side of the balance sheet had run its course, as we explained at the half year last year, and that's the increased competition on either side of the balance sheet that we're not currently saying. Then I think that's largely potential positive impact, as you called out yourself, on TFSME. But we sort of have to watch and see what happens to the economy and what happens to the competitive landscape on both sides of the balance sheet, but what we are seeing today is positive.