OSB Group Plc (OSB) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the OSB Group 2020 Results Call. My name is Bethany, and I'll be coordinating your call for you today. [Operator Instructions]. I will now hand the call over to your host, Andy Golding, Group Chief Executive Officer at OSB Group to begin. Andy, over to you.

Thank you very much. Good morning, everybody, and thank you for dialing into our 2020 preliminary results presentation. Firstly, I would like to thank you all for your patience in waiting a little longer than normal for us to announce our full year results. But as you know, we discovered a potential fraud on one of our funding lines in the days immediately before our previously planned announcement, which meant we needed to take stock and do some further investigation prior to finalizing our accounts. I think it will be fair to say that 2020 proved to be a year that few of us could have predicted. As the pandemic took hold on a global scale, people's lives were restricted, large parts of the economy were closed down, never before seen levels of government intervention and stimulus were rolled out and uncertainty prevailed for everyone. OSB's focus throughout the period was on operating as normally as possible, as well as looking to provide genuine support to our customers and colleagues. We kept our branches and call centers open for business as usual and dealt with thousands of borrowers through helping with repayment holidays at a time of significant uncertainty. We continued to be open for new mortgage lending, albeit with tightened criteria and control volumes due to the uncertain macroeconomic environment. We maintain that prudent risk appetite through the year and saw a strong credit performance across our entire core portfolio. We delivered strength in capital with our CET1 and total capital ratio at 18.4%. We ran a strong liquidity coverage ratio of 198%, and major use of both the TFSME and lending through the CBILS scheme to support our lending into the real economy. In 2020, we took significant provisions for COVID-related forward-looking assumptions as well as impairing the already mentioned funding line by GBP 20 million, but I'm also pleased to reiterate that the Board believes this to be an isolated incident. We plowed on with the integration of our business and achieved earlier than expected cost synergies along the way as well as restructuring the group through the insertion of a new holdco OSB Group plc, not least of all, to support future senior holdco debt issuance. We aligned our HR policies and Ts and Cs for our colleagues and created an enhanced common purpose, vision and value set to help guide our colleagues in the new and large group. As we leave 2020 behind us, we remain ultimately focused on supporting our customers, our colleagues and our communities. We have a strong pipeline of new applications in our core businesses, and they're back up to near pre-COVID levels. And whilst we remain focused on the existence of continued uncertainty, we do expect to deliver underlying net loan book growth of circa 10% in 2021, and we also expect net interest margin to return to 2019 levels, and our underlying cost-to-income ratio to be only marginally higher than in 2020. Turning to the next slide. Sorry, took me a couple of clicks to move that one on. Our results in such a year of uncertainty, hopefully speak volumes about the resilience of our business model. We clearly offered less gross lending in 2020, some due to the partial market closure for a period and some due to us limiting volumes through our own risk appetite tightening. However, we still delivered net loan book growth of 9%, excluding the structured asset sales we did earlier in the year. Our net interest margin was down slightly from the prior year, mostly due to the market taking a significant time period to pass on the full base rate reductions to savers. Our loan loss ratio increased to 38 basis points due to those previously mentioned COVID-related forward-looking assumptions and the funding line impairment. However, actual arrears across the group remained stable. We delivered a best-in-class cost-to-income ratio of 27%. And despite the market-related headwinds and the high levels of CET1 we're holding, we still delivered a return on equity of 19% and GBP 346 million of profit before tax, resulting in strong EPS for shareholders of 58.1p per share. I'll now hand you over to April, who will take you through some of our numbers in a little more detail.

Thanks, Andy, and good morning, everyone. I'm delighted that we delivered an exceptionally strong high double-digit underlying ROE of 19% in 2020, despite the numerous challenges thrown our way by the pandemic. Our profitability proved resilient with underlying profit before tax of GBP 346 million, a decrease of just 9% despite significantly higher COVID-related impairments. We grew net interest income by 3% and delivered an attractive net interest margin of 247 basis points, albeit down on the prior year, which I'll come back to shortly. Our efficiency metrics improved significantly in 2020 with the delivery of combination synergies, which knocked circa 2 percentage points of our cost-to-income ratio. 2020 also benefited from some lower discretionary spend in knockdowns, in particular, the first lockdown. We expect the underlying cost-to-income ratio to increase marginally in 2021 as the ratio in 2020 benefited from higher income from the gains on structured asset sales as well as that lower spend in lockdown. The underlying loan loss ratio increased to 38 basis points in the year, primarily due to adopting the more adverse forward-looking COVID-related assumptions in our IFRS 9 models, which I'll come on to in more detail later. Turning to the income statement. Just one thing to highlight here, the gain on structured asset sales in 2020 was GBP 33 million on an underlying basis. This includes transactions in both OSB and CCFS in January 2020. And early success of integrating our capital market functions and demonstrating our capability to accelerate organic capital generation through the sale of residual certificate. You can also see on this slide that we generated underlying earnings per share of 58.1p per share in 2020, down on the prior period, in line with that reduction in profit after tax. Turning to the next slide, which summarizes our strong, secure balance sheet. We delivered GBP 3.8 billion of gross new lending in 2020, which drove a 5% increase in the underlying net loan book to GBP 19 billion or 9%, as Andy mentioned, excluding the impact of the structured asset sales in January. It's worth noting that we quote net loan book growth after impairment provisions and growth would have been 10% prior to the funding line impairment. Based on our pipeline and current application levels and risk appetite, we currently expect to deliver underlying net loan book growth of circa 10% in 2021, although we do remain cognizant of continued uncertainty in the economic outlook, especially after the removal of government support. Turning to funding and liquidity. The combined group had a strong liquidity coverage ratio of 198% at the end of 2020, significantly in excess of the regulatory minimum requirement of 100%. We remain predominantly retail funded with diversification provided by Bank of England schemes and also securitization. We drew GBP 1 billion under the new TFSME scheme in 2020, which was used to replay slightly more expensive borrowing under their index long-term repo scheme and also to help fund growth. We expect to use the TFSME to refinance and extend the duration of all of our remaining TFS drawings with the potential to draw down further amounts to fund growth opportunities, subject to our encumbrance limits. Our integrated capital markets team were also active in the securitization market during the year from both a funding and the collateral optimization perspective. The credit quality of our loan book remains strong with 3-month plus arrears, stable at 1.3% for OSB and 0.5% for CCFS. Active COVID-19 payment deferrals reduced to just 1.3% of the group's loan book by value by year-end, with low levels of arrears on accounts exiting payment deferrals although we, again, remain cognizant of continued uncertainty over the true impact of the pandemic when governments support ends. Affordability remains strong for our Buy-to-Let lending with interest coverage ratios on new originations strengthening to 201% and 193% for OSB and CCFS, respectively. Our loan book is secured at sensible loan to values. The weighted average book loan-to-value for OSB and CCFS both reduced in the year to 64% and 67%, respectively, due to tightened criteria on new lending and also the benefit of some positive indexing. The next slide shows our NIM waterfall, which is, I think, very straightforward this year. We can see the simple driver behind the reduction year-on-year. Underlying NIM reduced to 247 basis points from 266 basis points primarily as a result of the dilutive impact of a delay in passing on the base rate cuts in full to retail savers. However, the full impact of the base rate cuts was passed on by the end of the third quarter of 2020. As a result, the net interest margin run rate in the fourth quarter improved significantly, and we also continue to maintain our discipline and control over mortgage pricing. Based on the asset yields and funding costs we're currently seeing, we expect the underlying net interest margin for 2021 to return to 2019 levels. The next slide provides more detail on the impairment charge the group recognized in the year, which represented an underlying loan loss ratio of 38 basis points. As you can see from the waterfall chart, the majority of the impairment charge relates to the COVID-19 forward-looking assumptions. Those totaled GBP 47.1 million, as shown in the blue bars. This included GBP 21.2 million from the adoption of more adverse forward-looking macroeconomic scenarios, GBP 4.8 million for stage in criteria enhancements, including payment deferral accounts. GBP 10.7 million for model enhancements and an additional GBP 10.4 million in respect of post model adjustments, take account of the impact of the government's support on credit bureau files. The group also recognized an impairment provision of GBP 20 million in 2020 in relation to the potential fraudulent activity by a third-party on a funding line of GBP 28.6 million provided by the group, secured against lease receivables and the underlying hard assets. The group's funding line business is primarily secured against property-related mortgages, and we believe that this is an isolated incident following an internal review. The business' usual impairment charge was around GBP 4 million commensurate with a stable arrears performance. You can also see on this slide that our coverage ratios have increased significantly in 2020, primarily as a result of those adverse COVID-19-related forward-looking assumptions, which we adopted during the year. I'm going to move on to capital. You can see that the group's CET1 ratio strengthened to 18.3% during the year. Our total capital ratio was the same as the AT1 and Tier 2 instruments issued by OSB no longer qualifies regulatory capital at the group level following the insertion of OSB Group as the ultimate holding company. Our leverage ratio also strengthened to 6.9%. The capital ratios at the end of 2020 benefited from the counseled final dividend for 2019, as you can see in the waterfall. The application of the capital requirements regulation, quick fixed package, were increases in stage 1 and stage 2 provisions added back to capital and an increase in the SME support factor. They also benefited from the structured asset sales and these benefits were partially offset by some further amortization of the fair value uplift on CCFS net assets and acquisition. The last bar demonstrates the strong capital generation capability of our business through profitability. We've retained profits after dividend significantly in excess of what was required to support the balance sheet growth in the year. And I'm delighted that we delivered an ROE of 19% on this strengthened capital position. Our capital ratios are significantly in excess of our minimum capital requirement of 9.41%, plus the regulatory buffers on top. However, it should be noted that they include transitional benefits of circa 1.7 percentage points at the end of 2020 from acquisition-related adjustments, subject to amortization, primarily the remaining fair value uplift on the acquired CCFS net assets as well as those IFRS 9 transitional capital add-backs, which includes the CRR quick fixes. as, finally previously disclosed, we have an interim MREL requirement from July 2023 of 18% of risk-weighted assets and an end state requirement of 2x Pillar 1 and Pillar 2A by July 2025. We anticipate our first MREL issuance in the first half of 2022, subject to market conditions, but also the outcome of the Bank of England's current MREL consultation. I'll now pass back to Andy, who will give an update on integration and our lending and funding franchises. Back to you, Andy.

Thanks, April. So I wanted to give you a little more color on our integration progress to date. By the anniversary of our combination, we've delivered net run rate savings of GBP 15 million, well ahead of our GBP 6.6 million target at that stage. We continue to progress well towards realizing the planned run rate savings for the end of year 2 and now expect our 3-year run rate to marginally exceed our original expectations. The synergies delivered to-date are evident in our cost-to-income ratio and were equivalent to a circa 2 percentage point improvement in our underlying ratio. We continue to pull talent and share best practice group-wide to enhance our processes and deliver benefits of scale. The new group commercial function executed 4 securitization transactions in the year totaling GBP 2.8 billion, further evidencing our enhanced balance sheet management capability as a result of the combination. We brought our 2 cultures together under a combined common purpose to help our customers, colleagues and communities prosper. And worked internally with groups of staff to create a new value set for the group with an increased emphasis on stewardship going forward. Our core loan books continue to deliver well despite the pandemic and our own controls over volume through criteria tightening during the year. Our conservative LTVs were supported by 201% and 193% rental cover in OSB and CCFS, respectively. Our retention focus continues through the OSB choices program with 75% of borrowers choosing a new product with us at maturity, well up on the 69% in 2019. And professional landlords accounted for 80% of the Buy-to-Let completions in OSB in 2020. We've continued our conservative approach into '21 with actively reduced volumes still controlled in the more cyclical business lines such as commercial, development and bridging, for example. Retail savings remains core to both our franchise value and our funding strategy. And in 2020, we attracted circa 46,000 new savers to the group. We retained 93% of maturing savers in OSB and 77% in CCFS and did all of that with exceptionally high Net Promoter Scores of positive 67 and positive 72 in OSB and CCFS, respectively. I've already touched on the securitizations we executed during 2020. And of course, we also disposed of the residual notes on the Canterbury 1 and PMF 2020-1b securitizations, generating gains on sale of GBP 33 million. So to summarize, the group's business model has responded well and demonstrated its resilience through what was a challenging year. On completion of all of our reviews, we will seek out any learnings from our potential fraud on the funding line and see if anything comes through that can enhance the group's risk management framework for the future. Integration is going very well. We've restructured to facilitate MREL issuance in the future and have ended the year with the dividend recommendation for shareholders of 14.5p per share. Going forward, we remain focused on our customers, our colleagues and our communities. Our pipeline is strong, and we expect to deliver circa 10% net loan book growth in '21, whilst clearly being cognizant of the continued economic uncertainty. We do expect net interest margin to return to 2019 levels and our underlying cost-to-income ratio to be only marginally higher in '21 than it was in 2020. Thank you for listening, and we would now like to invite you to ask questions.

[Operator Instructions] The first question comes from Benjamin Toms from RBC.

A couple from me. So firstly, what extent is the GBP 20 million you've put aside for the funding line insured and how does insurance in this type of product typically work, in what situations would insurer not payout? And then secondly, on Page 44, you help lease us out the various constituent parts of your impairment charge? Can I just clarify that once you strip out what looked like one-off impacts you end up with an underlying full year '20 cost risk of somewhere between 2 bps and 11 bps, depending on whether you include the funding line impairment? And thirdly, can you make a comment on your results in relation to negative rates and some key servicing systems have been identified as requiring further development. Can you give some more color on that? Is the cost of material? Is it included in your cost-to-income ratio guidance for this year?

Thanks, Ben. April, do you want to take the first 2, and then I'll touch on the negative rate project?

Yes. I mean, insurance policies, we have not assumed any recovery in that provision. You can't account really for insurance until it's sort of in the bag. We do have some policies, but really at this stage, we can't comment on whether or not we would definitely recover on them. We also have some personal guarantees. But again, that's not something that you would count until it's sort of in your hands. I think you also referred to the waterfall on Page 8 and what I've tried to do there in that penultimate BAU charge is to give you a sense of what the BAU charge was during the year. Did have some little benefit from indexing. Obviously, we did come up with a stage 1 provision for our new lending, and the rest of it really is commensurate with our stable arrears performance. But you're quite right that you may want to include the GBP 20 million funding line impairment in that kind of nonforward-looking COVID part of the impairment ratio.

Okay. And on the negative interest rates point, Ben. So I mean we've obviously had a project looking at how we would fare in the event of negative interest rates from an operational perspective. Until rates go negative 75 basis points or more, we don't have any portfolios of mortgages or books that are impacted. In fact, the great majority of our mortgage books have 0 or higher base rate floors. We know that our core system can run a negative rate as the benchmark rate. But we do have a very small number of mortgages that if rates went negative by more than 75 basis points, we would need to make some system changes in order to reduce the rates down on those loans and run them on an automated basis. I think your point was it is that expensive. We have done a high level cost assessment of that, and it's not going to move the needle. So that's not our primary concern. Our primary concern would be more about just how much time we would have to actually get the project executed if we had to do that. But my personal view equally is that the propensity for negative rates at 75 basis points or greater in the U.K. is a fairly slim chance. So we're ready. We've done the analysis. We know what we would have to do. We'll now keep in regular dialogue with our regulators in the Bank of England to see the direction of travel.

The next question comes from Grace Dargan of Barclays.

Just my first one. What do you see as your long-term CET1 ratio and how do you intend to get there given the strong print today? And then secondly, what do you think you can do in terms of a medium-term ROE? And maybe if I can just sneak in a third one, what's your appetite for portfolio acquisitions this year? And do you currently see opportunities in the market?

Thanks, Grace. I'll touch on portfolio acquisition and then hand back to April to talk about CET1 and ROE in the medium term. OSB has always been an active and interested purchaser of assets if the risk profile on the price of those assets is right. I think the stuff we saw come to market prepandemic didn't tick the boxes in terms of our kind of hurdle calculations, prices in excess of par or in some cases, significantly in excess of par is not our favorite way of buying. I think how much opportunity there will be in the market will depend very much on the longer-term funding dynamic at the moment, the wholesale funding markets are quite strong. So even if you're a nonbank lender and you've got securitizable portfolios, the appetite for yield is strong enough to get those portfolios away if that dynamic changes. And clearly, we're in such with all the sort of key brokers and advisers on mortgage portfolios that might come up for sale. If that changes, and we see opportunity will strike. And we always want to have a little bit of capital firepower in the war chest to enable us to do that. But as was [ EBITDA ] and, Grace, we've said before, it's got to hit the return hurdle threshold from a risk and reward perspective that we would want, otherwise, we may as well just originate. And we're not bad at that either. So that's that one. I'll hand back to April.

So I'll take the capital one too, obviously, the 2 questions are very connected, capital and ROE. Well, as I mentioned in my opening remarks, we are running with an excess over our minimum capital requirement plus the buffer. They're not as great as you might think from the headline number, as I explained, due to those items, which are transitional in nature, which are perhaps flattering the group ratio at the moment, which don't exist in the individual banks. But I mean, we would always look to run with some Board buffer above the regulatory buffers. And we'd like to have a management buffer as well. Those are typically sized on what we expect our growth needs to be over the next sort of 6 to 7 months. And I think when you look at our capital stack, it should scream out to you that it's all CET1 at the group level, because of the strong ratio, we were able to take our time in a measured way to look to replace the AT1 and Tier 2 issued out of our bank with issuances out of group. So I think our focus right now is to look for opportunities to optimize that capital stack to replace some CET1 potentially with AT1 and Tier 2. And of course, that would also potentially benefit your ROE but I guess we've delivered over more than the medium term. If you look back, we've delivered strong double-digit ROEs and continue to deliver high teens with a very, very strong equity position that we currently have. So certainly, our aim is to continue with that, subject to market conditions and cyclicality in the economy. So yes, on top of the agenda really for the Board to look at optimizing that capital stack. But we also have to remain cognizant that looking at those forward-looking COVID-related macroeconomic scenarios. We are predicting reasonably high increases in unemployment. And relatively tough decreases in house prices and even more selling commercial property prices. And therefore, we are expecting some defaults, which would attract higher risk weights. And some more higher balances, above 80% loan-to-value due to the HPI fall, which attract, again, higher risk weights. So we always consider capital projections and the fact that we do expect RWA inflation and so some of the capital has to be kept for that. And it's connected as well to your third question, which is the portfolio acquisition point that if we did see opportunities, of course, in the near term, we would want some capital firepower to take advantage of those 2. So I think no change really to our capital strategy, which is we want to make sure we have enough to cover the economic outlook to fund the organic growth opportunity that we see at high ROEs, to take potential opportunity of inorganic. And if we feel that we're going to be left with too much, then look for ways to return that in the best way to our shareholders. And I know that some share buybacks at the right share price, it's very popular amongst a number of them, particularly if you can enhance ROE whilst doing that. So I guess that's for the answer. We haven't obviously put out a specific target for CET1. It also depends, of course, on what happens with the countercyclical buffer as we emerge out of the potential economic downturn as a result of COVID.

The next question comes from Robert Sage of Peel Hunt.

Got a couple of questions. First of all, in terms of your guidance, if I could push you a little bit on this. I was wondering in terms of when you're projecting around 10% growth in loans, net balances this year, do you think that, that's likely to be second half weighted given some of the uncertainties you're seeing at the moment? And sort of very much related to this, in terms of your margin guidance, I was wondering what the sort of the current run rate is, whether you're already up at your sort of 266 basis points that you're generating -- sorry expecting for the full year? Or whether you would expect to see perhaps the exit run rate for '21 being above that level? And the final question was just if you got any comments about pricing dynamics and competitive pressures in the Buy-to-Let market at the moment?

Okay. Thanks, Robert. For any of you that. Just had your ears done in -- sorry, school ball error, I'm in the office in OSB, and they did a fire alarm test. So if you heard that, I apologize, I try to get on mute as quickly as possible. If I touch on the sort of growth aspect and the pricing dynamic that we're seeing in the market first and then ask April to comment more widely on sort of margin guidance. I mean, our guidance is based on what we're seeing today in terms of our run rate volume. So it isn't really second half loaded. We have an annual plan, which isn't highly seasonalized, and we always base our guidance on what we're seeing coming through the door and how that calculates out on the run rate basis. The 2 things that will differ where we get to in loan book growth is the first one is we are actively constraining some of the more cyclical markets at the moment. And if more economic data washes under the bridge that tells us the environment is becoming more favorable. We can start to release the criteria leash, maybe not all the way back to pre-COVID levels, but some of the way back to pre-COVID levels in those other markets. But I don't think that's going to have much of an impact in 2021 because even if we were to do that sort of Q4 or late Q4 post a couple of months beyond the end of the furlough scheme, that's really about pipeline building into 2022. So the guidance around loan growth is just based on what we're seeing and the criteria that we have in the market right now. The pricing dynamic, I mean, we're comfortable with the asset yields that we're earning in both the core markets of residential and vital there. There's always a little ebb and flow of competition. A lender will come in with an offering that looks significantly cheaper or pushes the boundaries on criteria a little bit more. We tend not to knee-jerk react to that because our core proposition is not always about price. It's tailored around speed of decision if it's a precise mortgages case through charter or around complexity and comprehensive nature of the underwrite and the overarching complexity of the proposition, if it comes through the camera line at all the InterBay brands. So we tend not to knee-jerk on pricing. We will tweak a maneuver as we go through the year. But equally, the funding dynamic at the moment is quite kind in terms of the pricing that we're seeing on that. April, anything you want to add in terms of margin?

Sure. I mean, I think I mentioned that Q4 was significantly improved due to those retail savings seeing the full impact of the base rate cuts by the end of the third quarter. We did actually do a further cut to our back book of easy access accounts. In Q1 this year. And we will see some benefit as we go through 2021 as our 1 and 2-year bonds start to refinance onto the lower prevailing rates. So we're not quite that run rate yet, but we will be shortly. But I think there is some sort of potential positives and some potential drags when you look at NIM, some of them we started to see in the first quarter. So on the positive side, we've continued to see a fall in actually the cost of retail funds. On the other hand, we have seen swap spreads widen at the 5-year point. And as you know, we do quite a lot of 5-year fixed mortgages. So it's costing us a little bit more to swap that interest rate risk out, which is offsetting that benefit from a little bit lower cost of retail funds. I don't think if we were to go back into some of those high-yielding mortgages, I don't think that's going to really have much of an impact on the net interest margin for 2021. I think that's more likely to be a 2022 phenomenon. But we might get a little bit more benefit out of the TFSME if we're able to use it with our encumbrance limits to fund a bit more growth rather than just to refinance the old TFS scheme. But I'm talking kind of second order 1 or 2 bps up and down in these sorts of items at the moment. So yes, we're not 100% there yet. And a little bit more to come on as the 1 and 2-year bonds refinanced, but a very strong start entry run rate for the year.

The next question comes from Ed Firth from KBW.

I think most of my questions have been covered. The only sort of small point I would ask about is in terms of capital and your capital surplus, which I recognize there are lots of numbers to come out. But really, however you cut it, it does seem like quite a strong number. So I guess my question is, to what extent is the sort of forthcoming MREL requirement, in your thinking in terms of any possible surplus capital distribution? I mean, it should be -- I suppose it's a straight question, should we be waiting until, I guess, first half of 2022, when you know what your MREL requirement is, when you know how much you issued, et cetera, before we start seeing any of that surplus being returned?

That's an excellent question, I'm very glad you answered that. Yes, that is definitely a consideration as we look at our strategy for optimizing that capital stack is what our MREL requirement is going to be and clearly, a very strong CET1 does give us that contingency, should there be any issue with issuing the senior debt for MREL at the beginning of 2022. So I think you're absolutely right. We're looking for clarity on what are the results of that consultation. I think the Bank of England published a sort of a bunch of questions. I mean, I'm not sure you couldn't really call it more than a discussion paper. When they do publish their consultation, it should give a very clear indication of where their thinking is. And we were actually very active in responding to the discussion paper, both face-to-face with them, which was great to get that opportunity. We put in our own response. We were very active in the U.K. finance response but also CEOs of mid-tier banks, we were very active in that response as well. So it's important for us to wait and see what the requirement is. And certainly having a strong CET1 base does give us some contingency if we find markets next year and not as favorable. But I think we've got plenty of time to issue. So that really is a sort of remote contingency point.

Can I ask a sort of related question? When I look at the yields on your AT1s, they do seem to be somewhere above some of your peers and some of your peers that I would argue, have nothing like you. Well, I wouldn't argue. [indiscernible] has nothing like your profitability and nothing like your capital strength. And I just -- what sort of feedback do you get from fixed income investors as to what's the case? I mean, what are their sort of issues? Because, I guess, given what's happened with them, when it was some companies, it's all reasonably personal to the moment.

I think a lot of it actually is based on the size of the issue. I mean, it's a really small issue, which meant that the sort of the investor base was quite small. I think -- I'm not sure who you're comparing us against as peers. But the first time you do it, there's always that new issue premium that investors are looking for. And the small size means there's less liquidity for them, so they expect a liquidity premium as well. And I think the important thing is to set up a regular program with a pattern of calling, replacing. And I think that -- just like the securitization market is becoming a regular issuer, you find your price starts to come down. And I think there's a dynamic there. So I think now that we're at a much bigger scale I think our issuances can be more above that sort of minimum benchmark, which I think could help as well. So I think it's sort of, I guess, familiarity, we'll be doing some debt roadshows clearly this year, the issue size and whether you're a regular sort of program issuer.

The next question comes from John Cronin of Goodbody.

Just a couple of questions from me. Firstly, on the NIM guidance, does that bake in an assumption around stable in terms of pricing this year? And secondly, on capital returns. Look, one of the points I wanted to ask you on is the potential inflation and risk weights if you don't retain IRB of transportation by the 1st of January 2023. And I understand we don't know what's the PRA position with respect to that finalized Basel III reforms packages, yes, but have you done any assessment or analysis in terms of what the implications could be from a capital perspective based on your HPI assumptions? And then thirdly, on the potential frauds, can you elaborate it all in terms of cost, what actually went wrong there, and whether or not you conducted physical inspections of the underlying [indiscernible]. And look, I might stick in a fourth, if you can give a specific on them. The fair value adjustments coming out of net interest income that moved around a little bit based on changing assumptions and experience. Can you give us some specific guidance in terms of where we should think about modeling that for '21 and '22 at this point?

John, I'll touch on the fraud one and then I'll ask April to touch on the clearly more complex questions around the numbers. But on the fraud ones to be fair, we're going to have to plead the fifth because this is a potential fraud, it's under investigation. We've got administrators in the company. We're not really at liberty to say any more than we have said in the release. So even if pushed, we have to consider the sort of legal privileged position and say, at this stage until we're much further advanced in this, we're not able to give you definitive advances to those kind of questions. But I will reiterate that we have done our own internal reviews, and the Board has also commissioned an independent review of the line to look at both our compliance with our existing policies and procedures and practices. And also last later than benchmark those against what would be regarded as industry best practice to see if we can find any learnings from that. But outside of that, that's really all we can say on the fraud issue. April, do you add?

Well, I think I could probably add one thing, which is just very factual, which is we have a range of different assurance practices that we use, and that does include sample-based physical inspections. But if I turn to the NIM guidance, I think you were asking about, does it assume stable pricing? Yes, it does. I mean we're always trying to grow [indiscernible] when we give our guidance sort of based on what we see today. And then you can then see if swap spread should widen or tighten, if rates should move, then you have a sense of what impact that could have. So there's obviously potential for competition on both sides of the balance sheet that could move things, but we've given guidance on what we see today. And then on the capital returns, yes, another very good question. I mean, there is a great deal of uncertainty over the new standardized rules. Will they actually come in first of January 23, given the continuing disruption from COVID? I think we'll probably find out later this year. Were there to be a big impact as a result of the way the PRA adopts them and some of the discretion they have, then I think they would have to give further transitional release. And it may well be the [ drums ] are telling me that there would be some elements of Buy-to-Let carved out and treated as resi, in which case, it's a nonevent for us. So quite a lot of uncertainty. Again, I suppose it's another reason from a contingency perspective that it's quite good to be sitting on a very strong capital ratio. You mentioned IRB. It may be that we don't need that as defensive, as I outlined. If you're also aware that it's kind of up to the PRA, not us, on the exact timing of accreditation. So it's good again, to have a strong capital base as a sort of contingency against that. We are still planning to submit model 1 this year. We're always very upfront or straight with you. In our prelims we mentioned that lockdown -- during lockdown, we progressed really well on a number of aspects, a lot of aspects on our IRB process. We had some issues with giving access to our systems to some of the third-party advisers who are helping us with that process, which delayed some parts. But nevertheless, we are still looking to submit this year. But yes, a good question. I'm glad you raised that. I'm afraid I didn't quite catch your last question. I think you were asking about, did you say fair value losses? I just wanted to check, I answered the right question.

No, just the fair value unwind and that's...

Fair value unwind.

Yes. I know the numbers have moved around a bit historically. So just very -- from a modeling accuracy perspective, any specific guidance you could convey for '21 and '22 and what we should assume based on your current estimates would be helpful there.

Yes. I mean, I think there was some -- a little bit of noise perhaps in 2020 because with looking at behavior, how long would people stay on the revert rate particularly in the Charter Corp. business. But I think this is something we would expect to unwind in normal circumstances fairly evenly over the remaining life of the CCFS mortgage book. And I think when we acquired CCFS at the end of 2019, we suggested it was about a 4 to 5 year weighted average life that, that was unwind over. There was also some movements in it because of the structured asset sales. We sold some of the mortgages that were in CCFS when we merged back in January, and that's also moved the needle on that amortization. But without further sales or any other significant event, I would expect, and we, ourselves, model a fairly even amortization over the remaining life. And of course, this affects statutory results, affects our capital, therefore, but it doesn't affect underlying NIM because this is backed out because it is an accounting [indiscernible] result of the merger.

[Operator Instructions] We have a question from Aman Rakkar from Barclays.

Just wanted to come back to the discussion around capital optimization. I mean, can you give us an idea of when you might be in a position to issue some of the presumably AT1 and Tier 2 instruments that you might look to optimize your capital back on. And then I guess related to that then, I guess, you're calling out 9.4% minimum requirement at the moment. If I was to put a capital conservation buffer in there and a fully loaded account cyclical, it's probably 13% to 14% minimum level as things stand. But when you issue that AT1 and tier 2, back of the envelope, I think that should fall quite significantly, probably closer to 10%. I mean, directionally, would you push back any of that? And I mean, how much higher above 10% would you really be looking to operate in, say, 2 or 3 years time once you've got these notes issued?

April, do you want to take that one?

So I was chatting away, but I was still on mute. It had to happen at some point. I just thought -- I hope I didn't worry you there, Andy. The first one -- taking the first part of your question first, which is when would we be in a position to issue, when we see a good opportunity in the market. I think our first priority, as I mentioned earlier, is to look to try and move the instruments that we've issued out of OSB in an orderly way, and some have quite some near-term call dates potentially. But just look at the best way to kind of move things at the group level. No firm decision made on that by the Board yet, but under consideration and discussion at the moment. And when the markets look good, then we would be in a position to issue. But we obviously have to look at the cost of carry as well. So it's all part of that optimization of the capital stack point. But it's top of the agenda of the Board once we get through year-end. And we're making some staffing changes in that area to ensure we have the right resources in place. And I think it's a good opportunity for us and something we're taking very seriously. Tier 2, we'd probably wait until we have our program set up in this or by the end of the third quarter where we can issue both Tier 2 and senior preferred out of the holdco. So really, I guess, it's market conditions. But everything else you said, I'm not disagreeing with.

And so thanks very much for that. I mean, I guess, maybe the numbers in and of themselves, you don't want to kind of confirm or push back against. But just more broadly, when we try and construct your minimum requirement, I mean, what is your appetite to operate meaningfully above that? I mean, how do you think about things that management buffers above buffers?

Well, I mean, I mentioned that, too, earlier, I think, in one of my answers in that we kind of look at it based on the amount of capital we think we need to grow, and we would look at our budgets and our forecast to determine that. And we would typically have 6 or 7 months as a combination of the Board offer and the management buffer. We obviously need to keep some capital in between profit verification. Our profits only get verified and become capital twice a year at interims and year-end. That's something as well that you sort of need to factor in. You will always see our capital ratios when everything has been verified. So it's sort of like the strong point, if you like. But we're not looking to run across the longer-term with excess capital because it's a drag on our ROE, albeit we're still able to generate, I think, an exceptionally strong ROE. It's just -- I guess I have to -- as we come out with some of the other questions, we have to be cognizant of a significant amount of uncertainty in the medium term, short to medium-term on what our capital requirement actually is, both from RWA inflation as a result of some potential downturn in the economy as a result of the pandemic, the standardized rules and MREL. So I mean, we're operating in a period of some uncertainty. And therefore, our contingency, if you like, in that near-term is our strong CET1 position.

It appears we have no further questions, so I'll hand it back to yourselves.

Okay. Thank you very much. If any of you didn't manage to get a question through or were unable to make any of the systems work, ping us an e-mail through and we'll happily get an answer back. But just to say, thank you very much for dialing in this morning. And thank you for joining the call, and we look forward to speaking to you all again soon. Thank you.

Thanks, everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for joining. You may now disconnect your lines.