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

So good morning, and welcome to Paragon's 2022 Interim Results Presentation. But let me start by actually welcoming you here in the room, and it's such a pleasure to be able to see human beings in the flesh rather than actually through the medium of a screen. So hopefully, we are back to a new, more positive normal in that regard. And for those that are not in the room and have dialed in, maybe we'll get to see you next time or in between. So today, we'll run through the results in detail as well as providing an overview of the trading environment, updating you on our strategy and our observations on the outlook, including upgraded guidance for the full year. Before we go into the detail, I'd like to just spend a couple of minutes looking at our key highlights. These results show a strong financial and operational performance and reflect the growing momentum in the business alongside the clear progress in the strength of our various franchises. Operating profits increased over 27% to GBP 105 million, a record outturn for the business. Our profitability is, as you know, driven by a combination of the loan book and the margin. So it's particularly pleasing to see both the loan book expand by 8.6% to nearly GBP 14 billion, and net interest margin increased by 25 basis points to 2.57%. This impressive growth in the revenue line has also been supported by tight cost control, notwithstanding the inflationary environment and our digital cloud-based transformation program as well as the excellent customer credit performance, which continues to perform to the same exemplary standards that you have seen over many years. New lending has been strong across the group with volumes touching GBP 1.5 billion over the 6 months, up 32% compared to last year and has been complemented by good progress in new customer retention strategies. Our new business pipelines are particularly encouraging in both buy-to-let lending and development finance, which bodes well for the full year outturn. Our savings business has also delivered good growth in the period with the deposit book, both directly originated and via our third-party platform relationships, now totaling GBP 10 billion, all at attractive pricing. Our balance sheet has always been a source of great strength. We've always sought to operate with a cautious risk appetite, both operationally and prudentially. And this has, of course, been maintained. At present, there is no evidence of any credit deterioration in any of the portfolios although the environment is clearly suggesting there will be challenges ahead for the U.K. economy. Post the end of March, we sold the remaining part of items unsecured loan portfolio, realizing a modest gain and which will also derisk the wider portfolio further. Our balance sheet and low-risk appetite provides a high level of protection. 99% of our loan book is secured largely on property with the buy-to-let portfolio sitting at 59% loan to value. And capital ratios are robust with the CET1 at 15.4%, and the GBP 50 million buyback program announced in December is well on the way to completion. And reflecting our confidence, we have today announced this program has been increased by a further GBP 25 million to GBP 75 million in total. Our strong financial and operational performance for the first 6 months and the confidence we have in the strength of our business model, franchises and the market propositions mean we can upgrade our guidance for the full year for new lending volumes in buy-to-let and the commercial divisions as well as upgrading our NIM expectations whilst importantly, maintaining the guidance for operating expenses. So I'll now hand you over to Richard, who will take you through the financials in detail.

Thank you, Nigel. Good morning. My first slide summarizes the income statement for the half year. Total income was up 17.5% on 2021's level at just under GBP 182 million with net interest up 18.8% and other income down 9.7%. There's lots of measure reflecting the trend reduction we've been seeing on this line in the last few years. Operating costs have risen by 13.8%. This reflects a combination of inflation effects and the further investment in headcount increases we predicted at the 2021 year-end. Notwithstanding this increase, we remain comfortable with the guidance we gave for the year. We saw a small impairment charge for the period, representing a cost of risk of 2 basis points with a cautiously positioned economic outlook being balanced by strong collateral values as house prices have risen. The overall operating profit for the 6 months was GBP 105.5 million, a 27.3% improvement on last year. We've also posted strong fair value gain for the period. This chiefly arises from swaps being put in place for the buy-to-let pipeline. These get fair value treatment until the underlying mortgages complete and accounting hedge effectiveness is achieved. And these credits will amortize back over time, but could well be replaced by further debits or credits from the emerging pipeline given the yield curve volatility we're seeing at the moment. Underlying profits were up 27.3%, as I say, but underlying EPS was up 29.4%. The difference is largely attributable to the changing share count given the ongoing buyback program. On the segmental slides, we can see a strong improvement in pre-provision profits in Mortgages and Commercial Lending, our 2 key operating divisions and a continuation of the trend reduction in Idem as its portfolio is amortized. The Central segment benefits from greater interest earned on central liquidity as rates have risen but also sees higher operating costs because most of our tech and project costs are focused on our Central teams. Last week, we disposed of the remaining unsecured loans in the Idem book for a very small gain, which now leaves just the secured portfolio. For those of you that are looking to update models, the unsecured portfolio generates about half of the total Idem operating income. With an uncertain rate environment, our initial guidance for the year was to see NIM expand by more than 5 basis points. However, we've seen a stronger-than-anticipated deposit -- sorry, stronger-than-anticipated expansion across the period. Our deposit beta was minimal for the first 2 base rate rises. And we now expect the outturn for the year to be more than 20 bps above the 2.39% that we reported last year. And this assumes a more normalized relationship to movements in base rates going forward. Paragon is not immune from competitive pressures in the savings market with Chase Bank being notable new entry during the period. As such, we tend to see a ratcheting effect following base rate movements, with margins initially widening and then reverting to some extent as rate administration activities kick in and the eventual deposit beta is delivered. As I mentioned on my introductory slide, the volatile yield curves that accompany the tightening phase of the Bank of England have created material fair value gains. We exclude these when looking at underlying performance, but they are a good guide to the value that would have been lost in both cash and profit terms if we'd hedged our book on completion rather than as the loans go through the pipeline. For some time now, we've highlighted the structural NIM benefits from our front book, back book dynamic on the mortgage book and our Commercial Lending diversification. This underlying trend has continued in the period, but it's been eclipsed by this liability tailwind that we've seen from the rate environment. Costs have increased as predicted. I've highlighted 3 of the more specific areas on the slides here. Headcount has risen after a flat period during lockdown. And at the 2021 year-end, I highlighted our wage inflation going into this year was about 5%. Salary review is taking place at Paragon on the first of October. So it was done with a fair degree of knowledge. We were undertaking a broad-based system enhancement and digitalization program. And that's been developing in recent years and have seen further growth in 2022. And I will talk to this in more detail in a while, but the investment is designed to enhance customer and introducer experience but also add operational efficiency. These efficiency improvements are particularly important in the higher inflation environment, especially as the group looks to deploy its capital and funding strength to accelerate growth. Finally, I'd like to reemphasize there's cost growth as planned. And we remain comfortable with the original guidance we gave for full year cost being in the low GBP 150 million. Now for a couple of weeks in January, I was actually looking forward to talking to you about a less volatile economic position. But the effects of Brexit and COVID have been swiftly overtaken by the war in Ukraine and the rising cost of living. It's rather stymied that plan. In response to this environment, we've updated our multiple economic scenarios. And we've applied the weightings that we applied when we first moved into COVID, which were materially higher than we saw on the -- when we first started doing IFRS 9. This weights our downside case at 35% and our severe case at 15%. You'll see that the 100% weighted scenarios was still material, result in a lower level of volatility now than we saw at the year-end in 2021 or even more in previous years with severe upside spread -- upside to severe spread, sorry, reducing to GBP 55.3 million. That is largely a result of house price inflation since that date. Despite this cautious stance, the resulting impairment charge is reduced from its first half 2021 level and is summarized on the next slide. So having peaked at 64 basis points in September 2020, our impairment coverage ratio has gradually reduced as the immediate COVID concerns receded in the portfolio season. The ratio fell to 49 basis points so the 2021 year-end stands at 40 basis points there. With an almost fully secured balance sheet, rising house prices have had a very positive effect on security values, mitigating the effects of these cautious economic scenarios. We continue to hold just over GBP 14 million of overlays on the impairment models. But these have been skewed increasingly towards the potential impact of higher inflation on our customers rather than a pure COVID-related scarring that we used before. Absent the overlays, the table on the bottom left of the slide shows what impairments would have reduced to GBP 32.3 million with a 23-basis point coverage ratio had we applied the same scenario weightings we used when we first transitioned to IFRS 9. And that's with those underlying harsh environment -- harsh scenarios in the severe and downside cases. Finally, for this page, at the table at the bottom right shows the behavioral scores of our different portfolios over the last year. This tend to be a really good lead indicator for emerging stresses in the book when we closely monitor and especially when things are volatile. But you'll see here, they remain very, very stable and per Nigel's comment earlier. When looking at capital movements during the half year, we've seen a stronger-than-normal contribution from earnings retentions, which has been boosted by the positive fair value adjustment that I've already noted. Net lending, dividends and the share buyback combined to result in a CET1 level remaining unchanged across the period. The figures reflect the completion of GBP 37.5 million of the first buyback in addition to the final couple of million we had left over from the 2021 program. The continued growth in Commercial Lending has seen the group's average risk weight density increased marginally during the period. Notwithstanding this and the distributions made, we ended up with CET1 of 15.4% and a total capital ratio of 17.5. PRA has made no secret about the challenges it's facing with resources, especially in its IRB authorizations unit. In addition to a number of firms, [ aspirate ] firms such as Paragon, they've been going through the process of updating the existing IRB firms' mortgage models to a hybrid basis. That's put them under a lot of pressure. Despite these challenges, we've made good progress, and we've had really good engagement around our modeling approach. And we expect to be discussing the other Phase 2 elements across the summer months. It was very much like to be -- for the process to be running at a faster pace. We've been really encouraged with the feedback we've had from the PRA, and we're confident in achieving a good accreditation in due course. And that'll build on our strong credit performance, established governance and our proven modeling credentials. And as soon as we're in a position to actually give more detailed guidance, we will do. But we're very much dictated by the PRA's timeline and the time it then takes for us to make refinements when we've had their feedback. My final slide looks at the progression of the dividend. Our normal policy is to make an interim dividend around 50% on the prior year final. And so we've enact the 9.4p for the half year. And for the full year, our policy remains to distribute around 40% of underlying earnings. Thank you. I'll now hand you back to Nigel.

Okay. Thank you, Richard. So turning now to our strategic priorities. This slide represents our strategic framework, including our key priorities of growth, diversification, digitalization, capital management and sustainability. We are a specialist bank, focused on sectors where we have a competitive edge because of our extensive and deep knowledge of the markets in which we operate, the customers we serve, the products we provide, the services we offer and the risks that we take. This excellence is created from our deep through-the-cycle experience combined with our extensive access to information and data analytics, some of which goes back decades and which also creates a distinct competitive advantage for the group. These priorities are being implied across Paragon's business line as core principle guiding our activities. Our strategic priorities are simple, fully integrated and work hand in glove with each other in pursuit of the group's overall objectives. We have and continue to seek strong balance sheet growth in our chosen markets, where we can optimize a good and sustainable return on the capital utilizing the group's core strengths, including its highly efficient operating model. Capital is strong, and the group is effective at internal capital generation, supporting the ability to grow substantially from here and the return of capital through the 50 -- 40% payout ratio and an extended buyback program over many years. Digitalization is supporting further organic growth. Our diversification strategies, opportunities to improve efficiency further and an increasing focus towards an enhanced sustainability model, all of which are reflective of the group's approach to its responsibilities whilst adding further growth and product diversification. Now turning to each of these areas in more detail. This latest reporting period has delivered strong growth in both new lending and our loan book, but it's not a one-shop wonder. We've witnessed strong growth over many years with compound average growth in new lending of 18.1% since 2015. The specialist markets in which we operate are witnessing good underlying growth levels where we have also achieved market share gains, aided by additional product launches and improved engagement with our distribution channels. It's not just about new customer origination though. There have been increasing efforts paid towards enhancing long-term customer relationships, thereby improving retention levels as can be seen by declining levels of customer attrition and also repeat business from our existing customers. Whilst our loan book has expanded by 8.6% over the last year, there's more to come, part of which will also deliver further diversification. The success of our diversification strategy has continued with the commercial division's share of new lending rising to 43% of total lending and its income contribution to GBP 42 million in the first 6 months, which compares to GBP 38 million in the equivalent period last year and GBP 6 million 5 years ago. As previously mentioned, this has essentially offset the runoff of Idem, which only contributed GBP 6 million towards profits in the period. Whilst we have sold Idem's residual unsecured loan portfolio, we still have strong and experienced M&A capabilities in the group. And we will, of course, have the potential to acquire portfolio should the opportunity arise in the future. As the chart on the right shows, commercial is not one product or one business line, thereby providing further diversification. Funding diversification is also a crucial value driver. Securitized funding has now reduced to GBP 1.8 billion, which represents 12% of the group's total debt compared to 100% 10 years ago. The optionality this provides is highly attractive, and its value is evident in the current favorable conditions in the retail savings market compared to the wholesale funding market. Diversification will be further supported by our digitalization program. Paragon, as I said, is a specialist bank with a technology strategy targeted at delivering a better customer proposition through faster delivery with enhanced service levels and provide improved data to facilitate better decision-making and improved cost efficiencies and increased operational leverage. We are undergoing a multiyear multi-business line cloud-based replatforming program, which will transform the way we engage with both the intermediary market and also new and existing customers. New digital technology is being introduced into virtually every corner of the bank with the prioritization towards customer-facing areas. Our new in-house savings platform was already operational and supports our growing third-party relationships, enabling us to reach customer segments not available through traditional channels. New business origination portals have been launched for our buy-to-let business as well as our SME broker community. These portals are helping our brokers provide a better, faster service to our potential customers. The launch of a new platform for development finance is imminent, and digitally based mortgage underwriting and processing platform is currently under development, the first aspect of which has been focused on providing further product offerings to existing customers. This has already delivered notable successes in accelerating the decision-making process, which to date have seen execution times improve materially as well as supporting our existing customers with additional financing requirements on a highly efficient basis and which could be used extensively as customers seek to upgrade their properties as part of their own sustainability requirements. Our new systems will make extensive use of API and open banking technologies and which will help enhance our customer propositions on an increasingly cost-effective basis. So turning now to capital management. At Paragon, we're blessed with strong levels of core capital and high levels of internally generated capital, which for the first half of the year alone added 1.6% to CET1 predistribution. However, we always treat capital as a scarce resource. And we'll always maintain a disciplined approach to its employment, prioritizing the optimization of the returns we can achieve. We are achieving a return on tangible equity tantalizingly close to our target of 15%. And we believe this target is not just achievable but sustainable. We have also managed strong growth ambitions whilst delivering significant cash flow to shareholders consistently over many years. The dividend payout ratio of 40% has seen GBP 339 million paid to shareholders since 2015, and this has been supplemented by buyback programs totaling GBP 335 million. Combined with a bit of rounding, this amounts to GBP 675 million of capital being repatriated to shareholders since 2015, representing nearly 60% of our current market cap. As Richard mentioned earlier, our IRB program continues to make good progress. And whilst it's a long and complicated process, there are noticeable benefits to come. The PRA is expected to undertake a consultation on Basel 3.1 later this year. And this has the potential to be disruptive for the sector as a whole. And before we know it, the January 2025 implementation date will be here. However, in this regard, we are very well positioned. Our capital levels and internal generation capability are real strengths. And with current capital levels standing significantly above the regulatory minimum, we have plenty of capital to support our ambitious growth plans. So we have been active in our broader responsibilities in our sustainability agenda. Significant work has been undertaking using our advanced data analytics capabilities to measure the level of operational and funded emissions as well as the risks these bring. Increasing disclosure and public engagement are evident with our inaugural sustainability report published at the end of last year, which has been universally well received. Additionally, external ratings have been achieved, confirmed or upgraded. With regard to funded emissions, we've released a range of product initiatives designed to encourage our customers to invest in improving their own emissions on their properties or in their businesses. We're also offering finance to support electric motor and commercial vehicles, a trend which will only grow rapidly from here. We've also offered a range of facilities to SME customers supporting their environmental plans. A range of operational initiatives have been undertaken, which will continue in order to improve the emissions directly under our own control as we move increasingly towards operational net zero by 2030. We're also conscious that our broader responsibilities are not just related to climate change as important as that is. We have continued to actively support the communities we work with and of course, our colleagues, particularly through the challenges of recent years, we have all learned to adapt to new ways of working. We are particularly proud to announce that we have been accredited with platinum status by investors and people, the highest possible rating which is only held by 3% of those reviewed and less than 1% of all companies across the U.K. Turning now to some comments on our key trading divisions. The strong momentum in buy-to-let new lending has continued from 2021 into the current year. New lending is up 19% compared to last year, and the period ended with a pipeline of over GBP 1.3 billion. We are therefore guiding that our new buy-to-let lending for the year as a whole should now be in excess of GBP 1.8 billion. The dynamics of our target market has changed in recent years and continue to change. We've seen continued evidence of professionalization of the buy-to-let market with professional landlords expanding their investments and increasing market share. Whilst 2021 was dominated by house purchase transactions, 2022 is the year of the remortgage, it being the fifth anniversary of increased landlord demand for 5-year fixed rate mortgages. We have invested further in technology and processes to improve our customer retention proposition, where redemptions have fallen again on the new book to 5.9%, leading to further reductions in customer attrition and a growth in the buy-to-let loan book of 8.5% to GBP 11.8 billion. And as you would expect, the credit performance has been exemplary. Data analytics and technology have always been used extensively in our buy-to-let business over our 25-year history and has been used in supporting our IRB application as we employ methodologies to more accurately align capital allocation alongside risk. Our buy-to-let credit performance has always outperformed the sector, and this remains the case today. The support facilities provided during the pandemic are all repaid, and arrears stand at 15 basis points, virtually 1/3 of industry averages. And with the average LTVs at 59% and only 1.6% of the loan book greater than 80% LTV, this demonstrates the asset backing of the portfolio is incredibly strong. Rental demand was disrupted in the pandemic with city centers experiencing weakness, while urban areas witnessed heightened demand. Rental levels have risen 11% over the last year due to a significant shortage of stock in the sector, where we are seeing tenant demand running at an all-time high. Turning now to our commercial division. The graph on this slide shows the level of new lending in our commercial division since 2018, which now represents 43% of the group's volumes. Here, we can see the pre-COVID trajectory has now been fully restored, continuing the upward trends supporting the diversification income and contributing to the group's structural NIM accretion. Turning to the various businesses within the commercial division, first, development finance. In the first half of the year, new lending in development finance increased by 41% to GBP 324 million, leaving the loan book at GBP 673 million, 22% above a year ago. Whilst housing demand remained strong, there are supply chain disruptions, which naturally delay housing starts and through the various phases of the build programs. Nevertheless, momentum has been good. Development finance benefits from long lead pipelines due to the nature of the sector's financing requirements, the pipeline of undrawn commitments, those facilities that are on the books but where state payments are still to be paid, stands at GBP 600 million, providing good visibility to the levels of lending activity over the next 12 to 18 months. Development finance will shortly complete a replatform and which will deliver an improved customer service proposition and greater efficiency as well as enhancing data management capabilities to support the next phase of our IRB program. Turning to SME lending. The COVID pandemic had the greatest impact on our SME division, creating high levels of payment deferral and significant reductions in cost of demand, part of which was met by various government funding schemes. The credit performance has returned to normality, and customers who are in need of support are negligible. Whilst customer demand has yet to return to pre-pandemic levels, this is primarily driven by the significant levels of advanced government funding provided at the time and which continues to be offered, albeit at greatly reduced levels. We participated in these government schemes but only to a modest extent, largely limiting our involvement to supporting existing customers only. Notwithstanding this, there are encouraging signs of renewed activity. New lending is 17% up on the equivalent period last year. And by comparison to industry data, we're achieving an improving market share. The loan book stands at GBP 639 million, an all-time high for SME lending. We are also partway through a cloud-based technology replatforming program, which is making extensive use of API technology and open banking, including the recent launch of a broker portal, which is already being used by over 60% of applications. It has the ability to access over 4,000 pieces of customer data on every single application, including embedded online access to customers' current account information as part of the underwriting process, which is a significant benefit for us, which was only historically accessible by the large banks. Turning now to the remaining components of the commercial division. First, motor finance, which experienced a sharp slowdown during the pandemic and for a period operated at virtually tick over levels. However, following a review of its strategy, it launched with a more targeted approach in the specialist sectors where risk reward could be better optimized. New lending has increased to GBP 76 million in the first half, and further growth can be expected from here. New product launches commenced in the leisure markets and in the electric vehicle sector, which naturally should expect to see significant growth as the sector delivers and matures in the coming years. And finally, structured lending, which provides asset-backed lending to the nonbank specialist lending firms, has seen an encouraging recovery from the pandemic with an increasing number of facilities being added alongside an improved utilization of existing credit lines. Clearly, good progress has been achieved across our Commercial Lending division. However, we are conscious that these asset classes are more cyclical in nature and that the environment could be more challenging in the year ahead. So the strong disciplined approach we've taken in the past will put us in good stead and will continue to be applied going forward. So as already mentioned, we are upgraded our full year guidance on new commercial lending to above GBP 1.2 billion from GBP 1.1 billion. So finally, turning to funding. The deposit book is up 14% year-on-year and now exceeds GBP 10 billion. We've continued to strengthen our franchise, enhancing flows with our third-party relationships like Raisin, Hargreaves Lansdown, Monzo, Revolut. There, there's been a significant change in the interest rate environment. And clearly, this process is still underway. Base rates have increased so far by 90 basis points with the beta providing a current tailwind feeding into NIM. Consequently, we are also upgrading our full year NIM growth expectations from over 5 basis points to over 20 basis points. Technology is also playing an important role in our savings business. A new platform to support our third-party deposit relationships is effective and working well, delivering improved efficiencies, strong operational control and enhanced resilience. The demonstrable success of our funding strategy has also been recognized externally with Fitch recently upgrading our long-term debt rating to BBB+. Looking forward, Open Banking is becoming more embedded in the banking payment sector. There are over GBP 1 trillion of balances with the major banks earning nothing or next to nothing. Even after the recent base rate rises, new technology will reduce friction and should improve inertia. And we've seen some of this strengthen during the pandemic as flows into the clearers group. There is a big prize here, and we are seeking to exploit the opportunities that should emerge. The group has a long history and a strong presence in the securitization markets. And whilst pricing is unattractive at present, it remains open to us to tap this funding source opportunistically. So in conclusion, the pandemic showed how well both operationally and financially resilient the business was. And strong growth and momentum in the recovery period reflects the strength of our franchises, our market positioning and our ability to execute. Loan growth has been strong, and improved customer relationship management is leading to greater retention levels, supporting good balance sheet growth. There is significant cloud-based technology replatforming programs underway across the group, which will improve both our customer and market propositions and improve our decision-making and cost efficiency. And much of it has the potential to help level the playing field with institutions that benefit from structural competitive advantages. The strong performance of the business in the first half of the year and our market positioning provides us with confidence looking ahead. Consequently, as mentioned earlier, we have increased our guidance for mortgages, commercial lending and the net interest margin whilst maintaining our cost targets. Nevertheless, we recognize that the country is facing a weaker economic outlook. There is geopolitical volatility, a cost-of-living squeeze. And interest rates will certainly rise further from here. However, our business is well structured, operationally resilient and financially strong. We have also shown our agility in reacting to stress events on more than one occasion in the past. Whilst the environment will create challenges, it will inevitably create opportunities. And we are well positioned to react to them as and when they emerge. So that's the end of the presentation. We'll now go to questions. We're going to deal with this in 3 phases. So we're going to deal with questions from the room. We'll then deal with questions for those dialing in, and then we'll deal with questions for the webcast. So -- and there will be pauses in between whilst they get loaded up. So if we go now, we'll go to the questions in the room. Okay.

Ben Toms from RBC. Firstly, on costs. You've reiterated your guidance for the full year today. I think in the current environment, the market will be quite like that. I think previously, you said in terms of guidance for 2023, the cost would be up again, but at a lower rate than the increase in 2022. Just interested on your thoughts there as inflation climate has changed since last time you said that. I think consensus looks like has it going up about 6% for next year. So just in that kind of context. And then secondly, in the context of the cost living crisis and buy-to-let, how should we think about that? Is that good for buy-to-let in -- with the scenario being that people can't get on the mortgage ladder, so they end up renting instead, and that's good for landlords? And should we think about that differently if it comes with a large fall in house prices at the same time?

Okay. Do you want to deal with the cost, and I'll cover the tenants?

Yes, sure. So the tech investments that we're making, we carry on that program. That runs into 2023 and probably '24 from the ones we're seeing at the moment. So we wouldn't expect any reduction in terms of the pace of growth on the tech side. There'll be volatility around inflation levels. As you stand today, it looks inflation may be a little higher towards the end of the year than we were predicting at the outset. Some of that may well feed in a little bit. But overall, if it does move, we don't expect it to be a material move up from the levels that we see in consensus for '23 yet.

Okay. Turning to the question on the rental side of life. So what -- clearly, what you have, we -- our view is that it's evidenced over previous cycles, the demand for rented property actually rises in an economic downturn. So it's kind of countercyclical in that nature. People were buying house -- house purchase, first-time buyers less, therefore, more moving into the rental market. The rental market is incredibly strong at the moment. And one of the key issues is a shortage of stock rather than -- there is a natural inflationary pressure. And long term, there's a very close correlation between rental growth and wage inflation. So you've got a natural kind of underpinning to rental growth still coming through. But with the countercyclical element, we can see that continuing maintaining itself in the current environment and potentially getting stronger. The shortage of stock is a product of going back to 2016 and the governance change in the tax arrangements and probably then with some further house price appreciation, some of the amateur landlords have exited the market. And so as a consequence, you've seen rising tenant demand, declining levels of overall stock. What we have seen within the professional landlord community is that they have absorbed that kind of vacuum that has existed. And so we see professional landlords gaining market share. So not only are the market levels of growth, but also our target market has expanded as part of that. So now weaker economic scenarios can create other problems elsewhere. And one of the things we're also very conscious of is tenants may be suffering their own squeezes. And so we do engage with the landlords. And we assess their ability and their capacity to be able to support tenants through challenging periods. One of the things we also embed in there is when we underwrite, we stress test the loans. So you've got an ICR interest cover ratio of 212% on flow. The stock will be a fair bit higher than that as well. So there's quite a lot of capacity there for the landlords to absorb those pressures within that. And we do think there will be some countercyclical element to demand, which will keep sort of like demand for landlords properties going up.

It's Perlie Mong from KBW. Can I just ask one on NIM trend and so what's happening on the funding cost side? So obviously, I've heard what you said in terms of there's more challenger banks, et cetera, coming in. Just wondering how competitive have you had to be like at the front end? Because a lot of things, as you pointed out, like it's like there is a sort of challenger space where people have been quite competitive in terms of pricing, but then the rest of the market where the large banks are is like people are not particularly moving because of inertia. So just how competitive have you had to be in terms of funding cost. And the other one is impairment. Obviously, again, noting that you have not seen any kind of deterioration, but it's a broader question. Just where do you worry the weak spots might be? And what are some of the economic metrics or customer behavior metrics that you're looking at? Because I'm sure you know as well as I do that we seem to be living in a world where none of the banks are seeing credit deterioration, but the market is incredibly worried. And with metrics like unemployment and arrears being lagging indicators by nature, by the time those come through, it might already be too late. So just how do you think about impairment? And what are the metrics that you look at as an indicator?

Okay. So in terms of NIM, I mean, the NIM is one start -- one line, incredibly complicated though, because it's got liability movements, both in variable and fixed rate. You've got what's going on in the swap market. You've also been going, what's going on, on the asset side depending on stock and flow. So there's like a million variables that go in to create one number. So first of all, it's complicated. Secondly, you've got a crazy market going on at the moment where so much volatility, so let's just take the swap market. It's up 2% since Christmas, 5-year swaps, 2% since Christmas, 80 basis points in 3 weeks. So actually trying to work out what is the spot rate, we can easily work out what the spot rate is. But what the trend rate is and whether it is going to still be that number in 3 weeks' time, let alone what it is today is very difficult. And when you look at mortgages, mortgages don't reprice as quick as swap markets do. So certainly not at the moment. So you've got leads and lags. And trying to work out what the correct underlying trend is really, really difficult. On the deposit side, so there's been a very helpful tailwind that's come through. We've seen the base rates up 90 basis points, but our variable rate deposit book has not moved as much as that by some margin. But there is still a process because we've got another base rate rise probably coming this week, either 25 or 50. And what happens to the dynamic of that is challenging as well to determine what then feeds through into NIM in the second half -- well, second half end of the year and beyond. So with all of these changing dynamics and the things are moving very quickly, an almost unprecedented level of rate of change in interest rates that are coming through. It makes it really difficult to sort of give you one nice, neat answer to that question. So what we've done is given you the guidance of the plus 20 for the full year. And we are confident in that number because we don't know what's going to then happen with -- Chase came in and sort of lobbed the grenade into the market with that 1.5% sort of current account with a 1.5% rate on it. And that sucked out quite a bit of activity for a period of time, less significant now. But I don't know what they're going to do next week. Maybe they'll do it all again. But again, so you've got fast-moving activity, changing environment. And I think with all of that noise, it's very difficult to land on one nice, neat number apart from the fact that the guidance we've given you for the full year. In terms of impairments, well, we start with the basis of the quality of our book, okay? So I won't bore you. I bored you endlessly over the years about that. And we've repeatedly outperformed on credit time after time after time. You specifically asked a question about the forward-looking metrics. So in there, we do have the behavioral scoring index, which we do use. This is data we pull in around about, I think it's 600 million, 700 million pieces of data we draw in from credit reference agencies on our customers every month. And that feeds through into creating a behavioral score index, which gives us some form of early lead indicator as to whether portfolios are weakening or strengthening. And again, there's nothing of note coming through on that. The other bit is now with the developments in technology, it gives us access to current account information for a lot of our customers. So the ability to -- we were historically blind to seeing customers' current accounts. But now, particularly on the SME side, it's incredibly valuable is we can go in and extract data to be able to see what's happening in terms of current account activity with our customers with their accounts in NatWest or Barclays, wherever and to be able to see where the turnover is going up this month versus last month, whether there's been any unusual payments going on, whether there's any unusual activity that's happening. And we use that to A, feed into our underwriting processes. But separately, we also use it as a monitoring tool as well. And again, there's nothing that's telling us to be concerned. We can identify individual customers' issues on that as well.

It's Shailesh Raikundlia from Liberum. I had 3 questions, if possible. Just a follow-up on the NIM side. So I mean, you're obviously highlighting the fact that base rates are going to go higher from here. So in terms of your guidance, are you sort of anticipating any further base rate rises in that? Because obviously, if the pass-through has been very low so far, I was wondering that it would probably be higher, your margin if interest rates keep on rising to where the market is expecting. So just if you could give us some guidance on that? Secondly, on -- just on the redemptions of your book. Obviously, you're highlighting that redemption rates have remained quite low, 6.7% and saying the new books or sort of new lending is about 5.9%. I see on the statement; you say that the scale of maturities are coming through quite significantly. So I was just wondering what you -- what you think would be redemptions for the second half of this year, given the fact that, obviously, you've got a very strong pipeline coming through? And thirdly, just on the IRB application. Basel 3.1, obviously, you highlighted the fact delayed till 2025. But I was just wondering, obviously, PRAs who might have its own ideas of how to implement that, if you have any ideas about how that would potentially impact you, given the fact that it's taking quite a long time to get IRB process through, do you have any sense of how the way PRA is thinking about the buy-to-let market, for example, in terms of risk-weighted assets?

Yes, simple answer to the IRB Basel 3.1 question is there's a consultation due out at the year -- towards the end of the year. The Bank of England does not provide sort of much guidance in advance of its consultation papers, unfortunately. So we're going to have to wait until we see that. We've done our own modeling. We run our Central capital forecasts. We run sensitivities around that, which would be assumptions that we make based on the European model of Basel 3.1 versus we stress that to become more unhelpful, less unhelpful. In all scenarios, our capital is more than sufficient to meet our planned requirements going forward. So there isn't any point across our internal 5-year plans where we have any cause for concern over the levels of capital. So Rich, do you want to cover the NIM question?

Yes. So explicitly within our numbers, we've seen 2 more base rate increases in this half year. But the challenge you have with the reaction to that changes, the deposit beta doesn't just happen the day after the base rate change. It could be a week or month. We could be reacting now to the last one for the next 2 or 3 weeks as well. So it's a messy environment in terms -- from that side. I think the other point there comes back to the position Nigel talked about in terms of swap rates and some of the fixed rate business. But then if you look at the fair value adjustments that you'll see that we put through, we make extensive use of hedging of our pipeline. That's all -- so that's all come through as a positive in this period. It will unwind going forward. But had we not hedged, all of that hit would have come through over the -- against NIM over the next few years. So that does help smooth the position for the pipeline for a new customer putting a new loan in today. They'll probably be getting a tighter spread against the spot than will be the case over the medium term. The mortgage rates do increase typically monthly. And so it will take some time to get that position back to equilibrium. But we also have it the other way for the last 18 months, where we were getting more than our normal -- the relationship between swap and mortgage rate. And that's embedded for the next 5 years in terms of our NIM program. So it's quite difficult to distinguish exactly which little bits that are driving which elements of NIM within the books because you've got these overall positions, both from historic fixed rates and also the administered rate books that are giving us some tailwinds at the moment. So if that helps.

Yes, yes, [indiscernible]. So split the loan book into 2, it's the legacy book and the new book. The legacy book, the last loan that was written in the legacy book was in 2008, beginning of 2008. So you can see there's like the youngest customer in that is 14 years, been with us for 14 years. So what you have is a probably an older population and also customers that are coming closer to their maturity. So it's no surprise that the old book redemption rate is slightly higher than the new book. The new book is something where we have active engagement with customers in offering additional products, additional services to them and where we see the potential for greatest levels of retention activity. We're 2.5 months into the second half of the year. We engaged with the customers quite a bit ahead of today. So we have fairly good visibility. So we're confident that actually the redemption levels that you see are going to be maintained for the rest of the year barring Chase Manhattan deciding to go into attacking redemption customers. I think -- was there any other questions from the room? Jason?

Jason Napier from UBS. Just coming back on net interest margin. I wonder whether you could talk about 2 things, please. The first is flow credit spreads in buy-to-let and the sort of rate elasticity one might expect on that as rates go higher. Clearly, not everyone thinks the Bank of England is going to 3.5%, but what your experience has been in terms of the yield that, that product can achieve in a higher rate environment. And then secondly, just looking at mix change, and that is a driver of net interest margin. Before the rate cycle became such a central conversation for investors, the well-established trend was that mix change would deliver an underlying increase in net interest margin over time. Does that change as rates go higher, given the new funding mix of the business?

Okay. So dealing with the first, I mean, this kind of builds on the -- an earlier question, which was around NIM. But the challenge is in trying to talk about spot rates and flow rates is quite difficult, given the speed with which this -- the apparent speed differences between swap rate movements and mortgage rate movements. Now if you look at the speed with which lenders generally, not us specifically, but lenders generally change their mortgage rates, it doesn't happen that often. You probably would have gone once a month, might be a bit more frequently at the moment. But it doesn't certainly keep track with swap rate movements. And part of trying to understand what the correct flow rate is, you need some stability. You need just a period of time when rates stop moving dramatically over a relatively short period of time. So to be able to be too specific on that is kind of difficult. When we are lending to customers, what we always want to do is to ensure that there is going to be sufficient rental cover to the debt service cost. And so when we look in at that, we are currently looking at an ICR of 212%, which is incredibly strong relative to the minimum sets of requirements that we have. So without any change in rental levels, there is still quite a lot of capacity to be able to absorb higher interest rates from here without there being increases in rental levels. Rentals are up 11% over the last year, not a million miles away perhaps from underlying wage inflation. And underlying wage inflation correlated to rents is a very well- and long-established trend. So you expect both of those dynamics to work. And so therefore, I think there's a lot of road still to run in terms of how far interest rates could go up relative to what the market could absorb and what the customers could absorb. Did we answer all your questions?

The mix side.

Yes, sorry, the mix side. I thought it was another one. So fundamentally, long term, the mix in our product shifts between back book, front book and different asset classes has been underpinning of around 5 to 10 basis points upward movement. Now nothing has changed in that. So our underlying sort of structural NIM movement should still be for the foreseeable future moving by 5 to 10 basis points. The macro stuff is the noise that goes on around it. So if we're done for the room, so if we can now go to the telephone lines.

[Operator Instructions] The first question is from John Cronin from Goodbody.

A few questions. One, going back to this very strong pipeline. And [indiscernible] share gains to your knowledge in market share terms over the 6-month period to 31st of March. And second is any evidence of accelerated refi activity and with the potential...

John, I don't know if you can hear us, but it's not a good line. So I don't know whether you can dial back in or perhaps post your question via the webcast?

Okay. I'll post on the webcast.

You're going to do the webcast? Yes, he's going to do the webcast. Okay. Good.

There are no further questions from the line. We've got a question here from the web. So we've got a few here from James Invine at Societe Generale. So we give you the first part. You've touched on some of these, but I'll go through it again. In recent years, the yield on your new mortgages has been around 4%. Could you please update us on this number now that the 5-year swap rates are around 2.8%?

Okay. So it's the same problem of looking at the swap rate, which moved 80 basis points in 3 weeks and compare it with a mortgage rate. So it's actually not helpful to be able to compare one with the other. You need -- this has got a very much a lag to be -- that's needed to be able to see what the correct mortgage rate should be relative to that swap rate.

Okay. And then James has got a sort of second series questions, clearly. It's around HMOs. Could you tell us what portion of your book are HMO properties? Is it fair to see that nearly all of the HMO landlords pay their utility bills for their properties? And have you assessed how well the landlords will be able to cope with the significant increase here?

Yes. So it's about 15% HMOs, 15% of new business. And one of the things HMOs typically have a significantly higher rental yield relative to the average rental yield. Therefore, they'll have a significantly higher ICR relative to the debt service costs. And therefore, they have quite a lot more capacity to absorb inflationary costs in whatever shape or size. And quite often, HMOs, as their name gives a clue to have multiple tenants. And so if any one individual tenant has a pressure point, then they've got a diversification of income streams as well. So we're big fans of the HMO market. We think it's a very strong, stable market, tends to be found more in sort of city locations, but we are big fans of that sector. We're very strong -- it's a very strong part of our business. We're very supportive of it.

Okay. That's all the questions from James. Unfortunately, John's question hasn't come through yet. So I don't know if we want to follow up with him later.

Yes. Well, maybe we'll pick the phone up to John and have a chat with him. So I think that's it for the day. So thank you. It's been great to see you, great to be able to at last shake hands again and to also be able to sort of exchange. It's much better doing it this way every time. But as you know, we're very happy to have further conversations. Richard and I are going to be around for a little while to come here. Richard has earmarked this afternoon and all day tomorrow to have conversations with you. So if you've got questions, you want to pose any, hopefully, very difficult ones for Richard. And then we'll be able to sort of help you with your models over the coming days. So thank you very much. As I said, absolute pleasure to see you. Thank you.