Vanquis Banking Group plc (VANQ) Earnings Call Transcript & Summary

Good morning, everybody. And thank you for dialing into our 2020 interim results. I'm Malcolm Le May. And it's been a half-year that no one expected. And I believe that Provident Financial has reacted to circumstances extremely well. We have delivered for our shareholders and customers whilst looking after our colleagues. All things considered, I believe our financial and operational performance has been both resilient and strong. We have continued to make progress in transforming the Group. We have navigated an evolving regulatory environment for the sector and updating our part in helping shape the agenda. And we have delivered on some of the strategic initiatives we set out in our Capital Markets Day last November. As we said at the Capital Markets Day, our aim is to establish Provident as the leading provider of responsible credit to the underserved, producing attractive and sustainable return for shareholders. This goal has not changed and now is even more important than ever for our customers. Its importance is increasingly recognized by the government and the regulators, nor indeed has the strategy that we set out at the Capital Markets Day changed to achieve our aim. In relation to today's presentation, Neeraj will be presenting the interim numbers, and I'll be reporting on the operational progress and financial highlights. Then I'll talk a little bit about our strategy and outlook before hosting questions and answers. As Neeraj joined us during the lockdown, no one has really had the chance to meet him yet properly, but hopefully, we can address this during the interim roadshows. I'm delighted that he is on our team. Turning to Slide 3 now. And when I last spoke to you at the prelims in late February, COVID-19 had just arrived in the U.K., but no one quite knew what was going to happen next. Throughout March, we ramped up our planning for potential outcomes, which put us in a good position to help our customers and look after our colleagues when the lockdown actually kicked off. Our focus throughout this phase was to manage what we could control. We cannot control the macroeconomic environment, but we could ensure our customers, colleagues and our balance sheet, we're prepared for the upcoming pandemic challenges. In relation to customers, we made the decision to keep lending responsibly to them, where we did obviously tighten underwriting as you would expect. We implemented customer payment holidays. For some, ahead of the FCA guidance. For colleagues, we moved to remote working prior to the lockdown. There are some of our colleagues qualify as key workers. They, therefore, have been working from our offices, helping our customers throughout the pandemic. We also rolled out well-being support for our colleagues and ensured that everyone working from home has the right equipment to work efficiently and comfortably. Turning to capital and liquidity, having a banking license in the Group was a significant advantage when improving our capital and liquidity position. Many in our sector have struggled to access capital, the banking license has made it considerably easier for us and we now have a very strong CET1 ratio of 35.4%, with liquidity of about GBP 1.2 billion. During this period, we also had Vanquis' VREQ removed, and we successfully tendered GBP 75 million of senior bonds in a capital and PL efficient way. We also renegotiated an interest covenant waiver for our Revolving Credit Facility. We also, as you know, withheld last year's dividends, and all of these actions helped make us more financially robust. Now the outcomes of all these actions that we performed much better than we modeled in March. But even though our financial performance was resilient, as you can see, we reported a Group adjusted loss of some GBP 32.6 million. Now a loss is a loss. And clearly, we would like it not to be. But I think it is also fair to point out that during this period, both Vanquis Bank and Moneybarn were profitable. Our social purpose, as you've heard me say before, is to help put people on the path to a better everyday life. Now this doesn't only equate to customers and colleagues, but in our view, to helping the wider society in general. Therefore, we believe as we have performed so robustly in the first half, we've decided to repay all further support we received back to the government because we just feel it's the right thing to do. Now I hope you find this new slide useful and interesting. It sets out products we're in, the size of the market, our current loan book, the customer numbers in the market and the cost of risk revenue yield, et cetera. It shows in a snapshot that in addition to the robust balance sheet and liquidity we have, we hold a dominant market position in the sub-prime space, which in and of itself is very underbanked. Now as the slide clearly shows, putting COVID-19 to one side, all of our divisions have the opportunity to grow their loan books and customer numbers. It also shows, not surprisingly, that COVID-19 has negatively impacted the loan book and customer number growth in the first half, except, of course, in Moneybarn where there is an interesting trend development. Therefore, when the pandemic ends and our loan book returns to growth, the metrics of revenue yield impairment, et cetera, will start improving. They will be moving in the right direction, which is clearly very positive for long-term, sustainable shareholder returns. Numbers on the slide can sometimes look a bit stark and not always tell the whole story. And in this case, I do feel all divisions have performed resiliently so far during the pandemic. Importantly, even though lending and collection volumes dropped significantly when the lockdown started, they have improved steadily month-on-month through April, trending, continuing into July and in what we can see so far in August. This is clearly positive for our customers, Provident and also the U.K. economy. The next 3 slides focus on how the divisions, Vanquis, Moneybarn and Consumer Credit Division, responded to the operational challenges of lockdown, helped their customers and our colleagues and also delivered on our social purpose. There is a lot of data on these slides, but I don't plan to call out each point, but I will flag some of the key logs. Turning to Vanquis Bank first on Slide 5. Call center colleagues were able to work remotely from day 1, now 80% do. And customers always could talk to someone if they wanted to. This is no mean operational feat when you have well over 1.5 million customers and the pandemic has arrived, and an operational call center had over 1,000 people prior to lockdown. Also with its customer champion hat on, the bank did not apply any credit line increases to its customers as a result of COVID-19. New customer acquisition of the bank was down at GBP 147,000 versus GBP 190,000 for the equivalent period in 2019. A good performance as there was absolutely no activity at the start of lockdown, and customer spend was down some 40% year-on-year in April. So by the end of July, it was back down to only 50%, lower than the prior year. The bank has also now restarted its phase reintroduction of credit line increases. Just like the other divisions, the bank also implemented the brand-new payment holiday procedures for customers, and they did this over a very short period of time. Take-up of payment holdings when introduced was around 3% of customers. But by the end of July, it was down to about 1%. This was much lower than our initial estimates. And despite the FCA extending the payment holiday, we continue to see a declining trend about to. Importantly, as the first phase of payment holidays roll off, we're seeing a greater-than-anticipated percentage of customers returning to normal payment patterns. Slide 6, Moneybarn made payment holidays available to its customers marginally before the FCA recommended it. And it remains open for new business from day-1 in a market where a number of the competitors were closed for business. This was very well received from customers and brokers alike, and put Moneybarn in a strong position when the lockdown began to ease, enabling it to increase its market share. As flagged earlier, Moneybarn's loan book grew in the first half to some GBP 529 million, and so did its customers' numbers. Also in July, Moneybarn had a record month for new car loans at around 4,500 in the month, with about 40% of the new car loans going to customers who we would classify as key workers. So at present, it does not appear that car -- it does appear that car demand has increased in our market, driven potentially by the desire to be able to use -- not to use public transport and to get to and from work. Payment holidays in Moneybarn were high and peaked at around 23,000 or some 27% of the workforce when first introduced. And I don't think that's surprising when you think it's probably the largest monthly outgoing for our customers. But just like Vanquis, as lockdown eased and the economy appears to be slowly improving, the take-up has dropped. And now only about 3.5% of customers are on payment holidays, and that's as of the end of July. Like Vanquis, Moneybarn customers rolling off payment holidays have exhibited similar characteristics with the majority returning to normal payment patents. Equally, the uptake of new payment holidays has been at a fraction of the initial rate. Turning to Slide 7. The consumer credit division was on track to break even before COVID-19, but now, perhaps, unsurprisingly, that has been delayed. With the onset of the pandemic, CCD has completely revolutionized its operating model as its customer engagement managers, we call them CEMs, could no longer go and visit customers. CCD's response to this problem among other responses was to roll out Provident Direct, its digital collection customer model, which was completed in just 2 weeks and embraced by customers and CEMs alike. For those customers who couldn't pay remotely, we provided the autopay cards, which so they could pay through, through the post office. Through this new customer servicing model, we were very successful. And by July, collections were running at some 90-plus percent of pre-COVID levels. And lending also has been reestablished, and we're lending to levels of -- with existing customers of circa 90% of pre-COVID-19 levels. And we were lending perhaps interestingly to new customers, and that's a definition of customers we haven't lent to in previous 6 months at or around 40%. It's probably fair to point out that lending to customers was temporarily suspended when lockdown started in line to our stricter approach to underwriting. Other changes that CCD made in the first half while we were introducing the 78-week and 104-week lending products and reducing its cost base, have, I believe, put the division in a strong position for the second half. That said, the impact of lockdown could not be avoided by the division and Satsuma was temporarily closed for new business, although they're lending for new business lending, although their collections remained robust. Also in relation to high cost short-term credit, we'll need to see what the FCA expects us to do differently following their recent paper. And once we understand that change, we'll adapt our model accordingly. The CCD forbearance is built into the product and roughly only 2.7% of customers took the benefit of payment holidays as of the end of July. So to conclude, CCD has been collecting very well in the pandemic, and has adapted well to the issue of new loans to existing and new customers. However, in this traditionally lower period of the year of loan issuance, we have seen the book shrink. Despite this, the changes we have made and the -- I believe the business is well placed for the traditional busy runoff to the Christmas period. So moving to Slide 8, to some of our half year performance, I think we have performed better than we expected when the lockdown happened in March. This is because I believe we took quick actions, we managed the factors that we could control, and we focused on our customers and our colleagues and ensured we have the strongest possible capital and funding entering into the pandemic. We also implemented payment holidays successfully and have done a good job managing their runoff, and the demand for their extension so far has been low. So in my view, we've managed the knowns and positioned ourselves well for the second half of the year. It is though the macroeconomic environment which we cannot control, which perhaps concerns us. We don't have a crystal ball and therefore we do not know what will happen to unemployment or the economy when furloughing ends. Therefore, though we are well positioned business-wise for the second half, we are cautious with the Group's outlook for the second half and the first half of next year due to the macroeconomic environment. So I'll now hand over to Neeraj, our new CFO, who, as I mentioned earlier, joined us during lockdown from Secure Trust Bank. He'll run you through our interim numbers before I wrap up with strategy and outlook, and then we'll take some questions and answers. Neeraj, over to you.

Thank you, Malcolm. I'll take you to Slide 10. So as you've already heard, we go into H2 this year with very strong capital and liquidity positions. A 35.4% CET1 ratio with GBP 215 million of surplus capital, and GBP 1.2 billion of liquidity with more than GBP 1 billion of [indiscernible]. This also shows the ability of Vanquis to raise deposits during the crisis, which is also very important and is very effective. The deposits were all priced below 200 basis points. Malcolm and I have driven these metrics from the beginning of the crisis to create optionality, both from a defensive perspective during COVID-19 as well as in a growth scenario, which we all hope will come sooner rather than later. Our objectives as set out at our Capital Markets Day last year are still as relevant to us as they were then, albeit now delayed. Receivables growth will drive IFRS 9 investment as will the improvements to the customers' digital experience, which can be supported by scalable and resilient backdrop resistance. Together with my treasury team, I'll be growing towards an optimized capital staff as well as a more efficient and diverse funding structure for the Group. During this crisis, customers have shown an incredible drive to protect their credit and where possible, reduce their debt burden. The IFRS 9 impairment charge in H1 has therefore predominantly been driven by the very material deterioration in the macroeconomic outlook. We have also taken steps to tighten credit acceptance criteria significantly, which I'll come on to later. I'll now turn to Slide 11. As you can see in this Group results summary slide, Vanquis and Moneybarn remain profitable even after the significant increase in IFRS 9 provision, which is mainly due to macro output deterioration. Our CCD disposition has been hit by the lack of new business during lockdown and the resultant impact on its receivables, which by then made to our short maturity. This will inevitably delay the path to CCD's profitability. However, the macro outlook is to be believed and taken with the tightening of credit criteria by the big banks, the number of customers looking at our type of products is sure to increase significantly. At the same time, we are seeing significant weaknesses in the business models of our competitive base during this time. The diversity of funding within our Group and the capital strength stand in strong contrast to help our customers achieve that rate every day long. I'll turn to Slide 12, which gives you a divisional snapshot. What I would like to point out on this slide is that the most significant change in Bankers and Moneybarn from H1 '19 to this year is the impact of the macro outlook on impairments. Utilization of credit cards issued to customers was hit significantly during the lockdown, and not surprisingly. Moneybarn, which has actually been able to increase its receivables during H1 this year by remaining open during lockdown, allowing those 3 workers that were looking to buy used cars to go to work, has been a great example of our business model, helping our customers to achieve a better everyday life. Our Provident business was nearly entirely impacted by the fast runoff of receivables with no new business during lockdown. New business levels are now returning to pre-COVID levels. Slide 13 sets out the key performance indicators, and these are some of those that we use within the group to both understand and drive performance across our businesses. Cost of risk has increased unsurprisingly, as I've already mentioned. There will be a stronger focus on return on required equity going forward as well as net interest margin and risk-adjusted net interest margin. The capital liquidity metric confirm the points we made on capacity and preparedness. Slide 14, which is interesting to see on this slide that the pre-impairment profit is only 15% down with net interest margin down by only 12%. This tells us that building receivables under type underwriting criteria, and improvements in the macro outlook over the medium-term will return profit levels back to those that were pre-COVID. The investment over the next 3 years in our businesses, digital customer offering, will help improve efficiency of delivery as well as reduce operational risk as the business scales up in a post-COVID environment. This will drive returns as more customers are helped in improving their everyday lives. Slide 15 is an interesting slide and talks about the spend behavior of our Vanquis customers. You'll see here that the initial fall in Vanquis customer spend has driven significantly by -- in the holiday and recreation activities, clearly unsurprising. It is interesting to see that in -- retail spending by customers doesn't seem to have changed much. At a more detailed level, we saw that the high street spending that dropped significantly, was replaced by a near equal and opposite increase of DIY spend. Unsurprisingly, spend on food increased, spend levels are beginning to return back to their pre-COVID levels generally. Slide 16. Moneybarn has seen the fastest recovery to pre-COVID levels of all our businesses, and our new business and collections are doing very well. This is after a significant tightening of credit acceptance criteria, which has led to new business quality being more near-prime in nature. It's also interesting to note that used car parties have held up well since the crisis started. Moneybarn is the only HP finance provider with the security of the car and an amortizing loan profile over an average period of more than 3 years. So whilst Moneybarn has no direct impact from car values, as is the case with PCP providers, and Moneybarn does have exposure on used car pricing in case if we possess cars whose loss given default. CCD business has benefited from accelerated introduction of Provident Direct and collections method that was introduced UK-wide and CCD loans are relatively short in duration, therefore suffer runoff more quickly than our other businesses, especially as was in the case of lockdown, where customers are both unable to take new loans nor have as much need for spending on important items. CCD's new business is seasonal and the most significant time of the year for new business flow is pre-Christmas. Quarter forward all its uncertainties will be an even more important period for CCD this year. Slide 17 looks at the impact of payment holidays on our businesses. It's interesting to see the low take-up of payment holidays in Vanquis, only peaking at 3.5%, and now below 1.2%. Our customers do receive a credit card as an important credit facility in their day-to-day lives. 23% of customers taking a payment holiday ended up in another formal forbearance after the holiday period ended. We will continue to monitor future applications for payment holidays, which, in theory, can be made up to the end of October this year. But under the -- looking at the current levels of taking up, this remains particularly low. Slide 18 looks at the paid holidays that's taken up in Moneybarn. They saw a much more material take-up of payments than Vanquis. This is partly due to that -- this option was offered by Moneybarn very actively. This was important since our Moneybarn customers are in the most not homeowners, and therefore, a car finance payment is the largest one of loan cost per month per FX. Nearly all will also need their car for going to work. Interestingly, 24% of those taking holidays have moved into another form of forbearance after holiday ended, so similar to bankers. Slide 19 evidences the material reduction in new business risks that I talked about earlier. And it shows the picture both in terms of intensity and in terms of volume. So I expect -- it's not unexpected to see that the tightening has also led to reduction in new bookings for the month. Slide 20 looks at the same metrics, but for Moneybarn and the risk reduction in new business in quarter 2 is also well evident by Moneybarn and has also led to improving volumes due to the move towards more near-prime lending, which is a deeper pool than the sub-prime lending. And this demonstrates a very strong relationship with introducers, which has strengthened during the lockdown through the fact that Moneybarn remained open to business where many did not. Slide 20 -- sorry, Slide 21 shows our robust coverage ratios. These remain robust and improved from 2019. As you all know, prime lenders, such as the high street banks hold significantly low coverage levels of impairment provisions, usually measured in low single-digit percentages. Examples of this are Barclays coverage in H1 2019, although principal 1.8% has now increased to 2.5%, an increase of maybe 1.5x. Lloyd's nearly doubled their coverage to 1.4% of receivables. Islamic lenders are also much more highly leveraged on their capital due to the low CRWA when they're predominantly consumer mortgage loan groups, which also helped us slim net interest margins. They all generally benefit from the implicit government guarantee that their systemic importance demands. Income trust, our business model delivers high net interest margins at very high end coverage with low levels of capital leverage. Slide 22. This shows the slide -- this shows the impact of COVID-19 and the macroeconomic outlook on our business and our businesses. On Slide 23, that goes on to look at the effect on our ECLs. This slide is quite important. The waterfall of the ECL shows the result is that we near GBP 1 billion ECL within our balance sheet for impairments. We've taken a prudent and cautious view when assessing the outlook by employment in the U.K. with a peak severe unemployment level in 2021 of 14.1%. This compares with others at very much the top end of forecast for unemployment. If we were to use the 14.1% as a 100% weighted scenario, the additional impairment charge that we would have to provide for, in addition to the GBP 73 million that you can see on the left-hand side would be an additional GBP 95 million. So whilst this is a theoretical number, it also shows the fact that within our GBP 215 million excess capital that this is easy accommodated. Slide 24, on receivables, really confirms the messages that we've been talking about earlier on this call. And the reason for the receivables is clearly down to the lockdown and obviously, the fact that we remained very open during the lockdown for Moneybarn. Slide 25 provides a waterfall for our CET1 from the end of 2019. Again, unsurprisingly, you can see the impact of the post-tax loss as well as the dividends canceled. While IFRS 9 transition amortisation continues and leaves us with GBP 705 million of CET1, which equates to 35.4% of the CET1 ratio with GBP 215 million of excess, which is a very strong position for any bank of our sort or nature. Slide 26. This restarts talking about something that I'm very keen on, which is not just the strength of our CET1 ratio, but also exploring the optimization of our capital stack. And the improvement of the Group return on equity through the use of Tier 2 capital, for example, and then maybe potential APIs as an alternative to CET1 only. It's interesting to note also that our CET capacity currently is around GBP 125 million in over and above our CET1. And therefore, in addition to our GBP 250 million additional capital that we have not been deploying the receivings as yet. So the growth that we could achieve with the additional forms of debt acting would be very attractive too. Slide 27 is really about the focus on our balance sheet and how we manage liquidity. The slide shows that in quarter 2, quarter 3, improvement in both the cost and the undrawn capacity of the Group's nonconsumer deposit funding has increased quite significantly. The removal of the VREQ that Malcolm mentioned earlier in quarter 3 has been instrumental in improving both the cost and diversity of funding in the Group. We will continue to optimize both cost and diversity of funding with continued close and positive cooperation with our regulators. This will help deliver a better value to our customers of a continued journey to invest to a much better everyday life. I'd like to hand back to Malcolm.

Neeraj. I hope those of you listening found those -- that financial update interesting coming forward to. Turning to Slide 29. And you can see here our purpose and culture, which I implemented in 2019, which we've embedded, and you've obviously heard me discuss before. And this is central to what we want to achieve here at Provident, how we want to operate and indeed, why we need to exist. I believe it's really proven its worth this year and creates a business advantage for us as a group. In my view, our purpose is now beginning to resonate just as strongly externally as it is internally. As regulators and government worked out how to respond to the pandemic, various consultative forums were created to help the financial services sector steer a path through it. I was asked to join the Consumer Finance Forum, which is chaired by John Glen, the Economic Secretary to the Treasury, and also the FCA and U.K. Finance CEO roundtable, chaired by Christopher Gillespie, who is the interim FCA CEO representing Provident and the sector. But I think 2 years ago, we wouldn't have had a seat at that table. So I think that shows the progress that both we and exceptions of our sector is making. Our involvement here shows that the government and the regulators feel our customers are important. I think this shows that they feel we may have changed. And it does give us a seat at the top table to fight for our customers in the sector break through the pandemic and beyond. And I think this is going to be very important if we're going to help our customers going forward. As shown earlier on Slide 4 and here again now, Provident's biggest opportunity is the sheer size of the sub-prime market in the U.K. As I said before, this is a market with approximately 10 million to 12 million adults at present, which is about 1 in 5 of the working population, with about 1.5 million to 2 million customers moving in and out each year. I take no pleasure in this statement because no one ever wanted a pandemic, but our market will grow because of it. So the opportunity for growth at Provident will increase. Also, what is becoming clearer as the pandemic progresses, is that funding is being held back or withdrawn from the sector. Going forward, it's likely that demand for responsible lending in our market will grow just as supply is reducing. Not a great public policy outcome and more helpful for our customers. The size of growth in the market due to the pandemic is obviously going to be difficult to quantify. But that said, the new customers will have the same characteristics and traits as the old as highlighted on the right-hand side of this slide. And they'll need specialist partners such as Provident to deliver them the tailored products and services that they want. Provident is the leading specialist credit provider for these customers and if we did not exist, alternative options for these customers would be severely limited. Slide 31 sets out our vision for the future underpinned by a number of growth and efficiency initiatives. The slide was first presented at the Capital Markets Day, and this shows the progress that we are making. Vanquis Bank is relaunching their loan proposition next year, expanding its white label partnerships and developing a self-employed proposition, all of which will deliver growth. Moneybarn is focused on core market growth, expansion of distribution through lead generators and moving further into towards the near-prime market, all again -- all of which, again, will deliver growth. CCD's key growth initiative this year was the successful rollout of Provident Direct for home credit, and this hybrid product has been a great success and implemented faster than we anticipated. And we'll take -- take-up will be significantly above forecast following its rapid rollout in the earlier part of the second quarter. This take-up has an effect digitalized the home credit collections operations with remote collections reaching in excess of 90% in April and May. Turning to Group. As you know, our medium-term aim is to create a bank for the underserved. This has not changed, but our focus is now on achieving cost and capital efficiencies, as shown in the Moneybarn securitization and the successful foundry tender. Therefore, ensuring that we have a balance sheet to take us through the pandemic, allows us to support our customers through responsible lending and also to fund future business growth. Finally, Slide 32. Provident, in my view, has performed robustly during the first half of the year and demonstrated its resilience. In fact, we have performed better than we modeled when the COVID-19 epidemic has struck. This -- the key to this performance was down to the decision that we made right at the onset that we would manage what we could control. And consequently, our focus was on customers and colleagues and ensuring that we have the strongest possible capital and funding position going into the pandemic and the unknowns that it was to present. Turning to our focus for the second half of the year and next, we will need to rebuild and grow our receivables books and invest in our digital offering to ensure that we have the best digital customer journeys in place. We are in a good position as we enter the second half of the year. The business has been tested. Our strategy has stood up, and we are delivering on our Capital Market Day promises. Our capital and funding is very strong. And our customer base is more resilient than most and exhibit some degree of countercyclicality. That all being said, we need to remain cautious about what may happen in the second half of the year as the macro environment is still very uncertain. As you can see on the slide, the key variables will be a deterioration in the U.K. economy, withdrawal of furlough and probably a rise in unemployment. We cannot predict the short term, but in my view, we are well positioned for the medium and longer term. We are the largest provider in the sub-prime market. We hold a dominant market position in credit cards, car finance and home credit. The prime -- sub-prime market will also grow because of the pandemic, and it looks like the supply of credit into the market is reducing. In my view, we have the strategy, the capital strength and funding, market position, product distribution and management team and culture to grow Provident and to create the bank we underserved. At the same time, delivering attractive long-term sustainable returns for our investors over the medium to longer term. Thank you for listening. We'll now take questions, which will be coordinated by Jess, our moderator. Could you please -- if you want to ask a questions, state your name and the firm and then Neeraj and I will do our best to answer them. Thanks.

[Operator Instructions] The first question comes from the line of Gurjit Kambo from JPMorgan.

I have 3 questions. The first question is within home credit, clearly, you've been able to remote lend and remote collect, is there a view that maybe this can transition to the model of the future? And do you need to really return to a home-based model given that it's working? And just linked to that, I guess, in terms of the reduction in the 10s by 300 people. Is that sort of linked to potentially how you're looking at the model going forward? So that's the first question. The second one is just in terms of GBP 74 million impairment that you said that you've taken related to sort of COVID-19 and the macro outlook. Just to be clear, is that based on like the base case scenario on Slide 23 for unemployment? Or is that based on a combination of sort of downside and more severe? And then the final one is, is there any -- can you give us any indication of sort of what percentage or what number of your customers have been furloughed during the last few months?

Right. Three very good questions. I will answer the first one, and Neeraj can answer the second, and I'll come back on the third. Yes, in terms of home credit, has there changes that we've been forced to make changed in any way the model to the future? I think lending to this segment of society will always require an element of face-to-face contact, both for origination and in some cases, collection. So while I think that Provident Direct will probably be more as a percentage -- as more significant part of the business than perhaps we might have thought when we first were planning to roll it out at the beginning of this year, I still think that there will need to be an element of face-to-face contact for 2 very good reasons. One is that a number of our customers want it. At this end of the social spectrum, there is element to people actually liking to have a face-to-face contact with people. It doesn't apply to all of our customers in loan credit, but it does apply to a number of them. And secondly, when customers do fall on difficult times, and payments are not coming through remotely, you will need to have a face-to-face interface with them. So I think that we will undoubtedly be seeing a greater percentage of, if you like, digitalization featuring in the model going forward. But equally, I think you won't get rid of the face-to-face contact altogether. And in answering your second question about the resizing of the CEMs, in part, it is making sure that we have -- we're operating as efficiently as we can do. But also, it does reflect the fact that there has been an element of greater digitalization on the collections side of them. So I think that's an answer to the first question. Neeraj, do you want to answer the question on the GBP 74 million impairment and whether or not it's in the base case and how that works?

Yes. Sure. What you'll see in the -- in their accounts is a table and the macroeconomic provisions, which shows that the weightings that are given to the base upside, downside and the severe downside. So the base case is weighted at 50% upside at 10% downside at 35% and severe downside at 40%. Taking those weightings and applying them to the unemployment macro indicators we come up with, that is how you get the GBP 74 million. And the other point that I made was if you take the 14.1% peak unemployment for 2021 and use that theoretically as a 100% scenario, that GBP 74 million that we've included would be increased by further GBP 95 million in the very worst case.

And then in answering to the question about what percentage of customers have been furloughed, we don't have any accurate statistics on that because, obviously, as long as customers are paying normally, whether it's in terms of their monthly repayments on the credit card or repaying their loans in Vanquis -- sorry, Moneybarn or indeed in the CCD, we wouldn't know whether they had or hadn't been furloughed. I think it's reasonable to assume a significant percentage of them have been furloughed. The only related stat I can give you is that we've done a very small survey of customers in Vanquis relatively recently to ask them if they or anyone in their family have become unemployed as a result of the pandemic. And that was running at around 4%, and I think it was running -- the last test was 7%. But that was a very small sample. So I'm not sure you can extrapolate that. And clearly, the other area, of course, is payment holidays. We've given you the stats on that. I think this is something that we will see more later in the year in terms of getting some more data on that.

The next question comes from the line of John Cronin from Goodbody.

And the first one, if I could come back to the substantial deposit build. And I guess, I'm thinking there in terms of that excess liquidity deployment and more particularly around your previously-expressed ambitions to potentially bring Moneybarn into the ring since. Does that early build and deposit balances position you in a better context for that conversation with the regulator? And if there was anything further to say on that at this point, whether it be in relation to timing or expectations more broadly? That would be helpful. My second question is just to pick up further on the provisioning point. Can you give us a feel for the granularity in an internal modeling context. And I guess, what I'm referring to particularly is I appreciate you've gone with a pretty harsh unemployment assumption relative to consensus like economist forecast as I see the Middle East. Most relevant, clearly, in the case of Vanquis and Moneybarn, but I would like to understand a little bit better in terms of how your model has coped with the very particular impact that COVID-19 is having on certain sectors of the economy and how that's enshrined in your modeling in relation to the disaffected customers in the service industry to which there may be a bias and so on. So to just get some comfort or color, rather, on that point in relation to your modeling confidence in your provisioning as a result? And then finally, if I could invite you to make some comments on the competitive landscape and how that has been evolving, particularly since the onset of the pandemic? And that might in time, crystallize possible M&A prospects or even substantive organic business build separate to what you're seeing as customers trickle into the sub-prime sector more broadly, that would be appreciated?

So I will -- I'll answer the questions 1 and 3, and I'll let Neeraj talk about the provisioning. I mean, yes, we are in extremely liquid position. We've also said our longer-term objective is to build a bank for the underserved. And clearly, having the ability to utilize retail deposits to fund other business -- other appropriate businesses within the Group is something that's on our agenda. Obviously, this is a journey, which we have to go down, we hope the PRA and others. And it is clear that there would be an interesting economic advantage of funding Moneybarn, utilizing other forms of capital and the traditional route which we've used, which you know is a revolving credit facility in third-party external bonds. In fact, you've already seen us at the start of this year starting with the securitization program there for the forward flow business. That's something we will continue. As indeed, we will look at utilizing, if we can, retail deposits to fund that loan book going forward. It's not something, John, that will happen overnight. It's something that we will require extensive discussions with the PRA. But clearly, in terms of the medium term, it's something we've got to look at properly. And with their consent, I would like to explore it further. It's really been put on hold from a discussion in the last few months simply because of the circumstances that we're facing. I will -- and I'll let Neeraj answer the question on provisioning and the granularity around that, and then I'll come back with some comments on the competitive landscape. Neeraj. Are you there?

John, yes. Just on the modeling. So the granularity obviously goes down to customer level and then goes into the actual loan itself. The way that we model is very much predicated on the probability of default, and that probability of default has been affected quite materially by the macroeconomic indicators that we've used. And as you say, they are -- seem to be more prudent than the average. In terms of how we look at each and every customer, that is something which would be ultimately more difficult to actually assess whether we think somebody in a particular industry is more likely to default or not. Because as long as they are paying, then it's difficult to start increasing that default level without seeing any evidence of that likelihood of default. So we're relying on the macro, and that's why we've taken a more prudent view of the macro to give us that buffer, if you like, against those kind of movements in the economy. We do find that, certainly, if you look at our CCD business, it isn't correlated to macroeconomic indicators. I think it's very much driven by collections activity. And the number that pay on time versus those that don't. So that continues, and we monitor that very, very closely to understand our impairment levels.

Okay. So that's the question on provisioning. In terms of the competitive landscape and how that may evolve. I mean, I think the first and foremost -- first point to make is, as I said in my comments earlier, this is a very large sector numerically by number of customers, 10 million to 12 million people. And in fact, current pandemic is likely to, certainly, in the short term, expand that. And we are -- so there's a need for credit for that segment of the community. And actually, particularly, I think, as we go further into the economic problems that this pandemic is causing, I think one of the great advantages we have relative to our competition is that we are financially robust, and that is in no small part because we have got a bank within our group. And I think we've also got the ability to access both through that and also our broader financial position, different sources of capital to fund growth. It's not for me to comment on the position of average in the sector. But I think, certainly, at the high cost, short-term credit end of the sector, some of the other listed companies have issued RNS announcements saying -- outlining some of the challenges they face. We've obviously been seeing that in the home collected credit end of the market, the guarantor loans market where there are 2 principal players, and one of whom has been attracting a lot of publicity about its circumstances. But equally, none of them really have the financial robustness that we think to have. Equally, on the credit card side of business, you know the -- there aren't really other than at the near-prime end of the market where you can argue with that CapOne and maybe Barclays have got a product, there aren't anybody really other than NewDay who is competing against this, and they're funded again differently. They're dependent on the securitization markets. The government hasn't given any particular access to capital to these chaps. And so I think that is one of the things that is constraining their growth on my personal belief. I don't know the details. But I think what I feel is that we are in a position to grow organically because of that opportunity. And certainly, at the moment, you look at the challenges we've outlined during this call that we still face in the back half of this year and possibly in the first quarter of next year, I think we've got plenty to keep ourselves occupied with without getting excited about M&A. So we'll just have to see how things evolve during the course of the next 9 to 12 months in that regard.

The next question comes from the line of Gary Greenwood from Shore Capital.

I've got 3 questions, please. So is this -- Yes, yes. I think it's the analyst done thing that you've got to ask 3 questions. So I'll ask 3 anyway. So the first one was just on the VREQ. So good to see the restriction was lifted there. Maybe it's useful if you reminded us exactly what the sort of restriction entailed? And therefore, as a result of that being lifted, what the increased flexibility that you've got within the Group is now? And then secondly, on IFRS 9 and the capital position. So obviously, the capital position has improved a lot in the first half of the year. I'm guessing that sort of the end of June core Tier 1 ratio is probably a peak if loan growth picks up in the second half of the year. And also and I would expect from IFRS 9 transitional relief runoff. So obviously, there's a mechanical runoff there, but I presume there's also some runoff as defaults come through. So if you could just give us some color on how you see that core Tier 1 ratio evolving going forward? And then last one, just a question on Slide 21. Just looking at provision coverage, the coverage ratio is relative to the first half of last year have gone up at Vanquis and CCD, but it's come down at Moneybarn even though it's up on the position at the end of the year. So I'm just trying to understand why the movement versus the first half of last year?

Okay. I'll answer the first one and then Neeraj can answer the second 2 questions. The VREQ was put in place in late 2016. And you'll recall back at that time, we were under an investigation from the FCA, and there was uncertainty about the change of model in CCD, which was turned out to be project accelerated, which, obviously, as we all know, didn't go well and led to the difficulties later in 2017. It required us to get consent from the PRA for any capital or other distributions from the bank to the broader part of the Group. So it effectively ring-fenced the bank from the Group. The lifting, I think, is -- and you have to check with the PRA, the lifting is indicative of, I think, a belief that from a governance perspective, the group is being well governed. And therefore, whilst we would always still consult with the PRA, we have that much more flexibility to move funds around within the group. And I guess that's evidenced by having -- have to be lifted, the fact that we -- it could taken into company loan, some GBP 75 million, funded by our retail deposits, and basically use that to redeem GBP 75 million of the bonds. Now that -- to put that into context, we were able to buy those bonds at a discount, as Neeraj said. So there is a capital, small capital gain doing that. But more importantly, going forward, it meant the effective interest on those -- on that form of funding was reduced from 8.25% down to about 1.7%, I think it is. So there's a clear economic gain. I mean, to the extent that we use the fact that we have got the bank in the Group going forward is something that we'll always do in consultation with the PRA, clearly. But I've already sort of talked about how that may have ramifications for how we fund Moneybarn in the future. I think it also -- it's just good business management to use it. And -- but I think under the rules, Neeraj can comment on this, that you have a large lending limit that any bank has, and that can lend up to 25% of its capital to any single entity. And that's something that having the bank in the Group to the extent that we can do that in collaboration with the PRA, we should utilize going forward when we can. So that's the VREQ question. Neeraj, do you want to tackle the question on IFRS 9 and also the one on coverage on Slide 21.

Sure. Thanks Gary for your questions. IFRS 9 and capital, I think that's a very good point. I think our view is that the IFRS 9 charge gain falls, and therefore, the impact on capital will come from growth, hopefully, as we move back to the balance sheet that we had before the COVID crisis started. And depending on the rapidity of that return will depend -- will determine the amount of IFRS 9 charge that we'll have to take. And clearly, as you all have seen in other settings that the rate of that -- the speed of that increasing receivables determines the amount of charge, and therefore, the steeper that curve, the more charge that will take and that kind of is the story of IFRS 9, as you see it. In terms of the economic outlook, as we said, we've upfront taken the impact for the book that we have today. And whilst that is a raised unemployment macroeconomic forecast level, that will then impact the new business as well at that level as we grow our books until the macroeconomic indicators, hopefully, come to -- come downwards in terms of size of unemployment. If they were to increase, which is, obviously, a possibility, then clearly, we would have to satisfy more IFRS 9 for that current. Does that answer your question, Gary?

Yes, it was more just around sort of how the core Tier 1 ratio will evolve from here as well because this is quite of an IFRS 9 transition in the range of -- so I presume as the balance sheet grows and the transitional relief rolls up, then the core Tier 1 ratio comes down. But just in terms of how -- sort of trend really in terms of how that comes down?

Yes. And I think there is 2 parts to that as well is that, as you quite rightly say, CET1 ratio will start coming downwards from its 35.4% because it's very high on that basis. However, if we start seeing the reverse of that, which is the receivables don't grow or will even decline, which is obviously not something that we would hope would happen or expect. But if that were to happen, the CET1 ratio, could that, in fact, go up even with the transition charges, et cetera, on the basis that our book would then create the CET1 coming back from receivables not being there. So those are the 2 outcomes, most likely that we're planning for is about the CET1 will start coming downwards as we utilize. And then if you look at the amount of excess capital we've got, this GBP 215 million versus around GBP 1 billion of additional or excess liquidity, those 2 things are in close agreement in terms of the amount of capital versus the amount of liquidity that we hold. We also have the ability to raise Tier 2 capital, around GBP 125 million of that, which, again, drive additional receivables growth and IFRS 9 capacity as we go frozen. You would have noted that I did use the word investing in IFRS 9 rather than just seeing it as the cost because I think in that scenario that we should start seeing increased receivables, we have to consider the fact that the IFRS 9 impact is something that just comes in this -- that territory. And as that rate of change slows, we will then see the profitable nature of that, but especially taken with the tightening of credit that we've evidenced in our presentation.

Okay. And then just on Slide 21, the provisioning on Moneybarn, the reduction in 24% to 19% in terms of coverage?

Yes. Yes. I think there's a number of reasons that, that has changed, is the H1 '19 and that's interesting because the real thing was the H1 '19, moving to the H2 '19 level is the real story. And the story there is around the tightening of credit criteria and the increase in the book itself, so the coverage was on a broader base. And as that book starts growing out, you're starting to see the impacts of that diversity of customer base. The -- as you saw on the Slide 20, the change in risk of new business in Moneybarn is actually very significant, and that's why I put those slides in there. So I think that if you take into account the change in risk factor from H1. So at the beginning of '19 through to the end of '19, followed by what we're now doing, which is even a further improvement in the risk than the 19% in terms of that context, is a much higher coverage than you'd expect to see.

Our next question comes from the line of Frederique Sleiffer from KBW.

I also have 3 questions, please. Firstly, on provisions. Your total ECL as a percentage of stage 3 loans stayed roughly flat at 104% from the year-end at 105%. Just wondering why you decided to keep that coverage flat and what would need to happen for that coverage to expand? And then secondly, on the consumer credit division, what are the main levers that you can pull on and will prioritize when we get more economic certainty in order to get to that breakeven point? And is there any indication you can give on the time line of this? And then just lastly, one small numbered question. What was the interest rate covenant amended to? I believe it was set at 2 times before? And is this valid until the end of the year? Or is this a permanent change?

Okay. That seems to be consistent. And Neeraj and I will split the 3 questions up. He can answer the first and third, and I'll answer the second one. So the first question is on the provisions, Neeraj, can you get that?

Yes, sure. So talking on stage 3, Freddie. So stage 3 has remained roughly the same because of the fact that, obviously, the customers that find themselves in stage 3 have basically remained of a similar size and nature, also taking into account the holiday impact, some of these customers would have taken a holiday in stage 2, and that will not move to stage 3 to not getting that normal movement. The increase -- the improving credit quality has been something that has been occurring in the beginning -- from the beginning of H1 '20. So it's not something that we're not expecting to see is at that stage 3 coverage remains sort of reasonably flat. It's the earlier stages that were impacted by the macroeconomic impact, which has been quite material. And that has been, if you look at the bridge that we provided, on macroeconomic -- on ECL on Slide 23, you'll see that the main makeup has been the reduction of ECL from volume drops and receivables that come out of our book and that has actually been higher than the amount of the increase due to the new business that we put on during the period. So that is how that manifests itself into stage 3 from your perspective.

So the second question was around the CCD, the time line. As you know, as we much publicized, we have been intending for that business to get back to breakeven this year. In fact, it was on track up until the end of the first quarter before the pandemic here. But clearly, as I said, we're not looking for that to be breakeven this year. I mean, one of the constant -- one of the reasons for concentrating so heavily on collections is that for us to lend to a customer in that business, they have to be up to date. And as I think you'll appreciate, Freddie, it's a very seasonal business. And therefore, we need to be in a position that -- and I think we will be in a position that when we go into the all-important fourth quarter where there's significant cyclicality in taking out new loans, which builds the receivables balance at the beginning of each year -- for the beginning of each year, that we have to have a busy Christmas period. So that's why we've been concentrating so hard on making sure we can collect and are collecting efficiently. So the extent to which that is successful in the fourth quarter is critical to its return to health. Clearly, also, as things stand at the moment, we don't see any reason why with the way lending is beginning to rebuild that should be impeded. But for another, so I say, massive outbreak of COVID-19, and everyone has to go back into lockdown, we have a much clearer picture on that I think by the time we get to our fourth quarter. So then the final question you asked was on the interest coverage ratio. Neeraj, do you want to just talk about how we've changed that and moved it out?

Yes. Just -- I mean, obviously, we don't disclose fully exactly the ins and outs of our way -- of our covenants. But what I can say is that the interest cover -- the interest covenant has been waived to the end of this year. And from there on, it's at a much reduced level to make sure that it meets the requirements that our banks can see that we'll be able to make. So it's very accommodating.

Our next question comes from the line of Portia Patel from Canaccord.

My question is about payment holidays. So I was just noticing in the notes to the accounts. You note a 50% reduction in the forecast activation of payment holidays in the second half will reduce the interim impairment charge by around GBP 30 million. I was just wondering if you could provide some color on what the forecast activation of payment holidays is for the second half. And should that turn out to be different from your assessment, should we be thinking about provision releases come year-end?

Neeraj, do you want to...

Yes, it's [indiscernible] questions are for me.

Anything with P in front of it is for you. Provision is important.

Yes. Yes. All right. Thanks, Portia. Yes. So we have taken a reasonably prudent fee on holidays. In terms of our H2 view of holidays, we've clearly got what we had already seen in terms of the way that we had forecast in H1 for holidays. We will be reviewing the way that our H2 will formulate out on the basis that we are seeing quite a large drop in that take up. At the moment, the issue that we have, and as Malcolm pointed out earlier, is our customers have until the end of October, to decide to take the payment. And one of the things that we're quite mindful of is the amount of payment that is yet to come as the furlough payments come to an end, and as more employers make decisions around redundancies and that becomes more crystallized. So there may well be still a view that those holidays start increasing again as we get closer to the end of October, and it may well be that there is no real impact. So we have, as you quite obviously have taken a prudent start on both holidays and the macroeconomic outlook. And both of those things if they were to transpire to be better, would potentially look to release on that basis. However, we are also expecting, if that were the case, that the amount of new business that we would be taking on at that time would then lead to an increase in total provision models due to the rate of increase that we'd expect to see in the more benign circumstances. So I know it's not a definitive answer, but you're right in what you're thinking by seeing that there are other compensating factors that then drive the IFRS 9 charge back up again, even though it's not for the reasons of the holiday.

That's helpful. Just to be clear, in terms of the assumption of the payment holiday. Did you say, your assumptions are consistent with the end of H1 level or have you budgeted for an increase come the end of furlough?

No, I think we've taken it reasonably consistently from what we'd assumed in H1, which was more prudent than we saw.

Next question comes from the line of Ian White from Autonomous.

Just a few follow-ups from me, please. A couple on capital. So you've mentioned a couple of times in the presentation, the idea of optimizing the capital base through lower quality capital instruments. Do you see that as a viable strategy given market conditions today? Or is that something that you're flagging as an opportunity kind of post-COVID sort of over the next 12 months? Can I just understand the timing around when that strategy could be put into action, please? That's question one. Question 2, also on capital. I noted the cut in the Pillar 2 capital requirement. It looks like, basically, on a look-through basis, you basically had the pension add-on removed. But the conduct and operational risk add-ons that were applied with FY '17 results, basically, are still there. Is there anything you could share in terms of how that conversation went with the regulator around those add-ons? Basically, what would you need to do, obviously, for over a medium-term perspective now, in order to have those add-ons removed? Or should we think of that, I think it was 6.8 percentage points that were added at FY '17, as just a long-term requirement of being a non-prime lender, basically, under the PRA's framework. That would be question 2. And then just finally, a clarification on costs. I think you said you plan to repay money taken under the furlough scheme. Should we expect to be some incremental cost in 2H as a result of that, basically? Is the effect to shift costs from 1H to 2H? And could you just tell us how much that would be, please?

Okay. I'll take the last one first. I mean, the -- we basically -- I think as I said earlier, we weren't looking to take a lot from furloughing the total. If we've gone to the whole year, which we haven't done, obviously, we would have taken about GBP 3 million. So -- but the amount we're repaying is substantially less than that because we haven't claimed that much. Do you want to talk, Neeraj, to the first question on the capital diversification timing?

Yes. And I think you're quite right in what you say is that the move to using Tier 2, for example, will be dependent on market conditions and the availability of price of that type of capital and we will assess that between now and over the next 12 months. So to see whether that is available and if it is available, we might choose to use it. And obviously, we will be using that. We would be looking at the market conditions of our customer base as well in understanding how much of such capital would be relevant to us. So it's more about flagging the fact that we haven't to date use such instruments. There is a market for them. That market is currently open. And we would have to assess where we fit into it. So that's the first question. And the second question around the Pillar 2 side of the equation. Well, I think, as you'd expect, is that whilst the regulators been coming up with their current total capital requirement for the Group have actually not really changed much, which is unsurprising and that the current conditions do not lead regulators to start significantly reducing people's capital requirements. So I think in a way, it's the fact that, as you kind of pointed out, it doesn't look particularly materially reduced is because of the fact that the conditions just out there for it. And as we carry on through the prime period over the next 3 years and hopefully, past the COVID process, then those discussions with the PRA will continue. And as we've seen with the VREQ removal, which I think has been a really big concession by the PRA during this period than other parts of the total capital requirement, will hopefully start coming downwards too.

I think that's the end of the conference. Thank you very much indeed, everybody, for dialing in and listening. And we obviously will update you at the next appropriate date, but don't hesitate to call Owen or Neeraj or myself, if there are any questions that you haven't thought of as of now. Thank you very much again for listening. Appreciate it.