Paragon Banking Group PLC (PAG) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us today at Paragon's full year results presentation. In a moment, Richard will run through the financials and I will then return to take you through the business performance, strategy and outlook, leaving plenty of time at the end for questions. But before I hand over to Richard, I've got a few introductory remarks so please, can you turn to the first slide. So 2020, as if you need reminding, has been unlike any other year any of us had ever experienced. Directly or indirectly, it's affected the lives of everyone in the U.K. and across the world and has affected every business, mostly for the worst. And it's in that context that we actually can be pleased with the performance this year. Of course, our business has been tested, but it has been deliberately built over many years with a high-resilient, low-risk appetite and with the long-term-through-the-cycle strategy in mind. While 2021 inevitably holds further challenges, this year's performance has certainly been resilient. And as we enter the new financial year, we are seeing an improving customer performance and growing new business momentum. The dominant impact on the financials this year has clearly been the COVID impairment charge taken at the interims, although the second half has witnessed a significant improvement on this. Return on tangible equity, a tad below 10%, contributed to the improvement in the CET1 ratio to 14.3%, an enhancement of 60 basis points. With regards to our capital ratios, it's pleasing to note that our IRB Phase 1 has now been successfully completed, although it is important to appreciate that there is still some way to go. In addition to the strong capital position, the quality of the loan book, both in normal times and in stress, has given us the confidence to reinstate the dividend for the full year, in line with the pre-COVID policy of 2.5x covered. The financial performance was achieved because of the strength of the operational performance. Extensive support was provided to our customers by our incredible, committed and adaptable employees as well as our stable technology platforms on which we run the business. Whilst new lending volumes naturally fell across the year, the net loan book still grew by 3.7%, supported by good customer retention. The deposit business was a stand out operational growth success with a 23% increase in balances to nearly GBP 8 billion, whilst delivering a fall in stock cost and an attractive and favorable front book/back book pricing gap. And as we commenced the 2021 financial year, there has been an encouraging recovery in new lending activities, now back to pre-COVID levels. The dip in NIM caused by the base rate repricing has now largely unwound and should recommence its medium-term upward trajectory. Whilst the increasing new business flow and growing pipelines are encouraging, we have not lost sight that 2021 will pose significant challenges, but we have made conservative provisions and we have made operational preparations. So we can now turn to the next slide. You can see that the business reacted with speed and agility, setting new priorities to manage the prices. This was on the back of many years of business recovery planning which was put into action in reality rather than through simulations and playbooks. The agility of our employees and the strength of the technology enabled over 90% of our workforce to work from home within just 4 days of lockdown. We supported our employees throughout this period with enhanced communications and well-being programs while supporting our customers through payment holidays and other methods of forbearance as well as participating in the government-backed lending initiative, CBILS and bounce back loans. Our traditional low-risk strategy, with 99% of the book secured, and strong capital ratios were strengthened further by adopting a more cautious risk appetite, including reducing new business LTVs. These are times which could leave your franchise and your reputation in absolute tatters. However, all of our products and services were available throughout the crisis as well as providing an increased customer engagement and extensive support to our customers in what was for them incredibly worrying moments. We believe that the actions taken means our franchise and reputation are stronger today than before the pandemic began. But our responsibilities are, of course, far reaching, as we can see from the next slide. 2020 has reminded us that these responsibilities and on starkest of terms and has driven us to redouble our approach and efforts on our culture, sustainability and customers. We believe our culture is unique. It's special and it's something we fiercely protect. Over this period, we've increased our employee comms by 60%, increased our engagement on diversity and increased our support to the community at large whilst also enhancing the wellbeing programs. We've provided extensive support to customers with a particular emphasis on those that are vulnerable and the feedback has been encouraging, with strong metrics across the business informing us about what we are doing well and areas we need to improve. And finally, on sustainability. We're all becoming increasingly aware of the implications of our actions on the environment around us. And whilst we may not be a business focused on consuming precious natural resources, we must take our responsibilities and our role within the business community with equal passion and commitment. Realizing what we do is crucial to ensure we understand the damage to the environment that we may cause so that we can look at how this can be improved and how the risk we're taking with our business are affected by the environmental changes. You will see the extensive data-capturing initiatives that are currently in progress, as evidenced by the increased disclosure in this year's accounts. However, there's still more to be done, including a number of new initiatives which will provide our customers with environmentally-enhancing products as well as ongoing analysis of the high carbon exposures that exist across the portfolio as a whole. Whilst we don't expect these to be material, we must all play our part to protect the future. I'll hand over now to Richard, who will take us through the financials.

Thank you, Nigel. As you'll expect, the results of the year have been dominated by the impact of COVID on impairments, demand and interest rates. So I'll try to give you some more of -- I'll try to give some more color on the impact of these drivers as we look at the different parts of the financial statement. My first slide, Slide 6, I will cover the income statement. Here we've seen that net interest was broadly flat to 2020. We've seen good growth in both the Mortgages and Commercial Lending divisions and these have offset the GBP 28 million year-on-year reduction in net interest we've seen from Idem Capital as that portfolio has steadily amortized. Other income fell by GBP 2.2 million. The main changes here relate to lower activity-based fees combined with lower broking and leasing income, which again reflects volume reductions in those areas. Operating expenses increased marginally to GBP 126.8 million. This is below the expansion that we anticipated at the start of the year with investments being moved back given the disruption caused by COVID. Impairments have increased materially to GBP 48.3 million, which reflects the IFRS 9-based expected credit loss approach from a suite of more pessimistic economic scenarios and the range of post-model adjustments. These PMAs have been put in place to reflect the potentially misguiding effect of payment holidays and other government support measures and I'll discuss these in more detail in a little while. The reduction in interest rates we've seen during the year has resulted in a small fair value charge. This is materially lower than the GBP 15 million we saw in 2019 and it's worth remembering these are noncash items and revert to 0 over the lives of the instruments that are being measured. Finally, just to be out with the comparisons, last year, if you remember, we sold a-- the residual in one of our securitizations and this trade or a similar trade hasn't repeated this time around. I can move on to Slide 7 to look at segmental results. The total clearly shows the impacts of the item capital amortization and also the COVID impact on impairment. If we exclude Idem, our pre-provision profits rose almost 19% in 2020. GBP 11.2 million of this, of course, just under 7%, thanks from the more mature mortgages segment and nearly GBP 17 million or 32% increase year-on-year came from Commercial Lending posting that stronger growth. In addition to the portfolio amortization, if you recall, Idem also saw a near GBP 4 million of income adjustment at the interim. Now this was to reflect the COVID influences on expected cash flows. At the year-end, we made no additional reductions to those cash expectations. Moving on to Slide 8. The next chart shows the segmental influences on net interest margin. We passed on the full 65 basis point base rate cut to our variable rate customers earlier in the year. And also the reduced interest rate also impacted on the earnings made on our liquidity holding, which also re-base lowest in May. At that point, the liability side of the balance sheet has gradually caught up and much of this difference is unwound as savings rates have fallen and our securitization vehicles have met their quarterly repricing point. As I've already mentioned, the amortization of Idem has continued to weigh way on the rate of progress in NIM. If you look at the charts on your screen, the bottom one shows a continued underlying progress of the group excluding Idem. So the main impact of the reduction of the period clearly came from our ongoing amortization of that portfolio. The disclosures that we normally give are around rate and volume variances and explain the back book/front book dynamics all included in the appendix. And it's also worth noting that by the end of September, most of the interest rate adjustment that we've seen post the base rate reductions that unwound and we're expecting 2021 net gross margin to recover to around its 2019 level. That's notwithstanding the low base rate environment we now operate in. We move now to Slide 9 and have a look at operating expenses. But for an increase in some of our deposit costs, which reflected the 23% increase in deposits that we've seen across the year, that cost would have been flat. In other words, we had saw a modest uplift in operating expenses, flat net interest income and a slightly lower other income which took our cost-income ratio to 43%. Operating costs are expected to rise in 2021 and probably towards the levels that we had originally planned for 2020 as we see further growth in savings balances and a continuation of the group's technology investment. In the next few slides, we're going to look in a lot more detail in asset impairment side. We can start with Slide 10 and the economic outlook. You'll recall that at the interim, we rapidly update you our outlook and the scenarios that we modeled. We fine-tuned these subsequently to reflect updated government policy and the range of forecasts that we've seen from economic advisers and regulators. The main changes we've made in the interim are spent essentially to lengthen the time to recovery, but we've also reflected the second lockdown and pushed back the timing of house price recovery. The latter has to be made, given the very resilient position we've seen in house price performance in the first half of this year, so we're seeing a later dip and a later recovery in that measure. These longer recovery times have served to increase the scale of the P&L impact of different scenarios. If we 100% weighed our upside, we would see a GBP 24 million write-back and if we 100% weighed our balance after severe downside case, we'd see an extra GBP 53 million of provision. Government policies have so far meant that unemployment hasn't developed as you'd expect given the GDP reduction. These are payment holidays and mitigated arrears that may have arisen. Repossession moratorium mean that there's been no flow for sales onto the market. Our forecast has seen that all of these start to arise again as does government support are phased out and we've made no changes to our scenario-weighting since the interim. Slide 11, I'll look a little bit more at the payment holiday experience. Overall, some GBP 2.6 billion of account was taken by payment holders for this year in 2020. These levels have now substantially unwound. So that really just reflects the fact that these are fixed terms, these are either 3- or a 6-month holiday. So with that peak that we saw in -- at the end of March, April and May, those clearly have to unwind by almost fully by the end of November. We've only seen extremely modest levels of pickup since the extension of the holiday program was enacted a few weeks ago. Importantly, of the GBP 2.6 billion that took relief, just over GBP 50 million of balances, representing 0.4% of our total book, have seen the arrears levels increase by a month or more when compared to the prepayment provision and as I've close customer engagement with these customers and also others that have had more modest increase within the -- in the arrearage. The -- while taking the impact of the economic and payment holidays together, we can now look at the actual resulting impairment. If we move to Slide 12. You can see at the top-right table, it just shows the spot position of the year-end now, both the interim and the 2019 prelim, but then also underneath our behavioral scores that we normally share. Our asset line models are forward-looking and designed to quantify the expected losses for loans that we defaulted. Those were significant increase in credit risk as a written and there's sort of no change in credit. These models all use historical correlations and these are based on well-seasoned and very detailed data that we've got going back many years. We use these to calculate probabilities of default, which is then applied to the portfolio characteristics now and against that economic outlook. The policy approach to furloughs, payment holidays, self-employment, income support, fee billed, and bank-backed loans all combined to make these correlations difficult to apply in the current situation. In simple terms, the GDP reductions we've seen so far should have resulted in materially higher levels of default than we've seen today. For Paragon, the biggest impact has arisen through the grant of payment holidays. With our modeling, we've incorporated probability default floors to this payment holiday portfolio as been informed by the combination of our close customer interaction. I focus on the most -- an extrapolation of those most affected also elements of the portfolio, but then extrapolating that further to reflect our economic forecast. The lagging effect of policy has also been approximated by looking at the outputs of adverse economic assumptions before the COVID relief were impacted and, in turn, grossing up our collective probability default profiles and the associated impairment. In essence, we've changed the approach to, say, the range of GDP and reductions and associated impact is also ahead of us. Absent these post-model adjustment, the pure IFRS 9 assets for the year would have been GBP 19.8 million lower. As I mentioned in my payment holder discussion, we've seen very little in the way of customer arrears during 2020. Indeed, our 3-month plus measure where we usually quote to the market, actually fell year-on-year from 18 basis points to 15. And as I also mentioned, we have -- we show our behavioral score some refi portfolios. These typically are actually the lead indicator of stress, but we ought to be a little bit cautious here because of the neutralizing effect of payment holiday on customer scores. So again, we have -- the information is clear and consistent, but some of the inputs may disguised. We put further detail on the impairments by stage, including a breakdown by division in the appendix. I can move on to the group capital slide, Slide 13. We continue to report on the standardized basis. During the year, we've submitted our module 1 application and may be invited into Phase 2 and it's the 4-phase process. As noted on the slide, our CET1 and capital ratios, total capital ratios, remained very strong and well over regulatory requirements. And these ratios actually also reflect the final dividend that's been proposed. The additional transitional relief we've had to Stage 1 and 2 IFRS 9 provisions in the year has helped a little. But the fully loaded ratios, excluding any of these benefits is down to 13.7% and 15.9%, respectively, for CET1 and total capital and those are both up on 2019 level despite the provisioning increases. We're currently going through our C SREP process with the PRA, so I would expect to update among any regulatory requirements from the 2021 input. Our final slide, Slide 14, just shows the capital bridge from 2019 through to September 2020. This is done on a reported basis rather than fully loaded and shows the beneficial impacts of these transitional adjustments, the after-tax profits that we've taken and both of these have served to increase capital resources as well as balance sheet growth. We've also shown the impact of the final dividend to show how capital is being used during the year and also there are small other movement item, which tends to just be small changes on the value of the defined benefit pension scheme that we have. In summary, we continue to accrete capital at a faster rate than it's deployed and this provides a strong basis for our future growth plan. I will hand it back to Nigel now. Thank you.

Thank you, Richard. So I'll now address the business performance, strategy and outlook. So if we can turn to Slide 16. Everything we do to build the bank and grow our franchises is based around our key strategic pillars. Whilst there are 6 green boxes on the left side, they're really grouped together into 4 cornerstones. First is ensuring we maintain our deep knowledge and experience supported by data and analytics, which allows us to take a low-risk approach in specialist areas where other larger banks struggled. Second, we are a specialist bank focused on specialist markets across the retail and commercial sectors and as such, we don't seek to compete with the larger banks in commodity areas. Increasingly, as we build more scale, we are ensuring that these specialist markets are big enough or deep enough for the products to make a difference to us. So from a group perspective, we can focus resources to optimize returns. Third, we've improved our technology over the last few years which certainly helped us adapt quickly during the crisis. Building on our cloud-based modular approach to improve our capability and capacity is a key part of what we're doing and what we're investing in and this is now being accelerated. And finally, we're working hard to try and level the playing field, which means trying to get closer to the big banks in terms of capital with our IRB application and in addition to this, we're also trying to level up on deposit costs, which I'll talk about shortly. Maybe it will never be completely leveled, but minimizing the gap with the bigger bank's competitive advantage has the potential to add significant value. On the right of this slide, I've set out 4 steles of disciplines that reinforce our strategic pillars. First, we'll always look to be capital generative, ensuring that our growth and dividend-paying capacity is self-funded. Second, the crisis has emphasized the benefit of being prudentially strong and low-risk from our capital, liquidity, funding and conduct perspective and this has been considered a long-term and sustainable strategy. Third, and again, the crisis and the uneven weights impacted the economy emphasizes the benefit of diversification, which we've been following now for many years and which we will continue to pursue. And finally, being able to absorb the stress during 2020 and still report a 9.8% return on tangible equity confirms our belief that targeting a 15% or better RoTE through the cycle is absolutely the right thing to do. And despite the impacts of the crisis, we have no reason to change this view and we'll aim to rebuild back to 15% or above over the planning horizon. Everything we do is filtered through this overall lens, constructed to ensure we build a strong bank that's capable of delivering attractive and sustainable returns for our shareholders whilst delivering on our purpose, supporting the ambitions of the people and businesses of the U.K. as a financial institution focused on being a specialist. We should now look at the individual business lines. First, Slide 17, and our largest division, buy-to-let. New lending for the year stood at GBP 1.2 billion, some 20% below 2019, due obviously to the impact of the closing of the housing market from mid-March. However, rental demand has remained strong, recovering quicker than the wider housing market, and when the market was reopened, it sprang to life quickly. The frozen transactions held together well and prices were not renegotiated and the release of pent-up demand was given a further fillet through the stamp duty holiday such that the market volumes are now reaching levels not seen for 13 years. This is, however, putting pressure on the housing system, extending the cycle times from application to completion and the emergence of significant delays. This is primarily a residential mortgage phenomenon rather than buy-to-let, but there is still some spillover to our sector. The buy-to-let pipeline dipped to a low point of GBP 599 million during lockdown, but has risen to GBP 868 million by the year-end and now stands at comfortably over GBP 900 million. Completions are also increasing on a monthly basis and acknowledging that uncertainty will continue, particularly around and after stamp duty changes. We will be hoping to see volumes increase to between GBP 1.3 billion and GBP 1.4 billion over the year. Naturally, we'll update you at the interims. Despite the drop in new lending, better customer retention has led to redemption rates dropping by 2 percentage points to 6.6%, driving up the net loan book by 4.8% to GBP 10.6 billion. We now turn to Slide 18. We'll cover the credit performance. Landlords used payment holidays extensively, primarily as a precautionary stance at the outset of the crisis. And as can be seen by the graph on the right-hand side, this initial burst reduced rapidly within a matter of months and the 21% of the book on payment holidays at its peak has since reduced to around 1% and we're seeing negligible new requests despite the recent government extension. The quality of this book is also evident on this page, with our arrears comfortably below the sector average as they have been for as long as this data had been captured some 21 years now. What is quite revealing though over the longer term is the transformation of the collateral back in the portfolio where the LTV, averaged at 66%, is now over 15 percentage points lower than in 2008. Averages, as we know, can always mask the broad distribution, but we only have 4.2% of the book greater than 80% LTV compared to 63% in 2008. Quoting data from 2008 is helpful and informative, but our IRB processes have been using our internal data covering the last 25 years. So let's turn now to the Commercial Lending business on the next slide. Our strategic pillars and disciplines apply as much to our Commercial Lending business as they do to buy-to-let. New lending across the year stood at nearly GBP 800 million, an 18% reduction compared to 2019. As can be seen on this graph, the effects on new business flows have been broadly similar, showing an abrupt reduction in the early spring and a steady recovery since then. And new business originations across the division are at 98% of pre-COVID levels during October. And acknowledging that an uncertain environment remains, we anticipate lending volumes to exceed GBP 900 million for 2021. And again, we'll update you at the half year. Turning to the key operating divisions within Commercial Lending, starting with development finance on the next slide. This is very much a relationship-driven business, with around 50% of new business being sourced from long-standing customers. Despite the crisis, lending volumes increased across the period, driven by the long-term project finance nature of the financing provided and because over 75% of the development sites remained open during the first lockdown. As can be seen from this slide, the pipeline did drop during the period as some of the new proposals were temporarily put on hold by the customers, although they quickly recommenced as lockdown ended. Forbearance was modest and there are now no customers that require support. Development finance delivers an attractive yield and at 62% loan-to-gross development value, refined the risk-reward relationship attractive. And with strong and highly experienced management team in place, we are encouraged by the growth opportunities this presents. We're adding resource to strengthen the relationship management team and seeking to broaden the geographical reach, an area historically underweight for the business. Turning now to Slide 21. We can look at the SME division. This was created from the original acquisition of Five Arrows some 5 years ago, which operates largely in the asset finance sector with 90% secured, with the remaining 10% unsecured being high-quality covenants in the legal sector, reflecting the group's low-risk appetite. SME lending experienced the greatest impact from COVID with new lending dropping sharply and quickly in March of this year and seeing payment holidays peaking at nearly 46% of the book. These were only deferrals of capital as interest was paid throughout. However, these holidays have now reduced to 2.1% of the book and new business flows have largely recovered to pre-COVID levels, with limited contribution from CBILS and bounce back loans. We are participating in the government-backed CBILS and bounce back loan schemes, having lent GBP 26 million by the year-end. Although this has been predominantly focused on supporting our existing customers whilst protecting the capital of the group. 2021 will hold its challenges and close engagement with our SME customers will be essential, but it also presents opportunities and we have a significant digital transformation project underway that will strengthen the division's proposition with both the broker community and with our end customer. Finally, turning to our savings division on the next slide. As I've said earlier, this is by far the standout growth performance across the group this year. Deposits are now up over 26% since 2019 and currently sit at just over GBP 8 billion and was achieved while driving down funding costs by nearly 50 basis points. The retail savings stock costs at the end of September stood at 134 basis points compared to 181 a year earlier and with the marginal cost now lower still. The strategy enhancing the product range and broadened the distribution capacity is part of our diversification strategy and is materially increasing the scale of our addressable market and we expect to continue to add product and distribution over the coming year. We do believe that technology will contribute to a leveling of the playing field with bigger banks over time. Over GBP 500 billion of retail savings, not including current accounts, not including SME accounts but just retail savings, are currently earning 25 basis points or less, some materially less. COVID has taught many more people now they can use the Internet to do their banking and when Open Banking delivers the simplicity of transferring money between savings accounts, the inertia will reduce. It won't disappear, we're not that naive, but only a small fraction of the GBP 500 billion needs to move in order to make a significant difference. Whilst retail savings have had a transformational year, our treasury operations have actively increased our contingent funding capacity, building enhanced liquidity and accessing the Bank of England's TFSME scheme. So finally to conclude, on the next slide. This has been an extraordinary year and we know this crisis isn't finished. I believe we reacted well, reprioritizing our business rapidly using our extensive experience and well-rehearsed business recovery programs. Our employees were amazing in the way they dealt with the situation with passion and care. The business performed well both operationally and financially and the balance sheet strength has enabled the dividend to be reinstated at pre-COVID policy levels. And we also have the confidence to reconfirm our 15% return on tangible equity objective. While this may have been interrupted, it hasn't been reduced or canceled. There has been an encouraging recovery in new lending at a tighter risk appetite with limited reliance on government-backed initiatives and monthly volumes are now back to pre-COVID levels. But we do not expect 2021 to be plain sailing. Government schemes will be unwound and then unemployment and insolvencies will rise. However, we have provisioned carefully and conservatively and we have made operational preparations to deal with the challenges that arise. A new world order will inevitably emerge and we will see different ways of working and different ways in which customers will transact with banks and financial institutions. We have already initiated changes to our operating model and accelerated a number of our technology plans. With a strong balance sheet, liquidity and capital supported by a resilient and stable operating model, we are well-positioned to react to the opportunities that will inevitably emerge. So thank you for listening and we will now be happy to take your questions.

[Operator Instructions] Our first question is from Benjamin Toms of RBC.

I have two, please. You've guided that NIM should recover to its 2019 level. I'm assuming that this is done on an Inc.-item basis. Can you give some color on the moving parts and the shape half-on-half? In half one, you usually gave some separate divisional guidance which would be helpful for our models. And then secondly, on the cost line, there's little change year-over-year in costs. In the presentation, you suggested that there will be higher growth in cost in 2021. What does this mean for the cost-to-income ratio, please, which has been creeping up into 2014? Should we expect this to also go up in 2021?

Okay. Richard, would you mind handling that? All those?

Yes, sure. So we haven't given divisional margin guidance before. Where we have given our figures, they've been directional, without a very specific level. In terms of the changes going into the full year, we see quite a lot of scope of volatility around rate changes and the like, liquidity requirements, liquidity-coverage ratios that we would tend to hold. So guiding to around the 2019 level is as good as we can give you at this stage. In terms of operating expenses, we -- if you recall when we had this conversation last year, we were looking at a number of technology spend. We've got -- we would expect more of our variable costs to also start to come through again this year as the business gradually returns to normality. And we don't see the impact of lockdown on various areas like travel accommodation and just actually getting those variable business costs undertaken. So we do expect that to move back towards the levels that we were indicating last year and this may have a marginal impact on cost-income ratio. I think that were it not for the dip we've seen from COVID-related demand and the impact of base we expect on NIM this year, actually, we would have seen further progress. So I do still think that the underlying trend will be downwards, but whenever you have some sort of step change either from an acquisition previously or from, in this case, COVID, you may get an interruption of that longer-term trend.

Just -- I mean just want to add there in terms of the NIM. The longer-term trend here, which is we've been pointing to an upward trend in NIM for a while, we expect that to continue. If you look, there's one of the slides in Richard's section that separates out the group NIM and the NIM ex item and you can see the significant influence the item has had over recent years. I mean it's, in effect, treat it as a closed portfolio and you can see it has a reducing influence here, 25%, 30% each year and, therefore, it's influence of -- on the NIM has a reducing effect. Therefore, making it look more like the ex item NIM growth into the future. Now if you also bear in mind in the appendices, there is the breakout of the divisional yield, so you can see the legacy book and the new book and the commercial book yields. Mortgages is a mature industry and we're probably underweight in commercial. So naturally, you would expect faster growth in commercial relative to mortgages and so, therefore, the growth of the new book versus the legacy book and also the commercial underlying growth should lead to that continued structural upward movement in NIM. But clearly, there's a lot of noise at the moment with the base rate changes and so we thought it would be better, as Richard has just done, to give you a bit more specific direction around what 2021 is likely to hold.

So just to summarize. Directionally, mortgage is up; commercial, up; item, down in terms of NIM. Is that fair?

Correct. Are you talking about the longer term or the next 12 months?

The next 12 months.

Okay. Richard, does that -- as you dealt with that question, do you want to just confirm?

That will be the expectation.

Our next question is from James Invine of Societe Generale.

I've got two, please. The first is on volumes. Nigel, I think you kind of talked about pent-up demand that didn't get satisfied during COVID has now been largely satisfied. Is that what I think you said? And I just asked because it seems that there was -- your conversion rate from pipeline to new business has obviously been pretty low and it just seems there's quite a lot of catch-up that could come there if it does come through. And then the second question is, again, on Idem, I mean if Idem continues to amortize, what's going to happen to the costs attached to that? Are they just going to get reabsorbed back into the business? Or would we look to cut those?

Yes. So let me deal with those in order. So yes, I mean, it's pretty obvious that what's happened in the housing market, for a number of months, nothing happened, people couldn't move, transactions which are just heavily disrupted. I guess what surprised me and everyone that those transactions, they just went almost into suspended animation and when the store took place, they all came back to life and there was very little in the way of drop-off. And I've kind of expected some people to try and renegotiate the pricing downwards in a more uncertain world, but they didn't. It just sort of basically is suspended life for a couple of months and then have started again. What's happening now in the house -- and I wouldn't make this a Paragon comment, it's a housing market comment -- there is huge congestion that's taken place because all of those loans, it was estimated that there was about -- sorry, no -- property transaction is about 430,000. Property transactions just stopped in that period and then they continued. That was then compounded by all the normal property transactions that would have taken place ordinarily through the summer and autumn, which is then compounded further by the Chancellor giving a stamp duty holiday, boosting demand. The consequence of that is there's probably just not enough surveying capacity, legal capacity, local authorities are taking between 30 and 40 days to return searches. So the whole process has just slowed down. I say it's an industry-wide thing, not just Paragon. So we've seen our conversion rates slow down, but what we see is we look at the aging of the pipeline and it gets cleansed frequently. So we're confident the pipeline that's there has a high propensity to convert, but the process has just been slower than would normally be the case. But what we're seeing is completion levels are picking up and so that pipeline conversion process is accelerating from where it was during the summer. And so, again, we're confident that there's going to be a decent flow of new business -- converting new business into the new year -- the current year. Turning to Idem. Yes, Idem hasn't done much in the way of new business for a couple of years now. And I think people may be surprised that the Idem deal team at its peak was only 11 people. And what it did is it sort of rented other services from the rest of the group as and when needed. So it leaned on other financial resource, it leaned on treasury resource and, importantly, all of the servicing is handled by a central servicing function that supports all of our servicing capabilities. So that particular division, largely the consumer loan servicing, has gone from over 400 people down to around 230 people over a number of years and we haven't made any redundancies because they've just been absorbed into the other areas that have been growing and the natural attrition that exists within the business. So we don't envisage a particular cost problem because of Idem. Clearly, what is happening is the income is reducing and it's that, that you have seen more of an effect on things like NIM than the cost effect.

Our next question is from Portia Patel of Canaccord.

I just wondered if you could give some color on any opportunities you're seeing perhaps over the medium term to improve the pricing of new lending in any of your divisions, perhaps taking advantage of changing appetite from the competition. And also any opportunities to broaden your addressable market perhaps as a result of changing appetite from the larger banks?

So I mean there has been some change of the competitive landscape over the period. They -- we saw the big lockdown one as it were. We saw a number of the non-bank lender competitors take several steps backwards, primarily due to concerns around funding. I think some of those are back, some of those are back and reasonably active, some are back but not so active. I think that's probably been more evident on the -- in a relative sense, on the development finance side where the competition there tends to be other specialist banks like Coutts and UTB and people like that, Shawbrook. But there are other sort of like credit funds who also participate in that market. They have been less active since the onset. Now we've also seen there's been some sort of relatively firm pricing. It's been very, very obvious in the residential; mortgage market, less obvious; buy-to-let, incredibly stable in terms of pricing, actually, maybe surprisingly stable. But everything is now at a sort of something like a 5% or so lower LTV than it was pre-COVID and the pricing is maybe up a tad. So you've got a good adjustment to risk-adjusted returns taking place there. But one of the things we just got to be a little conscious about over the medium term is the banking sector still -- the banking sector has taken a lot of provisions, but it still has a lot of capital and a lot of liquidity. And whilst we are in strange times and people do use their pricing criteria to manage flow as well, I think we probably should assume over the medium term that the competition will be where it was before COVID rather than maybe where it is at this particular moment. So I think one of the things that has been a real standout for us this year is actually our products were available, all of our products, all of our services were available all of the time during this particular crisis. And I think that shows the sort of the diversification that we have on our funding and the availability and the strong capital and also just the responsibility of continuing to lend into the market. So I'm -- I think there is plenty of opportunities out there. I think we've given some short-term guidance and also we've also given the longer-term guidance of the return on capital of 15%. That will only be achieved by continuing to grow the business, not standing still.

We do have questions registered on the webcast, which I will get to in a moment. [Operator Instructions] Our first webcast question is from Gary Greenwood at Shore Capital. Question one is, you've talked about how you see new business volumes developing in the current year, but how do you see redemptions changing? Second is, can you expand on what is involved in the various phases of the IRB submission? And finally, when considering the 15% RoTE target, how should we think about the capital structure of the group given that you currently have a surplus?

Okay. So Richard, if you could cover the IRB one in a second. But in terms of redemptions, you've seen redemption come down over the last few years as expressed as a percentage of the portfolio. That's a product of a number of things and there's going to be some influence to do with COVID, so there would be a correlation to market activity. So if market activity gets back to some sense of normality, it would be reasonable to expect that to unwind. But on an overlay to that is redemptions are also affected by the products that you have out on offer. So we participate quite actively in longer-dated fixed-rate products, which clearly keeps customers on the books for longer and has less frequency with which redemptions can take place. Separately, we have also stepped up quite a bit of activity towards professional landlords. Professional landlords have a lower propensity to redeem than amateur landlords. And finally, the ingredient is we're just working harder and working more closely with our landlords, offering them extension products when their maturity is approaching, both directly and by the broker market. So I -- longer term, one always used to sort of look at 15%-plus redemption rates, I don't envisage that happening anytime soon but I suspect it's unlikely to keep going down from where it is now. With regards to the capital structure of the business, we're at 14.3% called Tier 1 now and that's above our minimum. I don't think we felt compelled to take that down to the last basis point towards the 13% figure we've already guided to in the past. And clearly, going forward, we always have the ability to look at AT1s. We don't have that. We have a Tier 2 but we don't have an AT1. It's an option, we can look at it if we want to. There's clearly no necessity to have one on the books today. But I think what we will have to look at is also considering what our capital requirements will be in the growth environment that we continue to look at. And of course, I think we have always said to you in the past, we're not frightened to return capital if we don't envisage the need to use it in any reasonable timescale. Clearly, I think we're in some unusual times at the moment, so I don't think you should think that's on the agenda today. But we've also looked at capital to be deployed with the prospects of making acquisitions. We've done 4 in the last 5 years. So again, we're not frightened to consider those as well. But again, I think we are always going to have to look at this over the long term rather than in any short-term perspective of whether capital is in surplus today or will be in surplus a bit more by the summer. Richard, do you want to cover the 50 -- the -- sorry, the IRB point?

Yes, sure. So the Phase 1 is effectively an introduction and speaking phase where we have a lot of initial interaction with the regulator. Phase 2 comprises 4 modules, the first big one is around your actual models. You're also looking at your data and IT environment. Another big area of focus is the use and experience test just to demonstrate how those rating systems are actually used in determining and making decisions within the business and the influencing strategy and the like. And then in terms of the fifth part or fifth module that's part of this Phase 2, we're looking in detail at our rollout plan and in terms of what parts of the portfolio we have that long term are either suitable or not suitable to go onto IRB. So that's the main element for Phase 2. So it's a beefy element. But having got through those, Phase 3 would then be to look in a lot more detail at financial reporting and stress-testing approaches. There'll be another deeper dive then by the regulator in terms of our internal audit and model validation and the independence of that validation approach and an overall review of the government. That's the third phase. The fourth phase then is really an internal phase initially at the PRA where they will effectively work out where we are in terms of their overall process. They may feedback and ask us to change or update certain things, called the remediation phase, not the best word in the world but that's the way it would be articulated. And following that, assuming that other parts of the -- pass soon after and get to actually the issuance of an accreditation. That's the long modular process that we have for IRB and we can monitor therefore very carefully how we go along that path.

Our next question is from Ed Firth at KBW. This is the sort of environment where strong companies can pick up bargains in terms of businesses or loan books. What is your thinking on this? Where do you think are the most interesting opportunities? And would you like to expand your customer/product franchise?

So I think there is clearly dislocation in certain markets and maybe in pricing as well. I think there will, I think, inevitably be opportunities that arise. What we will always have to do when we always take a -- is we do look at things. We look at things on a fairly frequent basis at the opportunities that come up. Quite often, a number of the opportunities that come up are not that attractive or there is an unrealistic price expectation from the vendor. So it is on our radar, it is on our agenda, but I think it's kind of difficult in this current environment necessarily to make a correct value adjustment on either portfolios or businesses because there's -- a lot of businesses have been going through some uncertain times and therefore there is a heightened risk, which I'm sure is therefore reflected in the cost of risk. But it would be something that you would need to be very cautious about. And you've seen our risk appetite, we're not likely to bet the farm on things. But we are looking, we will look and we'll continue to look, but we'll only do something at the right time if it is absolutely the right deal for the business to do. Do we want to broaden things? Diversification is right at the core of our strategy, so we have broadened out our assets and our liabilities over a period of time and that remains core to what we want to do. So yes, we will look at those but we are a U.K.-focused business that is operating in the retail banking markets, so you should not expect us to consider something more esoteric outside of that [ premise ].

Our final question is from Jason Napier of UBS.

Basically, two on the deposit side of the bank, if that's okay. Just first of all, I wonder whether you could talk about the pace of repricing of that deposit base and how much of a tailwind that will be? And then secondly, as regards to diversification of that product set, I noticed that, at least at the moment through Monzo, you're only offering through the instant access market and there's nothing there in term. I just wondered, does this say anything about sort of your present balance of deposits? I know you've been looking to accumulate some excess balances and figure out how sticky those are. I wonder if you could just talk about the balance of products on the deposit side and where the mix may be a driver of NIM change going forward as you transition more from the term market?

Sure. I mean just dealing with that latter point, we've got some pretty tight risk appetite on how much we're willing to take in terms of easy access relative to the liquidity that we hold and that hasn't changed. And we will have to monitor over a period of time, but I don't envisage any immediate changes that are likely to emerge there. The vast majority of our book is on a fixed-rate basis and it is kind of the way we like it. When you look at what has happened on the deposit market over the last year, there's clearly been a big step-up in the savings ratio across the U.K. economy and huge -- of which significant sums have been used by consumers to deleverage debt as well as save into their bank accounts. What we have seen is strong inflows. There was some disruption caused during this summer by National Savings who for a number of months became very aggressive and more recently have done the complete opposite. And now we're seeing some fairly healthy inflows as people -- as they've repriced from over 100 basis points down to 1 basis point, yes, literally 1 basis point. So the net inflows have been strong. Jason, there's a slide in the pack, I can't get that number to hand immediately, but it's towards the back of the presentation and it shows the month-on-month volumes we've received and it shows the month-on-month stock cost and the month-on-month marginal cost. And what you can see is the effective way that marginal cost has come down. There's still tailwinds here supporting further reductions in the stock cost over -- for a period to come. So we see that as a favorable from the back book pricing position and so that's without doing anything else. And one of the key things we've been doing is trying to expand our addressable market, which we have done successfully, some of which would be by doing deals as we have done with Monzo and others. But there's more of that to come, so we're still looking to expand our addressable market. And by having a bigger market to go for allows us to have the optionality to drive and then lead to continuing to drive down funding costs. The longer term -- I mean, you and I have spoken about this before -- does the extraordinary amount of inert cash -- and it's inert because people just can't be bothered to move it or it's too much hassle to move. And I think all the work that we've done with people at Hargreaves Lansdown and Monzo and Revolut just shows how easy it can be by using platforms. And when we get to Open Banking, it's just one big platform at that point and the ability, therefore, to create greater mobility in the retail deposit market I personally find quite exciting. It's not an overnight and I'm not suggesting that GBP 0.5 trillion is available to us and it doesn't have to be. But it's -- there's a lot to go for and we only need a little bit of that to make a real difference. So I think it's been a real success story, well for a number of years, and this year has been a real success story for the deposit side of our business. But I don't think that success story is finished.

We have had further questions submitted on the webcast from Nicholas Herman at Citi. Could you kindly please provide a bit more detail on opportunities? With the caveat that the environment is uncertain and likely to change at this moment in time, which of the markets where you see -- where you are seeing a bit more dislocation and that potentially could be relatively more interesting from an M&A perspective?

I mean I think there's dislocation across all markets. So there's dislocation within the mortgage market, there's dislocations in almost every aspect of the commercial market. So if I -- the opportunities that can present themselves can come in any area, but if we're going to pursue a strategy of diversification, then -- if we bought another buy-to-let business, that wouldn't be much in the way of diversification strategy. And also, you kind of think we could do pretty much what -- anything we wanted to within that market because we've got such a strong franchise and platforms that exist there. So in terms of direction, I think to conclude on that, is there's dislocation that's taking place everywhere, but the areas I think we would be looking into would be more likely to be commercial than buy-to-let.

We have no further questions, so I will hand back to our host.

Okay. So thank you very much for listening today. As always, we will be happy to take questions off-line. I think Richard has penciled out the whole of yesterday -- sorry, tomorrow to talk to you if you want to cover particular areas. And we appreciate it's a very noisy year and a very complicated set of numbers in some parts and the environment is difficult to map out, so we're very keen to make sure you've got the best opportunities to get what you want out of these discussions. Perhaps the most important thing to finish with is to ensure you keep safe. This vaccine seems to be tantalizingly close and we would really want to be able to have the next meeting physically with you in the -- hopefully, UBS's offices in the city. So in the meantime, I look forward to speaking to you if you need to. And again, importantly, you take care. Thank you.