Paragon Banking Group H2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
December 3, 2024

There are 8 speakers on the call.

Operator

So good morning, everyone, and welcome to Paragon's 2024 Full Year Results Presentation. So we will shortly run through the financial and operational performance and then provide you with our perspective on the outlook as well as leaving plenty of time for questions. But before we get into the detail, let me spend a few minutes looking at the key highlights. 2024 produced another strong financial and operational performance and we're absolutely delighted with these results. We delivered good outcomes for our customers and shareholders and made excellent progress against our strategic objectives, demonstrating the resilience of our business as well as the benefits of our increased diversification and the investments we have made in new technology.

Operator

I want to highlight 3 key areas, our financial performance, our growth and our strong capital position. So first, our financial position. All the guidance metrics we set out at the beginning of the year have been met or exceeded. Underlying operating profits increased to nearly £293,000,000 underlying earnings per share were up by 7.3% and our return on tangible equity is at the top end of the range at 20 point 3%. Fundamentally, this has been achieved through a combination of good loan book growth and resilient margins, in addition to a disciplined approach to costs and risk management.

Operator

We had expected margins to plateau in 2024. However, we have exceeded the top end of guidance with NIM widening to 316 basis points. Despite ongoing investment across our franchise, operating costs have been well controlled and we have further improved our cost income ratio at 36.1%. Our high quality seasoned loan book demonstrated exceptional resilience and credit performance remains excellent, reflected by an impairment charge of only 16 basis points, some of which will reverse in 2025. The second area I want to highlight is the significant progress we have achieved in delivering our customer focused growth objective.

Operator

Our loan book grew in challenging market conditions ending up the period 5.6 percent up at £15,700,000,000 New lending was strong at £2,700,000,000 and accelerated as the year progressed with completions 20% higher in the second half of the year. 2024 has experienced a notable change in customer sentiment. We enter the new year with good momentum and with new business pipelines up materially on last year. Indeed, the buy to let pipeline is up 48% and the development finance pipeline has increased by 31%. Our savings franchise has seen strong growth with retail deposits increasing by 23%, enabling us to accelerate TFSME repayments.

Operator

And finally, our excellent capital position. Strong internal capital generation is a genuine strength of our business, adding 2.7% to CET1 across the year as are our capital ratios, supporting our growth ambitions and the further buyback of up to £50,000,000 announced today. We now have the near final rules on Basel 3.1, which are significantly less impactful than the previous version, but we continue to make good progress with our IRB application for our buy to let business. We are therefore well positioned as we head into 2025 ready to support further loan growth and any opportunities that may emerge. However, no bank results presentation is complete without reference to motor finance commissions.

Operator

As you can see, we have made no provision because we believe our exposure, if one exists, is modest. Nevertheless, we have enhanced our disclosures in the accounts, which support this position and I'll come back to this point later. It's clear that 2024's performance is excellent and this is a reflection of our long term disciplined strategic focus and progress achieved over the last 10 years since the bank's formation in 2014 and this can be seen in the following charts. Our focus on strong and consistent growth allied with robust financial and operational management is clearly evident and this performance is no accident. It reflects our approach in pursuing our strategy with long term objectives and reducing volatility.

Operator

Loan book growth has been managed carefully. We have never chased volume over asset quality or margin. This as well as structural changes due to diversification strategy and interest rate normalization have moved margins over the decade from around 2% to 3%. Operating profits have increased by 140 percent generating significant internal capital, enabling us to support balance sheet growth, complete 4 acquisitions, and return over £1,100,000,000 to our shareholders through a combination of dividends and buybacks. In addition, return on tangible equity and earnings per share have consistently moved up over the period.

Operator

We're very proud of the quality of our book. It has withstood a multitude of stresses in recent years from Brexit to COVID with our customers facing the sharpest rise in base rates in modern history across a relatively short period, an ever changing regulatory landscape and more recently a volatile and inflationary economic environment. Despite all of this, our impairments have only averaged 10 basis points per annum. And over the last 10 years, we've written off only £1,500,000 of our post financial crisis buy to let loans despite our total lending exceeding £16,200,000,000 The performance demonstrated by these charts is the result of a long term commitment to running our business prudently. Given the uncertain times in which we live, it demonstrates a track record in mitigating volatility wherever possible and seeking to optimize risk adjusted returns backed by a high quality loan book through the cycle experience and a deep understanding of the specialist markets in which we operate.

Operator

I'll now hand over to Richard to look at the period's performance in detail.

Speaker 1

Thank you, Nigel, and good morning, everyone. As Nigel just outlined, 2024 saw the group's highest operating profit outturn and we've ended the year with strong exit margins, improved pipelines and strong capital, all of which play into the early guidance we've been giving for 2025. Starting with the overall income statement, higher margins and balances supported a 7.6% growth in net interest income in FY 2024, where margins ended the year rising to 3 16 basis points and the net loan book grew by 5.6%. This is a little above our 10 year average. Other income fell following the end of a servicing contract in FY 2023, but should be stable going forward from this level.

Speaker 1

Operating costs include the new banking levy and came in just below our GBP 180,000,000 guidance. It's worth noting the improved efficiency we're seeing has taken the cost to income ratio down to 36.1%. This is the lowest level we've seen since 2015 when we started our commercial diversification program with the 5 arrows acquisition. This is now our asset finance business. Impairments were elevated in the year, but remained low.

Speaker 1

In H1, this was bike let focused and in H2, the main increase came from development finance. In both divisions, the increases came on variable rate loans with a higher rate environment, house price softness and inflation impacts combined to put small parts of the book under more stress. Operating profits were up 5.4 percent at just £293,000,000 We saw a smaller fair value movement when compared to FY 'twenty three. Being reported pretax profits rose 27% in the year. Underlying earnings per share rose 7.3 percent to 10.1p sorry 101.1p.

Speaker 1

This increase was above the increase in underlying profits and reflects the benefit of the 2024 share buyback. 2024 has seen further growth in profit growth in mortgages, but commercial lending has gone backwards in the year with margins lower at higher rates. However, it should be noted that part of this reflects our allocation basis

Operator

where the

Speaker 1

benefit of high rates is seen in our Central segment. The Commercial segment also saw an adverse impact from impairments. But as I'll mention in a few slides' time, a substantial element of this is expected to reverse in FY 2025. Looking in more detail at our net interest margin. Our full year activity of 316 basis points was little above the 3% to 3.1% level we originally guided to and the 3.1% plus that we upgraded to at the interim.

Speaker 1

Asset side new business spreads strengthened as the year progressed, offsetting some of the deposit led tightening that was anticipated and reflected in our guidance. At 314 basis points, our H2 NIM reduced by just 5 basis points from H1 and provides a good entry level to the new financial year. It's also worth remembering that commercial lending spreads remain significantly wider than buy to let and also the tighter margin legacy buy to let book continues to amortize. And both of these provide structural support to margins. What remains to be seen is quite how much of an influence quantitative tightening and the broader repayment of TFSME is going to have on the market.

Speaker 1

Our expectations are the base rates fall by about 1% over the next year and the overall deposit spreads continue to contract, taking our full year FY 2025 NIM to 3%. As I just mentioned, we expect deposit spreads to continue to tighten. We produced this chart at the interim and had strong feedback from it as it gives a useful feel for the deposit spread dynamics of the period at the period end, sorry, rather than the average for the period. So therefore helps understanding the general positioning of the deposit book. The first thing to call out is the rebalancing of the book that took place between fixed rate between variable and fixed rates that took place in FY 2024 when compared to the overweight fixed rate focus we had in FY 2023.

Speaker 1

With stronger spreads on variable rates, albeit down on the September 23 level, this mix change has an important factor in supporting margins over the past year. The second feature I call out is that we've gone from an after swap benefit to a small post swap cost from our fixed rate savings between September 23 September 24. And we're generally seeing stronger competition for fixed rate deposits than for variable rates during the year. My final point to note on this slide is the material level of pre placed assets that we have for the Bank of England, which give funding flexibility and access to liquidity via short term repo and ILTR. We also have gilts and retained bonds, which support our treasury operations as we seek to optimize the cost and risk aspects of our liquidity.

Speaker 1

Overall, I'd expect a further trend away from fixed rate savings in FY 2025, but for this to be less pronounced than the shift we've seen over the last year. Operating expenses came in within guidance and absorbed the new Bank of England levy. With a focus on cost efficiency, year end headcount was 7.3% lower than September 23 at just over 1400 people. And our cost to income ratio fell further to 36.1%. As we've noted before, despite being several years into our digitalization journey, we've only £8,000,000 worth of capitalized software costs on the balance sheet, the bulk of the spend being expensed as incurred.

Speaker 1

I've also highlighted the expected impacts on the National Insurance changes announced in the recent budget. This is £1,000,000 in FY 2025, rising to £2,000,000 in FY 2020 6. We've included these high costs in our guidance for FY 2025, which stands at £185,000,000 which would represent 3.2 percent inflation. Whilst our economic outlook remains cautious, the metrics for FY 2025 are generally a little stronger than we were previously expecting, supported by a stronger opening position. For a largely secured balance sheet, property prices continue to be the largest risk driver.

Speaker 1

And you can see from the chart on the right hand side that the severe scenario, which is based off the Bank of England stress test assumptions, continues to include a very substantial house price decline. And this is the single largest impact and the difference of the impacts when we're comparing the severe scenario to our base case. We've softened the scenario weightings a little in FY 2025, moving 5% of the severe weighting back to the base case. This continues to exceed the downside weighting we had pre COVID, but given recent experience, it was hard to justify as conservative a stance as we took in FY 2023. In terms of the impairments themselves, the net effect of the application of our economic assumptions to our book specifics at September 24 results in a 1 basis point reduction in the overall coverage ratio from the previous year.

Speaker 1

Judgmental overlays have been maintained at £6,500,000 As noted earlier, the provision charge for the year has been a little bit more elevated than normal on our variable rate portfolios, notably Bartolip and Development Finance, with the latter having a bigger impact over time as facilities face higher costs than were originally envisaged that's based in build and interest rate terms. Developments are underwritten when rates were already elevated or performing in line with expectations. A feature of IFRS 9 is the need to discount future cash flows at the EIR to arrive at expected credit losses. This discounting is particularly important for Development Finance, which carries the highest rates on our balance sheet to reflect the high capital requirements for those loans. The loans also only repay once the development is complete rather than on the DRIP.

Speaker 1

This discounting unwinds as the cash realization point gets closer and therefore serve to inflate the FY 'twenty five impairments a little and the benefits will come back in FY 'twenty five. Our overall balances in Stage 3 rose as a consequence of these two portfolios, increased to GBP 284,000,000 across the year from an opening position of GBP 206,000,000 Notwithstanding this effect, the cost of risk for GBP 2024 was still only 16 basis points. I've included our normal capital bridge chart in the next slide. Underlying retained earnings demonstrate our ongoing core capital generation. This is the 2.7% of CET1 that Nigel mentioned earlier.

Speaker 1

The notable year on year changes were around 0.5% benefit from lower fair value charges and an equal and opposite additional 0.5% used to support the balance sheet growth, where the higher risk weighted commercial portfolio grew by 16.1% in the year. The impacts from share buybacks and dividends were similar to 2023's levels and we ended the year with a 14.2% CET1 and a total capital ratio of 16%. These translate to more than £200,000,000 surplus to our regulatory requirements. On group capital, the key metrics behind the capital levels at September are included in the table on the right hand side of the slide. It's worth noting that the decrease in sorry, the increase in the commercial division scale in the year has driven the increase in the portfolio risk weight to 45.6% for 44.3% a year earlier.

Speaker 1

We ended up not completing the second half of the buyback in FY 2024, but the red cap figures here reflect the full buyback given the 30th September irrevocable that we made. And the consequence of the first £7,500,000 of our FY 'twenty five buyback is free from a red cap perspective if you start with these numbers. We've now started to see the PRA approving larger institutions' hybrid IRB models. And as a consequence, we're getting much more definitive feedback on our approach. We continue to adapt our modeling to fit the PRA's emerging requirements and achieving an IRB accreditation remains our objective.

Speaker 1

Timing, as ever, depends on the PRA's feedback and the process requirements for the consequent model enhancement that we need to make. As soon as we have anything tangible to say, we'll update the markets. Also on capital, the near final rules on Basel 3.1 were not as penal as we'd originally thought, with our September 2024 impact assessment of 104 basis points of CET1 comparing favorably to the estimated impact of 2.1% from the original CP. However, we're not counting our chickens yet. Given consultations relating to Pillar 2 are expected to conclude in FY 2025, which may mitigate some of this benefit depending on where they eventually land.

Speaker 1

One of the positive developments though from the 3.1% announcement was the establishment of the interim capital regime. This effectively adds a year for firms to get ready for 3.1%, making the effective date the 1st January, 2027. This is important for us as it gives us a longer runway for the IRB process to play out And we expect to apply for this option as soon as the PRA release the required documentation. As regards capital management, we've completed €92,500,000 of the €100,000,000 FY 2024 buyback. And in addition to announcing a new buyback of up to €50,000,000 for the year, we're going to finish the FY2024 program as well.

Speaker 1

With underlying EPS of over 100p per share of 24 full year dividend stands at 40.4p, an increase of 8% from its 2023 level. Our policy for FY 2025 is unchanged and we expect to distribute around 40% of underlying earnings for the year. Since 2015, when we updated our dividend policy and started the buybacks, we've distributed over £1,100,000,000 to shareholders by the time these distributions are made. At the same time, we've grown the loan book by almost 60% and underlying profits by around 120%. For my final slide, I wanted to say a bit about our return on tangible equity measure.

Speaker 1

For our return analysis, we look at underlying earnings and our tangible equity. To get to underlying earnings, movements in intangibles in the income statement are excluded and the value of intangibles in the balance sheet are also excluded. Our previous alternative performance measure did the same for fair values, removing the element of the fair value movement that goes through P and L and also removing the balance sheet fair value items from the denominator. The wider market does most of this, but excludes the balance sheet leg of the fair value adjustment. This gives a more conservative outcome when fair values are positive as they are today, but a more optimistic one when fair values move the other way.

Speaker 1

As you can see from the chart, the alternative approach would take the FY 2023 reported level to 17.3% and FY 2024 to 17.2%. Our plan is to base guidance and underlying reporting on this more comparative basis going forward. Importantly, though, we retain our 15% to 20% management target for this new ROTE measure. I'll now hand you back to Nigel. Thank you.

Operator

Okay. Thank you, Richard. So let me turn our attention to how the business has progressed against our strategic priorities and provide you with our view on the outlook for the period ahead. We've shared with you previously how we focus on these 5 key priorities and how they are interconnected and supported by our structural pillars of our strong customer focused culture, our passionate and committed people who hold such incredible values, and our excellent financial foundations with a high quality customer base, strong capital and significant liquidity. So turning now to how we have performed against these individual strategic priorities across the year.

Operator

So starting with growth, as I highlighted earlier, we outperformed the market this year and delivered a strong loan book growth of 5.6 percent, in line with long term trends, while our savings business grew by nearly a quarter. Moving on to diversification where this element of the strategy helps reduce volatility and exposure to individual sectors, as well as broadening our income sources and diluting our fixed costs. The evolution of our business is clear to see. Paragon is no longer a pure play buy to let operator. Our commercial lending operations make a greater contribution to our performance each year, with the division accounting for 45% of new lending during the period, growing at 4 times the rate of Baitalat and now accounting for 27% of group income.

Operator

With commercial lending generating a stronger margin than mortgages, this mix effect has been an important factor in the continued strong NIM performance for the year. Turning to digitalization. Our multi year technology investment program is delivering excellent results for the group with exciting developments in the pipeline. Our front end technology transformation program has significantly enhanced our capabilities in Baitrelet, SME lending and development finance, leading to an improved customer experience, expanded operational capacity and increased cost efficiencies. We have increasingly implied applied cloud based technology, utilizing extensive API connectivity, accessing multiple data sources, building partnerships and continuing the next level of our vision to be a leading technology enabled specialist bank.

Operator

Our new mortgage originations platform built bespoke to our needs will be live in the New Year and we are developing further exciting opportunities in our savings franchise. And we are also examining how AI can benefit the business, streamlining tasks and driving productivity. We already have AI embedded across many areas of our operation and we are running a further series of pilots across the group. With the front end transformation largely complete, we are moving our focus to our back end systems, which will improve our efficiency even further. Now turning to capital management.

Operator

Internal capital generation has continued to be strong with the group delivering a 2.7% accretion to CET1. This is a powerful and sustainable strength of the group and provides the ability to support growth and enhance returns to shareholders. Finally, we remain committed to doing the right thing as part of our sustainability strategy and we're on course to achieve operational net 0 by 2,030. Since 2019, we have improved our operational emissions reducing them by 48%. Our financed emissions, however, are based on our customers' assets and these present a greater challenge to reduce, although we are making progress here.

Operator

In buy to let, we're pleased that the EPC rating on the loan book improves month on month, and we expect further improvements in the coming years. We have seen a positive response to our green homes initiative in our development finance business, increasing the fund from £200,000,000 to £300,000,000 this year. Additionally, we recently announced an expansion of the range of green assets we can fund in our SME lending business. So much of our finance emissions are in the hands of our customers and much will depend on the government's framework in dealing with this issue. And in this context, we await the government's consultation on introducing minimum energy efficiency standards for rental property with legislation likely to present opportunities and no doubt some challenges for the sector.

Operator

So now let's turn to the performances of each of the business lines starting with buy to let. The buy to let loan book continued to grow during the year, up 4.4% to £13,300,000,000 mainly due to our strong retentions program and the recovery in new lending activity as the year progressed. As expected, new lending volumes were lower during the period, primarily due to a weaker housing market as the sector adapted to the higher rate environment, which affected completions during the first half of the financial year. However, buy to that completions accelerated during the second half of the year. They were up 30% on the first half as the market showed signs of recovery.

Operator

We have carried that momentum into the new year with improving sentiment, particularly amongst professional landlords who have benefited from strong yield performance and record levels of tenant demand across most areas of the U. K. Our buy to let pipeline has increased by 48% to £881,000,000 providing an encouraging start to the new financial year, helping us to upgrade guidance for 2025 compared to the £1,500,000,000 delivered in 2024. Our retentions performance remains exceptional with our overall redemption rate falling and more than 80% of our customers with mature and fixed rate mortgages going on to take a new product. The profile of the loan book continues to evolve with redemption significantly higher amongst legacy customers.

Operator

The new book consists predominantly of professional landlords and grouped by 9.7%, accounting for an increased proportion of the portfolio. Demand for rented property is expected to exceed supply for many years to come, with the latest data from Zoopla showing over 20 inquiries for every available rental property, double the pre pandemic levels. Demographic trends such as a rise in single person households, the inadequate supply of alternative social housing and the expected 10% population increase by 2,036, much of which is expected to be by way of immigration. Well, they all combine to create sustained demand for our customers' properties. The new government has launched a revised version of the renters' rights bill, and we've been working with them to ensure its various changes are implemented in a sensible manner to avoid unintended consequences.

Operator

The budget somewhat pleasingly did not increase CGT on buy to let properties, but did raise stamp duty surcharge on 2nd homes to 5%. Whilst financially unhelpful, professional landlords have managed their way through previous increases in this tax rate and will do so again. We anticipated that buy to let volumes would be weaker in 2024, but confidence has changed. The pipeline is now stronger and we expect our 2025 mortgage lending to be comfortably above that of 2024 with our 'twenty five guidance of between £1,600,000,000 £1,800,000,000 The asset quality of our buy to let book remains excellent and arrears are significantly lower than the broader market. The average loan to value on the portfolio stands at 62.8%, only 2.6% of the book has an LTV of greater than 80%.

Operator

As you saw earlier, actual write offs are negligible, which reflects our focus on prudent underwriting, extensive use of data analytics and the highly experienced portfolio and property management teams. As said at the half year presentation, mortgage arrears have fallen declining from 68 basis points at the end of March to 38 basis points at the year end reflecting the improving environment. Despite this affordability continues to be managed closely. We have always operated conservative stress test in this area and applied it rigorously throughout, including employing tests over and above regulatory requirements. It's clear that although debt service costs are higher, rents have kept pace, leaving the current debt service ratio, the ICR, in the pipeline standing at over 200%.

Operator

So now let's turn to the commercial lending business lines. The contribution of commercial lending continues to grow. The division is integral to our diversification strategy and a core driver of our structural NIM expansion, delivering NIM of 5.9% in the period. As I mentioned earlier, commercial lending accounted for 45% of new business volumes during the period, whilst contributing 27% of income. Similar to buy to let, we are upgrading our new lending guidance for 2025 to between £1,200,000,001 point £4,000,000,000 Good opportunities exist across the commercial division, and we expect to see further growth over time across the markets in which we operate.

Operator

So turning to each division in turn. Development Finance is a cyclical business with recent performance being driven by the interest rate environment and broader trends in the housing market. The housing sector has been exposed to significant volatility in recent years with rapidly increasing mortgage rates impacting buyers' ability and appetite to purchase new homes. Therefore, we previously anticipated that our development finance division would see weaker growth across the across new activity due to these factors, as well as issues more specific to the sector, including supply chain disruption, cost growth and planning constraints. Despite this, the division recorded loan book growth of 18% year on year as existing facilities continue to roll out their build programs, supporting robust cash drawings.

Operator

The portfolio has been resilient in credit terms similar to mortgages. The sharp increase in interest rates impacted certain customers, which required careful management from time to time. But our cautious underwriting, good LTVs and a highly experienced team saw the portfolio performing well and with high degrees of resilience. There's also been a notable increase in confidence over the year with a significant step up in inquiry levels and the pipeline now 31% above September 2023 levels. We also have the potential for a change in planning rules supporting the new government's plan to increase house building.

Operator

So now moving on to SME lending. SME loan demand in recent years has been sluggish due to the unwinding effects of COVID and the weaker economy. However, our SME division was able to take market share, witnessing new lending growth of 7.3% and supporting loan book growth of nearly 8% to over GBP815,000,000 The benefit of our technology investment continues to be seen with 69% of new business submitted going through our broker portals. Using AI, which assesses over 4,000 pieces of customer data with each application, we can make lending decisions faster and more effectively, delivering better customer outcomes. Further technology developments are in the pipeline, including greater use of streamlined decision making to deliver funds to customer accounts more quickly and replatforming of the back office to strengthen the division's foundations to facilitate further growth.

Operator

Credit performance remains strong with nearly 90% of the books secured. The portfolio is performing incredibly well with no indications of credit deterioration or concerns from the early warning indicators. Our market share in this sector is still low and opportunities exist to grow the division even further over years to come. With an ongoing technology investment program and an experienced management team, the division is well placed to achieve this objective. So turning now to the remaining areas of the Commercial division.

Operator

Although motor finance business flows were softer compared to last year, the loan book growth was still strong, up 11.4% year on year, with growth being particularly evident in the leisure vehicle market. The portfolio is resilient and as with SME, we are seeing a robust credit performance. Clearly, the motor finance industry has recently been focused on the FCA investigation into commission structures and the more recent Court of Appeal decision. We only started lending in this area in 2014, and we've built high quality book that looks very different from the recent Court of Appeal cases. Our customers are prime borrowers with a different level of sophistication compared to the profile of the appeal cases, and also with a significant focus on leisure vehicles.

Operator

The portfolio has low arrears and has experienced low complaint levels. Furthermore, as you will see from the enhanced conduct note, the vast majority of our business has been originated by brokers, not car dealers. Our aggregate commission payments to dealers since 2014 is only £9,000,000 with just under £40,000,000 having been paid to brokers. And the commission rate has averaged only 3.8%. This is not an exposure estimate, it is the total we have paid to motor finance intermediaries.

Operator

As mentioned, we have not taken a provision, but we have set out enhanced disclosures in the accounts. And I suggest if you want to discuss this in more detail, then please reach out to Richard separately. Finally, structured lending, which provides asset backed lending to non bank specialist firms has had a strong period of activity with a 52% increase in the loan book to £257,000,000 Alongside good customer retention, its new business pipeline is strong and we anticipate healthy growth in 2025. As seen elsewhere, the credit performance here is exemplary. Our commercial lending division is generally regarded as more cyclical in nature than mortgages and has performed particularly resiliently in this more challenging economic environment.

Operator

With a NIM approaching 6%, 3 times that of mortgages, it provides the group with a strong risk adjusted return and a structural NIM benefit. Turning now to funding. As I referenced earlier, our award winning deposit franchise grew strongly, finishing the year with balances of £16,300,000,000 We are proud to be one of the fastest growing savings franchises in the U. K, developing a diversified and flexible proposition. The higher rate environment has no doubt driven deposit growth across the market, and we have continued to provide good pass through rates to our customers.

Operator

Finally, our strong ISO product range has been highly successful as savers have increasingly turned their attention to the attractive returns available. Although portfolio rates appear to have peaked, retention levels are high and customer feedback remains strong. The growth in our savings business has been incredibly strong over a number of years. 2 years ago, the balances stood at only £11,000,000,000 This growth has been supported the expansion of the loan book and the repayment of wholesale funding, including old securitizations and £2,000,000,000 of our TFSME repayments. This requirement is now virtually complete and our need to raise new deposit growth will reduce significantly going forward, which will help in margin management.

Operator

Nevertheless, we expect some liability margin contraction in 2025 and this is already built into our guidance. Despite this, we will still focus on expanding our customer reach as we continue to develop our savings franchise. With over £650,000,000,000 in current and savings accounts, earning below market rates, significant opportunities exist to broaden our customer reach. Advancements in technology have contributed significantly to the growth of our savings division, and we are actively exploring our new innovative opportunities to expand our product range and enhance our offerings. We're also widening our wholesale funding options where the group has a long history in the securitization markets.

Operator

We are working on a covered bond program, which has the potential to support wholesale issuance at pricing comfortably inside mortgage backed securities. Alongside this, we are delighted to announce the confirmation of a second credit rating, this time from Moody's alongside the existing rating from Fitch. Additionally, we have set up a number of market repo lines, which will continue to diversify funding and utilize our extensive contingent collateral capacity. We have a strong savings franchise and have built and continue to build optionality in our funding model, enabling us to support growth and optimize margins. So in conclusion, we have delivered an outstanding financial and operational performance in 2024, aligned to our strategic objectives with the outturn ahead of expectations we laid out at the beginning of the year.

Operator

Underlying profits have reached a new record. We have delivered an outstanding return on tangible equity and NIM performance. And we have managed to grow the loan book well in challenging market conditions, supporting our customers and helping them to achieve their ambitions. The asset performance of the book is excellent and the headwinds that led to an increase in arrears across some elements of the portfolio appears to have passed. Customer confidence in our property related markets has recovered following the volatility of 2023, reflecting an improved new lending pipelines.

Operator

And we enter 2025 with good momentum. We continue to diversify our business, spreading the sources of income and defraying the fixed cost structures that inevitably exist in a highly regulated sector. We are also continuing to diversify our funding sources, all of which will give better opportunities in margin management. And we now have some clarity on the future regulatory environment and the near final and more favorable Basel 3.1 rules. Nevertheless, despite the benefits, we are progressing with our plans to move to the IRB approach.

Operator

It is clear we've been able to consistently generate robust levels of internal capital, which has supported strong loan growth and a program that has seen capital repatriated to shareholders of over £1,100,000,000 We expect to continue generating strong levels of capital in the future, which will be implied in supporting organic growth, as well as providing us with the ability to participate in the long awaited consolidation in the banking sector. And of course, maintaining our long established commitment to capital management, employing it most effectively for the benefit of shareholders. Our business is in great shape. We have a high quality customer base and a strong balance sheet, and we stand ready to react to the opportunities and challenges as and when they arise. So thank you, everyone, and we're now ready to take your questions.

Operator

The usual process, you have to press the button on the microphone. And of course, name and number, Gary. There we go.

Speaker 2

It's Gary Greenwood at Shore Capital. I've got 3, hopefully, quick questions. So first was just around the budget. You mentioned the increase to stamp duty. I was just wondering if there were any other observations around customer behavior either before the budget or since?

Speaker 2

The second one was around capital. So I note the additional Moody's rating that you've got. I think your Tier 2 bond matures in 2026. I was just wondering if you've got any plans to add any AT1 to the capital stack to make it more efficient. And then lastly, just on deposit growth, I think you sort of said that the TFSME refinancing is broadly done now.

Speaker 2

So should we be thinking of deposit growth more in line with loan book growth now? Thank you. Okay.

Operator

So I'd say no, nothing of any particular note in terms of customer behavior around the budget. There wasn't sudden rush of people trying to buy their properties ahead of the stamp duty changes or selling them. There's lots in the press about everyone selling their properties. We have to say we didn't notice it particularly in being particularly evident in our portfolio. In terms of other capital, no plans and no immediate plans for an 81, it's an option, it's always available.

Operator

We get regularly courted by the investment banks to issue 1, but we'll issue 1 when we're ready on that front. And deposit growth, yes, you're right. I mean, if you look, our deposit growth has been exceptional, 23% this year, 25% the year before, gone from 0 to 16,000,000,000 in 10 years. And if you think we were financing a growing business and refinancing the old securitizations and any wholesale funding, So we've had to run a lot harder than the market, every year we've taken lots of market share on that. Now we're kind of we're mature, we're more our demands on the market are far less than they have been in the past, which actually is a great position because you imagine being in the market and you kind of have to take more and more and more money from the market, you have to pay up for it.

Operator

So this will give us, I made reference in the few words I said about margin management. And I think it gives us better price management in the for the flow of new business as and when it comes through.

Speaker 3

Sanjana Dattawala from UBS. I have three questions please. First, if you could talk about the pricing trends in buy to let and your expectations on spreads in that business in the context of the rate view? Secondly, on deposits, you expect spreads to tend towards 0. So over what period?

Speaker 3

Is that partly due to the lagged effect of repricing but also on the new flow? And then what are the upside and downside risks to that view? And finally, if you could tie that together for margin development from 2025 into 2026, please? Thanks.

Operator

Okay. I'll do the buy to let one. You do the difficult ones. The difficult ones. The difficult ones.

Speaker 1

Sorry.

Operator

Buy to let pricing, so if you typically look at the asset margin is about 2% on Bitelet and I'd say that margin during the course of 2024 strengthened. It was a little bit lower earlier in the year and it was kind of like at this kind of the 2%, maybe even slightly above it towards the end of the year. From month to month, it does move around a bit, but our aim would be to consistently try and deliver a 2% asset spread. What you tend to see in, which I'm sure you've seen it in banking generally, there's a kind of a trade off between asset spreads and liability spreads. When rates go up, you make more money on your liabilities, less on your assets, Just in the pure spread sense, when rates come down, it kind of switches.

Operator

So overall, we're looking at that 3% margin is where we want to get to. In one sense, you don't really mind where it comes from.

Speaker 1

In terms of deposits, our planning view is that once we hit base rates at their sort of resting level, probably in the low 3s. At that point, you'd be pretty much neutral in terms of your deposit margin. So given that we're looking at a percent off base rates next year, you're probably looking at the same in 26%. So a similar if you like, squeeze on the deposit spread in 'twenty six compared to 'twenty five. So over to that, it gives a bit of a steer in terms of the thinking then generally in terms of that post 'twenty five piece.

Speaker 1

I think the as well as the deposits though, clearly the asset spreads are important. As Nigel mentioned, we're looking at around a 2% spread on buy to let. That strengthened a little bit during FY 'twenty four. As rates fall further, you expect probably to get a little bit more on from that side as well, but not a huge amount. But also I think the for our higher yielding commercial businesses, it's that was always the strongest margin business in the group, if you like, pre the rate increases.

Speaker 1

We didn't pass the whole 5% on to those customers. You would expect to take a little bit more margin back as rates drop, but not a huge amount. So I think that helps support that position probably to something a little bit more balanced in 'twenty five compared to 2020 sorry, 'twenty six compared to 'twenty five. So broadly, we haven't got to the point that we're giving 2026 guidance, but I wouldn't expect it to be materially different to 'twenty five.

Speaker 4

Portia Patel from Canaccord. I've got three questions as well, please. You mentioned, Nigel, taking market share in SME lending. And if you can just remind us who you're taking share from, that will be helpful. Similarly, in Bytolet, you've talked about the pickup in new lending in the second half and the outlook for FY 2025.

Speaker 4

Just keen to understand whether this is largely market driven or you're taking share in the buy to let market as well and from whom? And lastly, to the point about increasing professionalization, just interested to know what the number of average properties a landlord on your books has now versus 5 years ago? Thank you.

Operator

Okay. So the SME market share, so I think the dynamics that's happened for the SME market, actual lending volumes, the kind of non government backed schemes, so the COVID schemes, lending is still the stock of lending is still lower than it was in 2019. So there's still a kind of a recovery phase of shifting it back to the private sector as it were or non government backed sector still underway. So you do get kind of like things distort from time to time. Our market share is not coming from the bigger players in that market, the kind of the Lombards and which is NatWest, the Lloyds and the HSBCs and the like.

Operator

So it's very much the people we compete with are going to be the specialist banks and there's also quite a lot of non banks in the asset finance markets as well. So that's kind of our key competitor set and that's where we've grabbed a better market share from. In terms of on the buy for let side, in terms of the way that market shares have gone there, we've seen some of the players have been quite active like Nationwide or TMW have been probably more active in the last year in buy to let. But where we've done and taken our growth from, I think it still remains in the core markets in which we operate and the people, the competitor set that we see is probably the ones you know, it's the OSBs, the order malls of this world. So it's the areas that we focus on is very much 99% of what we do is to a professional landlord or complex property.

Operator

So it's that same competitor set that we've always had on there. The professionalization of the buy to let market, I think is an interesting thing more generally because you hear a lot in the press about the kind of the build to rent, which is kind of synonymous or deemed synonymous with the professionalization of the sector. But what we tend to see there is those are kind of bespoke properties with particular sets of requirements, which is and we do some of that through our development finance area where we build and obviously sell, but we don't tend to get involved in that there on our professional buy to let side. But the typical number of properties per landlord is about 14. So and has it changed much?

Operator

Probably within the professional community, it hasn't changed that much. We've just been doing more professional. So the kind of the average number per customer, our overall customer base has probably changed across that period.

Speaker 5

Just got one on the non performing loan sorry, Elise from KBW. I saw the Stage 3 loan has gone up quite a bit by 70% in commercial lending compared to the first half. In the announcement, I saw that you said it's mainly because of the UK building sector impact. I'm just wondering if you can elaborate on that a little bit more, please. And second is, would you see this trend going to next year as well?

Speaker 5

Thank you. Yes, sure. So yes, there's a subset of our

Speaker 1

development finance book where the underwriting and the inquiry levels predated the increase that we saw on both interest rates and inflation. And so for a number of those developments, they've struggled a little bit as we've gone through this more inflationary period. So those costs have been higher, ash price have been a little bit softer than they thought. It's not all of them, but it was a subset of the loans that were written where the inquiries came in, in sort of 2021 into the beginning of 2022 where rates were very flat and they weren't expecting an increase. So a small number of those have had challenges.

Speaker 1

We keep tight tabs on the rest of the portfolio. At the moment, we would have said that actually the position is quite stable. So you wouldn't expect the same rate of increase, certainly in terms of where we're seeing things at the moment. I think the rate outlook is going to be quite important there. If we do see rates continuing to moderate 5% over the next year, that has a big benefit on the affordability of variable rate loans.

Speaker 1

So you wouldn't expect a repeat of that performance. If we look at the first half and second half, the first half on buy to let had seen a similar profile. So at September last year, our 3 month plus arrears were 34 basis points. By March, they doubled to 68. But over time, by September, those have come back to 38 basis points.

Speaker 1

So I think the certainly for the buy to let business, there's been more time for landlords to pass rent increases on and you have actually started to see rates come down on those variable rate loans. So we'd expect the same to come through on development finance.

Speaker 6

Thank you. It's Stuart Duncan from Peel Hunt. I have two questions, if that is okay. On redemption levels, you said about remortgage activity and what impact that would have, and where would you expect redemption levels to trend back towards? I think you made us stop passing comment almost around consolidation in the banking sector.

Speaker 6

Just be interested to know what you think stimulates that activity in the shorter term?

Operator

Okay. So redemptions, I think the if you do have to split our book up, there are 2 very different dynamics going on with the portfolio. So the redemptions in the legacy book tend to be higher, they're older, more seasoned. The last loan there got written in what 2,007, 2,008. So you can see there's a natural life cycle to some of those are getting close to their kind of final maturity.

Operator

So there's one factor related to that. Separately, you've also got just a dynamic of market activity. When the market's buoyant, the market's growing, you'll naturally get more redemptions. And clearly, we've had a couple of years where that's been weak on that side. What we would expect to see is almost like an equal and opposite effect in that redemptions on the book, the stock could go up, but you would probably outperform on the new lending side as well.

Operator

So there is a definite correlation between those 2, both positively and negatively. So I think the kind of the net loan book, which is ultimately the only thing that matters, unless obviously you're replacing different margins on the way through, It's probably neutral against those dynamics on there. The other one, consolidation, I mean, this is kind of like the thing that keeps getting talked about for quite a while. I think there's a lot of banks in the UK that do a lot of similar things and there's probably a need for a bit of consolidation. The trigger points to that is inevitably willing buyer, willing seller at the right price.

Operator

Sometimes those things stay apart for too long. Equally, you've got a bit of a cloud at the moment going on with regulatory change. You've had BOL 3.1, which is kind of like the mist is clearing on that one at least. But you've also now got the conduct issues on the motor finance side and that has it causes people to pause for thought on that one. So I think it will happen, but I've said that before and it probably well, it's happened in certain parts.

Operator

The Challenger community have seen a lot in the last year with the kind of the Virgin's and the co ops and the like, But the kind of the specialist arena are still expected to happen, but it just hasn't happened yet. And of course, we remain an interested party there. Is there any more questions from the room? Just need to check for the any calls coming in via the

Speaker 7

Yes. I've got a 2 part question here from Ben Thoms at RBC. I'll do the second part first. It's motor finance. Does the distinction between commissions paid to motor dealers and brokers really matter?

Speaker 7

I would just thought the key question is whether the commission was paid as part of the transaction and the amount of the commissions and methodology in calculating it was not disclosed to the customer. And then it's the second one, on consolidation. So I don't know if you want to do the first one first.

Operator

Okay. Well, in terms of the consolidation, I hope I answered that question. But if Ben wants to reach out and have another chat about it, tell him to just get in touch. I mean, there's a good disclosure on Motor Finance Commissions in the account Section 28 or Note 28. And what we set out there is a clear position of the maximum commissions we've paid to the dealers.

Operator

We set it out in total and we set it out individually whether it's by a dealer or whether it's by a broker. The reason for setting that out and the point which Ben has kind of raised there is if you look at the Court of Appeal cases that came out, those were all three of them were focused on car dealers. And the issue relates to the fact is that if you go in and buy a car, the kind of the communications piece or the judgment handed down was highlighted in the fact that the profits were expected to be made by the car dealer from the sale of a car, not from commission. And clearly, when you have a broker, there is no other income. It's just an expectation of they do some work on behalf of a customer to get them a piece of finance.

Operator

So there is definitely a different fact pattern that was definitely set out quite clearly by the Court of Appeal. We'll see in terms of what that means in terms of the as and when it gets to the Supreme Court, if it gets to the Supreme Court. But nevertheless, even if there is no differentiation between car dealers and motor finance brokers, the total that we're talking about is £49,000,000 of commission, which I repeat is not necessarily the liability.

Speaker 7

Actually, this question on consolidation was slightly different. Does it actually make it easier for you to progress organically? Is it easier now perhaps to get good underwriters with the consolidation that's taken place in the sector and the current motor finance issues?

Operator

I think that's the we've never had a difficulty in getting good underwriters or good people. But I said, therefore, I don't think the dynamics of whether the consolidation has happened nor the difficulties that may be being experienced by some in the motor finance space. So I'd say it's not really been a particular point that we see as important at this stage.

Speaker 7

I think that covers everything. Thanks.

Operator

Is that all from the phones? Yes. Okay. Unless there's any last minute questions, I'll draw proceedings to a close. Richard is available to talk to you today and tomorrow.

Operator

So if you want to have some already asked for calls. If you want to have a call with Richard, please do so, get in touch with him. And of course, we'll be around for a little while to come. So happy to carry on chatting if any of you want to talk. Thank you very much once again and we'll see you in 6 months' time.

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Earnings Conference Call
Paragon Banking Group H2 2024
00:00 / 00:00
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