Virgin Money UK : 2021 Interim Financial Results Fixed Income Presentation Transcript

Virgin Money UK PLC Interim Results 2021 - Fixed Income Presentation

Friday 7th May 2021

Virgin Money UK PLC Interim Results 2021 - Fixed Income Presentation Transcript

Hosted by Justin Fox (Treasurer), Richard Smith (Head of Investor Relations), Matthew Harrison (Head of Treasury Debt Capital Markets) and Stephen Hynes (Head of Structured Funding)

Justin Fox, Virgin Money UK PLC

Good morning, everyone, and thank you for taking the time to join us today. I hope you're keeping safe and well. You have myself, Justin Fox, Group Treasurer and I'm joined by Richard Smith, our Head of Investor Relations; Matthew Harrison, our Head of Treasury Debt Capital Markets; and Stephen Hynes, our Head of Structured Funding.

I'd also like to take this opportunity to acknowledge the efforts of Lesley-Anne Johnson and Dianne Wheeler, who will both be leaving us over the coming days. Not many people get to enjoy the career arc that they have both had over the year, with its highs and lows. We are certainly better off for having had the benefit of their guidance and experience. We wish them well for the future.

As a reminder, we've decided to start holding Fixed Income calls at every full-year and half-year results as part of our strategy to be more proactive on the debt investor engagement front. The presentation we are talking through today is on our website if you want to go and find it there. If you do have any feedback following today's call, we'd be delighted to hear it.

We've published some Fixed Income slides, and Richard and I will talk you through those. We're going to give you a brief overview of our financial performance in the first half of 2021 and what we're seeing across our balance sheet before taking you through the capital and liquidity position of the Group, as well as touching on our funding plans for the rest of the year. And then at the end, we'll open up for Q and A. Right now, I'll hand over to Richard to talk you through the first part of our first-half results. Richard.

Richard Smith, Virgin Money UK PLC

Thanks, Justin, and good morning everyone.

Starting on slide four. The Group's first half of 21 improved across the franchise, and we delivered a statutory profit of £72 million. Underlying profit more than doubled to £245 million due to lower than anticipated impairment charges.

NIM improved in the early part of the year rising from 152 basis points in Q4 to 160 basis points in the second quarter, which translates to 156 basis points for the half. The improvement reflects the continued success in reducing the cost of term deposits and improving our mix. We have also benefited from improved lending spreads and given this performance, we upgraded our FY21 NIM guidance and now expect NIM for the year to be around 160 basis points.

Deposits grew 1.5 percent in the first half of the year, with relationship deposits rising 12 percent as consumers and businesses continue to maintain higher balances during lockdown.

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Virgin Money UK PLC Interim Results 2021 - Fixed Income Presentation

Friday 7th May 2021

As you know we managed our loan book cautiously through the earlier part of the year, particularly in mortgages where we prioritised pricing over volume. Business lending remains stable and personal lending performed solidly despite a reduced demand for unsecured lending.

Our H1 costs of £460 million were down 1 percent year on year, however, during the lockdown we have had to rephase some of our cost initiatives and we now expect to deliver less than £890 million this year. We'll deliver those rephased cost reductions in H1 22, as well as other cost opportunities that have arisen as a result of the pandemic.

Asset quality remains resilient across the book. We haven't incurred any material specific provisions or experienced a deterioration in asset quality across any of our portfolios to date. Our H1 charge for the cost of risk was 11 basis points and we expect that the cost of risk will remain subdued this year but is likely to trend higher next year for obvious reasons.

Although we've refreshed our economic scenarios to reflect the revised more positive economic outlook, we have not yet experienced the pandemic without Government support. So have decided to maintain our prudent provision levels of £721 million, with coverage remaining broadly stable at around 100 basis points.

And finally, CET1 strengthened in the first half to 14.4 percent, 13.9 percent if you exclude the software adjustment in the period, and this leaves us with a management buffer of circa £1.3 billion above our minimum regulatory requirement.

Turning to slide five. On this slide, you'll see the March economic outlook as set out by Oxford Economics. There continues to be positive revisions since our Full Year Results, and this has been driven by a few factors. The biggest driver of which is the vaccination program rollout which has exceeded expectations, but also the government has continued to extend support well beyond the original plans which has had a big impact and finally, we've also seen material injections of stimulus in other major economies around the world.

The Oxford Economics outlook for GDP has therefore improved, and their base case now suggests that the economy will recover back to pre-pandemic levels within the next 12 months. Consumer spending levels are recovering and it's likely that spending will continue to increase as restrictions are eased further. In April, credit cards started to exceed the same period last year, rising to finish nearly 90 percent higher in recent weeks for credit card spending.

Importantly, expectations for peak unemployment levels have also reduced, but we believe that there is still likely to be an economic impact from the forecast unemployment levels when the government support ends. Another key indicator to watch closely will be how consumer behaviors around spending patterns evolve given the large pools of savings that have been built up.

Whilst this improving backdrop does provide some scope for greater optimism, the recovery is still in its early stages, and we think its right to remain cautious until the full effects of the removal of government support are understood. We're also conscious that we'll be living with variants of the current pandemic for some time. Hopefully, vaccinations will prevent any further lockdowns, but at this stage this can't be guaranteed.

Given the more optimistic economic backdrop and the strengths of our capital, funding and credit position, our top priorities going forward will be reducing the operating costs of the business, to accelerate our digital transformation, and finally, to build our customer franchise and experience.

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Virgin Money UK PLC Interim Results 2021 - Fixed Income Presentation

Friday 7th May 2021

Turning to slide six. Customer balances continued to grow during this first half as customers saved more and businesses carried additional liquidity. A large proportion of that growth is in current accounts, and as a result, relationship deposits increased 12 percent over the half. We improved our funding mix, reducing more expensive term funding during the period, which alongside re-pricing drove the overall reduction in cost of funds and our NIM expansion. We also reduced our wholesale funding given the growth in customer deposits, as maturing secured funding does not need to be replaced. Taken together, we expect to see a continued reduction in the overall cost of funds during the second half of the year.

Moving now to slide seven. You see here that we are managing lending balances prudently through this year as we navigate the pandemic.

In our mortgage business, we entered the year with a more cautious view on HPI and chose to prioritise margins amidst strong market conditions, with balances broadly flat during the first half of the year.

Business lending balances were also stable during the period as growth in government- guaranteed lending offset lower BAU lending, where we remained focused on managing margin over volume.

Personal lending continues to be impacted by tougher market conditions and declined 3 percent over the half. This was a resilient performance given the market context as we continued to benefit from a high proportion of balanced transfer cards, which are typically more stable than revolving credit facilities that rely on consumer spending. As restrictions have started to ease in recent weeks, we have seen some encouraging signs of consumer spending patterns, which will support card balances into the second half of the year.

And as we navigate the tail end of COVID, for the remainder of the year we will continue to be focused on maintaining pricing discipline and underwriting criteria, in what continues to be an uncertain environment. Looking ahead, we expect consumer lending to remain stable in the second half of the year and to grow thereafter.

Moving now to asset quality on slide eight. Overall credit quality remained stable in the quarter, with the proportion of Stage 3 balances remaining at 1 percent. Arrears and default levels remain low across all portfolios and forbearance levels remain stable.

We continue to support customers with payment holidays where appropriate, although we are only seeing around 1 percent of portfolio balances on a payment holiday, with the vast majority of those that have expired returning to making payments.

We've maintained a prudent credit provision level of £721 million and broadly maintained coverage ratios across all portfolios, with our total coverage ratio at 100 basis points. This produces a £38 million income statement impairment charge in the period equivalent to a cost of risk of 11bps.

During the second quarter, we updated our economic scenarios in order to reflect greater optimism and also refreshed scenario weightings to include a higher upside weighting. As a result, our Stage 2 balances reduced in the second quarter, and nonetheless, we remain prudent in the face of an uncertain outlook, particularly as support measures are withdrawn. As a result, reductions in modelled ECL from improved staging have been offset by increases in post model adjustments reflecting the economic uncertainty.

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Virgin Money UK PLC Interim Results 2021 - Fixed Income Presentation

Friday 7th May 2021

We expect the Group's near-term cost of risk through FY21 to remain subdued, but likely increasing into FY22 as government COVID related support measures are removed.

I'll now finish on the outlook on slide nine. We've made good progress in the first half of the year and continue to drive the key pillars of our strategy, which form the foundations of delivering double digit statutory returns and then profitable growth in the medium term.

Pleasingly H1 saw us generally able to improve the Group's guidance. NIM is now expected to be circa 160 basis points for the year, whilst cost of risk is expected to remain subdued in the near term through FY21. Costs are expected to be less than £890 million for the year and we will say more about them longer term at FY21.

I'm now hand back to Justin to talk you through the capital, funding and liquidity positions of the Group in more detail. Justin.

Justin Fox, Virgin Money UK PLC

Thanks, Richard.

As you can see on slide 11, underlying profit generated 100 basis points of CET1, whilst the £200 million reduction in RWAs during this period, largely reflecting the impact of business model updates and stable lending volumes, increased CET1 by a further 22 basis points. If you take away AT1 distributions of 12 basis points, the Group therefore generated 110 basis points of underlying CET1 capital.

While we expect it to be removed later this year, the new EBA intangible software benefits increased the CET1 ratio by a further 46 basis points but that was offset by exceptional items, including legacy conduct charges, restructuring costs and acquisition accounting unwind costs totaling 55 basis points, along with 2 basis points of other charges.

Therefore, CET1 -- the CET1 ratio finished 99 basis points higher at 14.4 percent on an IFRS9 transitional basis or 13.9 percent if you exclude the software intangible benefit, or further still, at 13.2 percent on a fully-loaded IFRS9 basis.

Looking forward, we are confident that we'll exceed the guidance, as Richard mentioned, of 13 percent when we exclude these software intangible benefits. Note the year-end guidance no longer includes any benefits from RWA initiatives, this is the move to IRB for our credit card portfolio and the adoption of hybrid mortgage models. These are dependent on regulatory approval, so timing remains uncertain as to when these benefits materialize.

If we then move on to slide 12, our capital position remains robust across all metrics. As disclosed in our Q1 trading update, in line with PRA policy statements, our Pillar 2A CET1 requirement reduced by 30 basis points in the period, to 2.2 percent, and is now set as a nominal amount which provides stability should RWAs increase during periods of stress.

The lower Pillar 2A requirement means our CET1 minimum requirement, or MDA hurdle, has also reduced to 9.2 percent, giving us a meaningful £1.3 billion CET1 management buffer on top of the £700 million of on-balance sheet provisions.

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Virgin Money UK PLC Interim Results 2021 - Fixed Income Presentation

Friday 7th May 2021

Total capital of 21.2 percent and the UK leverage ratio of 5.2 percent are still prudent, and at 29.3 percent we remain comfortably ahead of our expected 1st January 2022 end-state MREL requirement.

Turning now to the breakdown of our total capital stack on slide 13. As a reminder, our capital structure is reasonably straightforward. All of the Group's regulatory capital and MREL is issued by our holding company, Virgin Money UK PLC, and is fully eligible from the CRD IV perspective, there are no issues about grandfathering. There's also no FX exposure in the capital structure, providing stability during periods of market volatility.

As you can see, excess total capital of 6.8 percent over our regulatory minimum is largely due to our excess CET1.

We don't have a target level of AT1 or Tier 2 per se, but we aim to maintain headroom above the regulatory optimum to cover potential RWA increases that we model through our planning process.

Over the medium term, we will look to manage these buffers in an efficient manner through potential redemptions and any refinancing activity, without changing overall loss absorbing capacity.

Our call policy remains unchanged. Future capital call decisions will be assessed on a broad economic basis. That is balancing factors including relevant funding costs, current and future regulatory capital and MREL value, rating agency treatment, and wider wholesale funding needs. And of course, all calls are subject to PRA approval. We are clearly very aware of upcoming call options, but given what I have just noted, it's very difficult to talk about what we could do at this point.

For the AT1 investors out there, at the Company level of Virgin Money UK PLC, available distributable items of £790 million represents 10 times our 2021 AT1 coupon payments.

Turning to our MREL position on slide 14, in January the Bank of England published the Group's interim and end-state MREL requirements. As I've already mentioned, our MREL ratio of 29.3 percent comfortably exceeds our expected end-state requirements of 26.3 percent of RWAs. This means that for us, our future MREL issuance is solely focused on building a prudent management buffer, with no more than £0.5 billion of holding company senior debt issuance planned over the remainder of 2021.

One question we do get asked a lot is whether we expect to become leverage constrained for MREL purposes. The short answer is no, given our forecast RWA density we would expect to remain RWA constrained for MREL purposes.

Turning to our funding and liquidity position on slide 15. As Richard has already mentioned, we saw customer deposits continue to grow during the first half as customers saved more and businesses opted to maintain higher levels of liquidity given the uncertain backdrop. As we look into the second half, we will continue to manage prudently for COVID, as the persistency of those deposits is difficult to gauge depending, in part, to the extent to which consumers and businesses need to utilise the savings they've accumulated. The Group continues to expect some reduction in deposit balances as we continue our strategy of optimising our deposit mix. Given our higher customer deposit balances, we have taken the opportunity to reduce our wholesale funding stack

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