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Edited Transcript of ARW.L earnings conference call or presentation 8-Aug-19 8:30am GMT

Half Year 2019 Arrow Global Group PLC Earnings Call

London Aug 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Arrow Global Group PLC earnings conference call or presentation Thursday, August 8, 2019 at 8:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Lee Rochford

Arrow Global Group PLC - Group CEO & Executive Director

* Paul Cooper;Group CFO & Executive Director

* Zachary Jason Lewy

Arrow Global Group PLC - Founder & CIO

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Conference Call Participants

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* Anthony Da-Costa

Peel Hunt LLP, Research Division - Analyst

* Gary Greenwood

Shore Capital Group Ltd., Research Division - Research Analyst

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Presentation

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [1]

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Good morning, everyone. Thank you for coming, and welcome to Arrow Global's first half results. I'm going to kick off today by talking through the highlights from a financial and a strategic perspective. Zach will then talk you through the fantastic momentum we're seeing across the franchise, followed by Paul who'll take you through the numbers.

And I'll finish with a quick summary so that we've got plenty of time for some Q&A at the end.

So we turn first to Slide 6. You can see good year-on-year progression for all key financial metrics. As you know, Arrow is a highly cash-generative business, and this starts with our core collections. I'm pleased to say that in the first half, they increased by over 13% to GBP 202.1 million. This excellent performance is supported by our continued underwriting outperformance and has helped to drive free cash flow up over 28% to GBP 115.3 million.

I want to emphasize the importance of this figure as it gives an indication of the real cash generation in our business prior to new portfolio investments, and our optionality in terms of how we choose to deploy this cash.

We noted at Q1 that we deliberately rationed capital in anticipation of higher returns later in the year. This strategy has been well executed, and I'm delighted this has translated into investment of GBP 165 million, up 13% year-on-year; at the same time with an increase in net IRRs to 18%, up 2 percentage points to a 4-year high.

I'm particularly pleased that these returns have been produced on the combination of our specialist platforms and unique origination model and our more recent acquisitions, particularly Europa Investimenti and Norfin generating new opportunities of really strong returns.

These businesses are evidence that our focus on high-value niches is the right one. Zach will walk you through how the enhanced forensic underwriting expertise has enabled us to undertake transactions that are of more secure in nature than other asset classes.

This is contributing to our higher returns, albeit the underlying cash flow and IFRS earnings profile is less front-loaded compared to some other asset classes as we explained in Q1 and Paul will cover today. These assets are extremely attractive assets to own within a balanced portfolio. In addition, they're also extremely attractive to our capital partners. And in the future, the majority of such positions are likely to flow through the [mason] fund management business that we continue to build.

Our decision to invest less capital in Q1 had the result of significantly reducing leverage as well as net debt due to the businesses' high-level of cash generation. As previously guided, leverage has marginally increased since then, commensurate with the larger-portfolio purchase volumes. Notwithstanding this, leverage remains lower than where we started the year despite the growth in the book, and we remain committed to our medium-term leverage target of 3x to 3.5x, and we remain confident of being in that range by the year-end.

If we turn now to gross AMS income, you can see that it grew 14.4% to GBP 68.3 million as we saw solid performance in the underlying business and strong contributions from our new acquisitions. The expansion of our AMS Business remains a key part of our 5-year strategy, and we'll address some important details on that strategy today.

Operationally, the business performed very well in the first half as highlighted by the 6.9% increase in operating profit. Underlying PBT is up just under 1% year-on-year largely due to increased finance costs as well as the higher revaluations that occurred in the first half of last year, both of which Paul will cover this morning.

Statutory profit increased by over 200% to GBP 32.5 million due to significantly lower adjusting items.

Underlying ROE continues to outperform at 32.7%, significantly above our mid-20s target. Altogether this has put us in a position to recommend an interim dividend of 4.4p per share, an increase of 10%. We remain committed to our payout ratio of at least 35% of underlying net income.

I'm pleased with these results today, but as we set out at our Capital Markets Day, we'll always favor cash generation and sustainable long-term value creation over short-term earnings growth.

We believe we've got a compelling strategy to transition Arrow to a more capital-light model.

As we've set out today, we've decided to accelerate these plans, and 2019 is therefore an important pivot year for the business.

So we turn to the next slide, as we explained at our Capital Markets Day, our vision is to be the innovative and valued partner in credit and asset management. To date, we've been extremely successful in putting in place the building blocks.

We've created a differentiated business model and market-leading platform, positioning us to capture the massive market opportunity in a unique way, 2 interdependent business lines serving our vastly expanded client franchise and feeding each other with opportunities in a largely closed ecosystem of off-market deals.

We carefully created that platform over the past 6 years by acquiring 12 servicing businesses that enabled us to target the high-margin niches in each market that we find attractive. The One Arrow program ensured that we successfully integrated these businesses, instilling the right culture, oversight, capability and resourcing of a center, necessary to turn our 12 acquisitions into a single pan-European business capable of operating at scale.

Combining these capabilities means we can support our clients across an impressive spectrum of granular asset types from consumer to mortgage to SME to small ticket real estate and to securitization of structured credit.

We are the specialist partner of choice for our clients in these granular asset categories in our 5 countries. The market approach makes us relevant to a high percentage of the deals available and makes us strategically important to our clients. This has positioned us well to invest our own capital directly into this enormous market at industry-leading returns. And in addition, it's made us the partner of choice for sophisticated institutional investors seeking exposure to the underlying assets, resulting in a successful track record of investing and managing third-party capital. Consequently, we now have EUR 58 billion of gross book value under management.

It's a wonderful platform that gives us relevance and pricing power and off-market deal flow in our market. And I'm particularly proud that nearly 80% of our dealers are off-market. That's really a testament to our differentiated business model and quite unique in financial services.

This growth and evolution of business model has naturally led us to focus on our next 2 key strategic priorities: firstly, our ability to grow our fund management business. Alongside building a track record of investing and managing capital for our investment partners, we've also acquired 2 regulated fund managers: Norfin and Sagitta, a subsidiary of Europa Investimenti.

We already have EUR 1 billion of AUM in our fund management business, and we're confident we can grow this business materially.

And secondly, now that we've successfully consolidated our business acquisitions into one cohesive platform, there's now a clear opportunity to benefit from our enhanced scale and drive efficiency and remove costs.

When you bring all this together, we're highly confident we've created the foundation of a successful capitalized strategy.

This will see us drive AMS revenues from the current 1/3 of gross revenues to 50% as well as to drive AMS EBITDA margins to at least mid-20s over the next 5 years.

Let me now explain how we intend to do this, and how fundamental a shift in the business model you should expect to see. Slide 8 illustrates that we have a unique and compelling market offering for our fund management business. This underpins our confidence in our ability to expand our offering to third parties, and what exposure to the high return assets that we can originate and manage. It clearly shows that our differentiated strategy means we do not compete head-on with the large global debt funds and the European funds.

In fact, many of them are our clients, and no local competitor has our scale and reach focusing on smaller transactions originated off-market.

Given this and the massive market opportunity of the [buyer now] scale platform, we've decided to accelerate the move to build our fund management business at a group level. We've announced today the formation of a new subsidiary, AGG Capital Management, and the appointment of Andrew Grimditch as its CFO. Andrew brings sector-specific experience that will help Zach and our investment team of a discretionary asset management products to our capital partners. We've dedicated significant resource to this capability build and have also bolstered our risk management and commercial teams to prepare for the growth in this attractive business segment.

AGG Capital Management is expected to contribute favorably to the accelerated development of the fund management business by its continuation of the trusted fund management business activities already within the group, including the activities of Norfin and Sagitta.

Slide 9 shows that the combination of our local in-market -- local teams in market and our centralized structuring and investment team is really powerful. Combined with local regulated specialist servicing platforms on the ground, we're able to originate smaller deals away from competitive auctions at higher returns.

Many of you have seen a version of Slide 10 before. Without all of the components of the Arrow machine, it's impossible to do what we do, and we now have a platform able to do this at significant scale, exceeding our own balance sheet capacity and that's [telling]. And this is what provides the opportunity to connect our deal flow to third party capital managed by us on a discretionary basis.

Building out our fund management business will play a key role in accelerating the delivery of our AMS targets by allowing us to capture more of the economics in a typical Arrow deal.

Slide 11 demonstrates how Arrow will increasingly reduce its capital intensity, but capture more fees from a wider range of services from traditional, collection-based servicing fees to management fees and in time performance fees.

It's really important to emphasize this doesn't represent a move away from our co-invest strategy. It just positions us to be able to purchase and manage more of the equity structure, while still investing alongside our roster of capital partners.

Successfully executed, I truly believe this will be transformative for Arrow's business model. As I've said, we envisage investing alongside third-party capital managed by Arrow. It is possible that as we execute this strategy, we'll choose to do so at slightly lower levels of capital investments at least in the short term.

In addition, there also exists a wide range of assets where we like the risk profile, but inevitably have limited appetite currently since they don't fit neatly in our IFRS-managed balance sheet. Our ability to originate and underwrite these assets will enable us to grow our discretionary activities faster.

And together, these 2 points mean additional cash generation from our scaled-up fund management business will support the lower leverage levels that we're committed to obtaining.

A further fundamental point I'd like you to fully appreciate is that this strategy is executed of a scale that we envisage. It will rapidly enhance the business model by ensuring in time funded through the capital markets becomes one funding option, not a necessity, providing infinitely more capital flexibility in the future. Put another way, we believe this is transformative to remove the primary reliance on a single source of funding.

This decision to accelerate our plans for our fund management business will have some short-term earnings implications. This arises partly because we'll incur additional costs in the build-out phase, but also because our 2 existing fund managers will grow more slightly than planned in the short term. We'd originally planned to grow these businesses this year through offerings at a local level. And we remain committed to this strategy in the longer term, but the opportunity to accelerate at a much larger scale by the group has become so apparent that all of our focus and resource is now on achieving this.

This year's emphasis in strategy is really exciting, but it will mean a delay in these local businesses contributing to our P&L as envisaged. Building a larger scale operation undoubtedly offers more value to shareholders, and we're convinced this is the right short-term focus that will create significant long-term value. I, therefore, encourage you to look at the end goal rather than the next couple of quarters of earnings while we execute that plan.

Sitting alongside the acceleration of our capitalized strategy and equally integral to our confidence that we'll hit, if not exceed, our AMS guidance is our continued drive for simplicity and efficiency in our servicing platforms.

I should expect 12 acquisitions over 6 years contain duplication. We also have asset growth in certain markets that exceeds other markets. And as prudent managers of capital, we want to focus our fixed cost in niches where the platform and the capital deployment growth opportunities are the strongest. And then finally, we want to continue to drive positive operational gearing by establishing centers of excellence where certain operating activities are best performed.

We talked to you before about the Big Three, BAU efficiency programs, already transforming the way we run the business. These had a major impact on the way we think about the business, and we expect to see the benefits flowing to our earnings from Q4 this year as our run rate cost starts to reduce.

Our focus has now inevitably turned to the next phase of our efficiency drive. We've conducted a full review of our operating model and cost base and believe there's significant opportunity to remove duplication and align the overhead more closely to our capital allocation.

We've identified benefits from what I call our Whitestar model, our market-leading Portuguese platform. In other markets, we got the same opportunity to merge our existing capabilities into multi-asset class servicers with common support staffing and infrastructure without impacting the revenue-generating activities.

In addition, we've got an opportunity to rationalize our IT platforms, removing legacy and benefiting from the use of more reliable cloud-based technology.

We, therefore, commenced a simplification program that will result in GBP 20 million of run rate cost savings by the end of 2020. This will entail a cost to achieve also in the region of GBP 20 million, the majority of which we anticipate incurring in H2 2019. We believe this is a compelling payback. The benefits will be felt most strongly in our AMS business and will support a significant acceleration of our margin guidance of the mid-20s March EBITDA margins.

In addition, we expect growth in our central function costs to slow materially.

This initiative will contribute strongly to increased cash generation and the improved quality of our earnings. Together with the pivot in the business model that I've set out, it means that our earnings will be proportionately less capital intensive, less reliant on noncash adjustments and underpinned by predictable capital-light fees at sustainable higher margins.

Altogether, this will underpin the operating leverage potential on our new scalable platform and drive a positive jaws between revenues and costs.

The 2 initiatives that I've set out today bring benefit to our medium-term targets across the board. And it's worth remembering that these are 5-year targets that we only set out in November. Most notably, it will accelerate our progress towards our revenue and margin targets for our AMS business. The enhanced cash generation should also result in deleveraging well into our target range.

The start-up costs associated with the plans for our fund management business means we shouldn't expect this activity to be accretive to earnings until 2021. And while the associated overheads aren't adding cost to the business in the short term, in time there'll be more than offset by the simplification program that we've announced today.

We remain confident we'll achieve our cost-to-income target ahead of previous guidance. All in all, I believe we've got a compelling strategy for the long term, and that the pivot we're undertaking is both essential and creates attractive value for shareholders. We are mindful that we need to execute well, but I believe we've got both the team and the plans in place to deliver that.

Now I'm going to hand over to Zach who'll talk you through the commercial performance in the first half, and his work on delivering our strategy.

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Zachary Jason Lewy, Arrow Global Group PLC - Founder & CIO [2]

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Thanks, Lee. Good morning. So it's obviously been a very active quarter and active first half of the year. I start with this slide, which I think explains some of the context of the increased volume and the high purchase rate that we saw in the second quarter and the improvement in returns, which is there was a significant regulatory event that happened in the quarter that, I think, is helpful to our forward-looking volumes, which is -- in April, finally, at the EU-level path to regulatory backstop, to how assets get ringed down on NPLs within banks. That's important because obviously, banks can write them down as quickly as they want to, but given the regulators effectively have put the banks to stress test, asset quality reviews. IFRS 9 has had an impact. You've had Basel III, now Basel 3.5, IV, a whole series of initiatives that have tried to improve bank's balance sheets.

The obvious signaling effect that the regulator felt is further necessary to put a backstop to make sure that asset write-downs happen to a schedule is an important message in terms of the tone it sets for banks that they supervise, but I think also from the market in terms of the sales volumes, which we'll show you on next page. The thing that is important is this. So banks can write them down as quickly as they want, but this is the minimum pace they need to write them down, and which you understand from banks is once they start writing them down, that is capital disruptive, right?

So how much they sell the asset, they're taking the loss without the corresponding recompense. And so when you meet with the banks and we've had, obviously, a lot of time with a lot of the banks in the region, and you see on the bottom of Slide 16, the high NPL rates, the tone we're getting, which is obviously the shadow of the regulator, if you will, is that we're 10 years past the crisis. If you still have NPL rates in the 20s -- and we're probably closer to the next downturn than we were to the prior downturn, and it's been 10 years since the last crisis, the idea that you are still holding NPL rates in the 20s, we're never going to let you enter the next phase of a crisis at that NPL rate. And so you definitely feel effectively the hand on the shoulder of the bank saying I really need you sub 5. I don't want you to start the next phase of a cycle -- entering that cycle at greater than a 5% loss rate. And as you see here, there's just an enormous distance for some of the banks to go to get to that level, and that's clearly front of mind for all those banks in terms of assets they need to sell that comply with this regulatory update.

That's the primary market. If you look to the secondary market, basically, there's a timing effect. I think this is important to understand which is obviously on the day an NPL is created, 100% of that happens inside a bank. But as you go T 1 years, 2 years, 3 years, 5 years, 10 years, 15 years, given the lifespan of some of these markets and some of these asset classes, increasing wallet share goes to operators like us, i.e., the day it gets created, the banks haven't sold any yet. If they are selling $1 trillion or $2 trillion, depending on which market we are playing in, they sell them in relatively big chunks. Those funds that buy them are fixed-term, fixed life funds. They resolve what they can, and then they sell down and/or outsource and ultimately, exit -- 100% exit the end-of-life tail positions to guys like us. So our wallet share is relatively low at the time an NPL is first formed and very high as NPLs get to the maturity of their life.

And so there is a lag effect in which we can see our forward feedstocks. If you think about what we're buying today, it is the back-end of crisis euro funds. So where funds are our clients, and we talked about that early -- earlier in the presentation, it's their 2008, 2009, 2010 funds, it's funds they raised in a crisis were relatively smaller and then deployed in the recovery. You are now getting, as we look forward to next 3 to 4 years to a position where these are funds that were raised in 2010, '11, '12, '13, much bigger funds. These are the guys who bought all the [NAM] assets in Ireland, et cetera. So these are much larger vintages that you see, and you see the growth on Page 17. I mean it's an extraordinary 5x growth over time.

As those get to end of fund life and our wallet share increases, it puts us in a very strong position to have increasing volumes go through the platform, but also allow us to be far more selective on IRRs where we have very high market shares in those secondary markets.

Going back to the primaries, if you look at where our sources of volume are, you have NPLs, you have noncore primaries and then you have the secondary market. I'm going to focus just on the first of those 3, just on bank's NPL primaries. And I'm only going to focus on granular assets, so ignore derivatives and ignore corporate credits and things that we don't do. Just in the granular asset classes, so consumer, small business, mortgage, real estate, Italy, Portugal, U.K., Ireland, Netherlands, we show you here what the composition of the assets are.

And we -- you really do see a material shift over time from the point of our IPO when we were only in 2 asset classes, which were U.K. and Portugal consumer, and hopefully, this graphic makes it abundantly clear why. Basically, obviously, right after the crisis, banks have provisioned consumer assets to a point they could sell them. They don't have as many left. But that was effectively the tip of the iceberg, so the 5% that amounts to consumer assets really was a forward look at the rest of the disposal programs, which are much, much, much larger in size as you see. I mean it's literally 95% versus 5%. And what you need to think about in terms of capital deployment is, let's say, the consumer assets sold for 5p or 10p in the pound, these other assets can sell for 30p, 40p, 50p in the pound if there is real asset collateral behind them. So buying 5% for 8% purchase price is a completely different capital requirement to buying 95% to the 35% purchase price, right?

So where we sit now is having given the banks time to provision, the small business loans, the mortgage loans, the real estate loans, the loans that do have underpinning collateral value, the banks are now at a point where they have enough provisions to sell. To the extent they don't, the backstop is kind of fixing that problem. And so you just see a torrential amount of volume that is going to come out over the next 5 years, which is why Lee was so clear that growing our wider fund management business to have the capital requirement and the scale there to go with our operating platforms really gives us effective synergies and a really beautiful model taken together.

So what you'll know, and I'll toggle for a second between Slides 18 and 19, is -- you'll see the categories that are on Slide 18, consumer, small business, mortgage, real estate in the countries we're in match very neatly to a very deliberate strategy of buying companies to be in the same places in terms of consumer, small business, mortgage, real estate, master servicing giving us the data. I can't emphasize enough how valuable this platform is to the franchise.

So we have 35 million data records, we have GBP 58 billion under management. We sit in a place where we are the scale operator in our chosen niches, and we have huge information, operating and scale advantages.

That is synergistic to a wide array of business model development. So obviously without this big platform, we would not be as confident to raise, in that sense, as big a fund management business because you, obviously, need the two to act in harmony, right, the size of the fund management business development to be roughly proportionate to the market share you have as an operator, and those two deliver synergies obviously. One gives fantastic sourcing and servicing to the fund management business, one gives capital and scale to the servicing business, the two have a fantastic harmony between them.

It really allows you to grow enormously without -- while deleveraging without the need for any capital intensity. And that's a really attractive place to be. I'll show you that both plays into volumes and returns on the coming pages.

So the first thing I'd say is this is already happening. So I mean if you go back to 2014, 100% of the capital we deployed, Page 20, was Arrow's balance Sheet, so the GBP 137.7 million. And if you're buying 5% of the underlying asset base in consumer for 5% of face value, it's reasonably clear why we have the capacity to balance sheet all of that.

If you roll forward and you see the volumes that followed, which hopefully now it's very visible what's driving those volumes, you see you're in a completely different scale. So going from deploying GBP 137.7 million to almost GBP 1.9 billion in a 5-year span is just an incredible growth. And our own capital deployment, which was 100% at the time of IPO for everything we bought, we funded it by our balance sheet, that proportion is now down to 14%. That signals quite a few things. One is we're pretty experienced doing this, and two is that we do have capacity to grow our own fund management business deployment without really taking away any real opportunity from coinvestors who play in the market segments that are more of the global buyout segments and not really the mid-market and operator segments where we play. And so as you see, this is something that's developed well, going from sub GBP 115 million to over GBP 1.9 billion in the time frame has been incredible scale in growth. And to my points in the first 2 slides, we're just at the beginning of that cycle. I mean there's -- in the next 5 years, this will have, if anything, an increasing expansion of that development.

If you look at it in a different way, so Page 21 shows how we break down the GBP 58 billion. We have GBP 36 billion, which is effectively servicing for other people; and just about GBP 22 billion, which is servicing for ourselves. If you think about that and just pause for a moment, we -- the GBP 22 billion is an amalgam of everything we acquired since 2005 through to now, so we've had almost 15 years to build up that volume book. The GBP 36 billion is the result of the last 4 years of servicing for other people. At the time of IPO, that was 0, effectively 0. So this is a trend that isn't new. It's just the scale of it is obvious, and we think that done right, we can access a far greater plateau that creates, as an owner of fantastic synergy, an upside to that.

And then switching out to our returns and effectively the buying performance in the quarter. When you look at Page 22, Lee showed a quite similar slide to this earlier, I just want to emphasize how it affects us as a buyer, which is these are really different business models. So depending on how familiar you are with the NPL market, you know I've done a long-term effort in these meetings to try to articulate the difference between the different franchises, so investors can judge who has access to what deals and who performs in what ways. I just want to effectively reemphasize that I think it's the right context to how we performed in the quarter.

So you've got the large-scale buyers. They're inherently migratory, right? They change countries, they go to where there is distress. So they might buy in Italy one day, Greece the next, China the next, Brazil and so on.

We are not those guys, and they may have 20 people sitting in London or whatever shape they're in, but there's a small number of people who operate more like a trading desk. And then you have regional opportunistic buyers who have special [SIP] funds in general. They are also migratory. So where there are special situations, stranded assets does move around. And hence they need to buy different types of assets in different geographies often with leverage and again, usually about 20 people typically sitting in Mayfair basically running around Europe, trying to buy these things.

If you look at us, the difference is really noticeable, right? So we're 2,400 people. We have the conduct side of banking license in a lot of markets where we operate. We do lots of small deals, so we buy things where the average purchase price is EUR 3 million. I mean that's just a really completely different operating niche to the others. So you look at those first 2 categories, there may be, in the history of that whole sector, nobody who's managed or been bothered to do a deal for GBP 3 million, in the sense they -- if all you earn is management fees, GBP 3 million as a purchase price is noninteresting number. And so we really operate in both in investing niche that's pretty unique to us and a servicing niche that we've built very deliberately over the years that's maximized opportunity, and that's translated into this quarter effectively or this half year. The IRRs have increased, so we've been able to be increasingly more selective as we look at the different deals and the different asset classes. And we'll talk through the asset mix later in the presentation. GMMs are back up to 1.9, which is encouraging. So we are translating all the things I've described in both the supply and demand of feedstock, our own platform, we're translating that into pricing power and the ability to drive up returns while also putting up pretty record levels of volume.

And again, I think the stat we are always proud of is the 78% off-market. So in these small deals where we tend to dominate, where they tend to be operating niches that require our platform, we tend to be in good shape in terms of getting those into bilateral processes from repeat clients, and that's again driven the strong performance this half year.

If you look at the volume splits and again, we can't resist showing effectively the period-on-period change over the 5 years, you would just own a much more diverse business. I mean it shows through every single metric, and it shows here as well in terms of the composition of the vintages. You'll see probably the most notable component is why Italy is so big. I think that has two pieces, which we'll talk to. One is we think we have a really unique operating niche in Italy, which is high margin and low risk, and we'll talk to why we are excited about that. The second thing is that, basically, as you look through, effectively, I don't think that a tiny piece will be as big as that on the go forward in the sense that I don't think as a permanent basis, Italy will be half albeit the market size as you saw on the earlier slide would justify a large allocation to Italy.

This is probably as high as we'd want to go. However, what I'd say when you look at the top right is we are doing a lot of secured activities.

So we mentioned that the quality of the actual collateral and the effectively asset quality we're buying has been rising. That is definitely the case, and we'll talk through some examples of that in the coming pages.

So if you look at our back book, I guess one pause in it whilst Italy was big in the half year at 50% which, again, I think is we'd never want to go higher than that. It's still a diversification of the back book. So obviously at the time of IPO, the back book was effectively mostly U.K. and a bit of Portugal. That's now evolved into a balance, and so part of why we -- we're happy to deploy at 50% in Italy in the first half is it naturally balanced us. We will clearly hit a point where that is not the case, where Italy is fully represented, and we'll have to taper back the balancing to achieve that, but we had really good opportunities this quarter. And so we took them, and it resulted in a more positive balance in our back book.

You go to Page 26, we talk about our loss rates. The thing I'd say is if you go back to that slide in your mind where we are the local operator, we're using the 35 million data records and the fact that we're the incumbent operator in markets that often have requirements in the conduct side of the banking license, meaning you may only have 1 or 2 or 3 regulated players who have the right to buy to positively select the assets we want to buy. When you're 80% off-market, you're doing your own diligence process more or less how you want to in the sense that if the decision you're being asked to, whether it's either the collateral value, whether it's how the asset presents, so imagine you're looking at a deal where there is a tax claim ahead of you, or the documents aren't clear, or the date that the seller gives you doesn't match what you've seen in court, or you've already got an exposure to that and you don't want another, or you have a bad history with something and you want to carve that out of the perimeter of what's for sale.

When you're off-market, you can make that positive selection. So not only can you design the due diligence process on a bespoke basis to match, what you see is the opportunity and to put the appropriate risk management around the underwrite of that particular deal, but you also have the right to effectively shape what you want to buy both in terms of being selective. So choosing not to bid things that you don't find attractive, but also even when you do buy, buy things that are quickly cash generative and things that you like in terms of the risk reward on offer. And so having 2,400 people, having 35 million data records puts us in a completely unique opportunity to do that.

I finally end that slide by saying the fact that we are not migratory. We're steadfast in our 5 countries, and we are super deep in 5 fixed countries where we are operating 76% on our own platforms, really puts us in a place where we can make those decisions very consciously. And so that's why we have such a low loss rate. And so if you go over the last 10 years of the deals we've done in terms of write-downs, not impairments where you wind up hoping to collect 2 and collect 1.8 or something, but actual write-downs. I'm not collecting your original purchase price back, the totality of the GBP 1.8 billion we've invested since 2010, we've only taken an actual capital loss on 0.3% of what we've bought.

Now if you also had experience in direct lending or other types of finance, I think this shows how safe an investment style this is i.e., if you make lots and lots of lots of small individual diversified risk decisions in the method I have described with the data and the operating capability I've described, and you get all the discount before you buy it, so you're buying at a huge discount, this just gives you a data point to show you the power of what that discounting is worth in terms of risk management.

Going to Page 27, I guess again, trying to show a similar theme and be more transparent in the mix effect. So I think in several different presentations, we've talked to mix and so on. I think this should hopefully give you a much clearer view of that. So what this slide on Page 27 shows is on the x-axis time since purchase; on the y-axis, it's percent of purchase price recovered, right? And what you see is that the asset classes do perform differently. So the dotted lines are unsecured exposures, the solid lines are secured exposures and the countries are different colors. And what you basically see is they each have their own profile. And so by being active and very deliberate to allocate our capital, you can build sensible money multiples and sensible IRR profiles and sensible exposure balances by effectively buying different cash flow streams that add up to a balanced vintage. And that is exactly what we do. So we lay out a [percent] plan, and that's what we buy against.

We obviously are opportunistic to optimize capital returns against that and to minimize losses, but it produces this attractive cash feature that you see on Page 27, which is after a year we tend to have 35% of the money back gross and so on. It gives you effectively de-risking from the go by buying -- on average, having different asset types that produce rapid and helpful cash payback. That's why we're such a cash-generative business.

I would close that by just saying because we tend not to lever the individual assets, that cash payback is quicker, right? So if you're in different categories of NPL buying where you bought really big things, with leverage, you'd have a waterfall and the senior debt would get paid back first and so on. The fact that we're buying smaller things so we tend to buy unlevered means that cash payback is quick, gives us more cash flow to go buy more portfolios with. It also allows us to effectively amortize our exposures. So that if you have a downturn, if you have a Brexit, if you have something that's negative, you are effectively re-basing the price daily as the amortization effect that gives you the cash back. You are not waiting for some big, heroic event later.

We talked about Italy, and I think we do want to just pause on why we're confident, and why we're enthusiastic about that particular investment strategy. So in Italy, we really only do two things from a buyer perspective. One is we buy from clients who want to sell positions on our Zenith platform where we're a very large master servicer. The second is we buy positions with Europa Investimenti, and this is an important line of business for us as you see given the large capital allocation to Italy. In this past half year, we wanted to give a slide to it. So let me try to explain succinctly what that business does. We have 60 people in that business. The business has been a very consistent buyer. As you've seen, it's bought EUR 156 million since 2010 with only EUR 1 million aggregate write-off position typically returning very high IRRs.

What they -- they are the market leader in buying bankruptcy claims. So what they do is they look at positions in bankruptcies, and we track thousands of bankruptcies forensically with our 60 people. And what we're looking for is positions where real asset value exceeds what we think we can buy the unsecured claims in the bankruptcy act. So in effect, imagine there is effectively GBP 10 million of cash in courts say, and imagine the unsecured claims are likely to get half of that, we tend to buy at a discount to that price.

So in effect, due to the complexity of the court process, in effect, there are 600 different Italian banks, you get a chance to buy up 2%, 3%, 4%, 5%, 6% claims in that creditor class at a discount. Once you've done that, you then also have a strong voting position, which you are able to go to the judge and also try and buy effectively the GBP 10 million at a further discount, and one of 2 outcomes come from that. The judge says, yes, in which case you crystallize both discounts the first of which paying back -- effectively, you get paid back on your original unsecured claims from the benefit in the sense that the payment you made into court to buy what's in court pays back the actual claims that you've acquired.

So that's why when you look back at that payback curves we showed on the earlier slide, it's how you know unsecured pays back quite quickly, or somebody bids higher than you and you don't get to buy the GBP 10 million that's in the court, but all the claims you've bought up to that point effectively get cashed out at a premium. So you win either way. The only downside to this strategy is if you don't build a voting control position, but since -- the Europa team has been doing this since 2010, they're in a fantastic position that for 100s of bankruptcies were already effectively in voting control. And you can't get caught from behind, right? No one can push you out of that position.

So this is a niche where data is helpful, but what's super helpful is twofold: one, your competitive advantage grows over time, right? The more voting positions you control, the more influence you have, the stronger you are. The reason this business has so much synergy to Arrow is that if you look at what's inside the bankruptcies we target, they are stuffed effectively at different origination channel into the very same assets that fit that platform description we showed earlier.

So what are we getting, we're getting unsecured claims, we're getting secured positions, we're getting effectively the collateral that goes with mortgages or real estate, and we're accessing effectively the same asset classes plus cash in court at effectively a double discount. It's a fantastic business in which case as long as the first purchase is at discount to the collateral that's inside the perimeter, you lock in a win, and that win only grows if your voting control or somebody else bids higher leads you to effectively double dip.

I just want to end that slide by pointing out 50% of the 5 biggest investments we made in the space were against cash in court. We're literally buying cash at a discount with a 20% IRR. And the reason that has long-term sustainability is think about what's happening in Italy itself, so guys invested about GBP 200 billion into the Italian market. One of the securitization reports we've seen, they collected GBP 8 billion in the early goings of those. They have a huge distance to travel. And if they're late on their time frames, which in Italy is inevitable, and they're sitting up against fixed fund lives, they are very active sellers of these positions.

Now they have no ability without the platform to actually aggregate voting control, so if I'm a big fund and I bought a big portfolio in Italy, and you read about that in the paper every week. And I'm sitting here, and I'm a 4% owner of a minority bankruptcy where I have no voting control and I'm passive and a minority, I'm literally a hostage. I could sit there for 20 years in a 5-year fixed fund with my IRR clock burning.

And so those guys are foresellers. Look, you own the largest securitization trustee of its kind, so you have a huge knowledge of that marketplace and the full business ends. And you're also the smart buyer with 60 guys who are huge, like deep analytical guys who have all the court relationships and all the asset valuation skills and you've got a partner to service the assets, you really are in a unique franchise position to play. And so in Italy, we really just do these too many factoring activities, basically supporting the Zenith business by buying from that platform and effectively driving unbelievable risk-adjusted returns in the Europa Investimenti business, which I think shows through in every stat about Europa in terms of low loss rate, the high IRR, and why that's a unique business that gives us advantage.

However, and this is one thing I just want to highlight is, this -- the one kind of idiosyncrasy that comes out of that is, as you look -- the maturity of the business from being effectively unsecured in U.K. and unsecured in Portugal, so effectively two asset classes that had smooth monthly cash flows into being effectively 5 asset classes in 5 countries, what you'll find, and we'll give you 2 examples deals here are, it's not that every single cash comes back in equal amount every month, right? Because my example of the Europa Investimenti business where you buy a secured book and a piece of real estate is sold, these are not entirely smooth experiences. You will have cash flow peaks and troughs. And so the good side of embracing these asset classes is it provides tremendous scalability for the servicing platform and tremendous scalability for the fund management business. The other good side is it's where the 95% of the market is, so by volume and even more by purchase value, and it's where we have leading servicing platforms. So we do need to embrace it, it's the market opportunity, it's what's going to fuel the continued exponential growth of our AUM.

But the bad side of it is the cash isn't monthly. I create an interesting challenge for Paul is that the cash flow isn't literally smooth monthly. And so part of Lee's point about the next few quarters is you do need to work through as we are scaling up activity, the overall size of the prize as an owner is spectacular, the pathway to get there won't be literally walking down the garden path. There will be various turns as we go towards that. And so this just gives you examples on Page 29 of how you basically take control, build a position, sell a building, take control in Portugal with the largest REO seller in Portugal. 1% of all real estates sells in the whole country. I mean we've got a huge platform there between Norfin and Whitestar. Gives us a fantastic advantage, allows us to price everything down to the street or building level, which nobody else can do, and priced down the individual court level. But it doesn't mean when you buy them, you've got the lumpiness of selling the buildings one by one, which, obviously, we need to be transparent about.

With that, I hand it over to Paul.

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Paul Cooper;Group CFO & Executive Director, [3]

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So thanks, Zach. Good morning, everyone. It's great to present such an operationally strong set of results for the last time I stand up here in front of you or at Arrow. While the operational numbers are good, there are a couple of distorting elements outside of our control that impact the bottom line, and I'll highlight these as I go.

So cash income, which is the total of cash collections from the Investment Business and revenue from the capital-light AMS business increased nearly 13% to GBP 247 million. And this represents the cash revenues for the business before noncash accounting impacts and is a good measure of how much cash the business throws off.

Portfolio income from the IB business, including impairment gains and fair value gains, reflect the 104% collections outperformance versus the initial underwrite, and this increased by over 5%. The principal driver of the increase in fair value gains is due to the continued growth in portfolio assets classified as fair value as well as increased gains that are reflective of strong collections performance for this category of assets.

Impairment gains were lower than last year. The 2018 half year benefited from initial impact of the rollout of our precision science expertise across the group. Lower revaluation gains should continue to be expected moving forward with higher quality AMS revenues offsetting this.

While H1 investment volumes were healthy at around GBP 165 million, the majority of this was Q2 weighted as we held back capital deployment from Q1 to take advantage of increasing returns.

This caused collections to move into the second half of the year, resulting in around GBP 2 million drag on revenues. This is consistent with our philosophy of ensuring that we maximize long-term value to shareholders. Another more general point to make on portfolio investments concerns how the nature of investments we're purchasing is changing. And as Zach noted, the new businesses we've acquired have given us the expertise to purchase assets such as REOs. These assets have an improved terminal outcome but tend to have a longer initial period of unrealized cash flow at the start of the assets' life compared with assets that Arrow has historically invested in such as U.K. unsecured credit.

As such, you will have seen that we've started to specifically break out real estate assets, which for us, are usually accounted for under IAS 2. These are less likely to generate cash flows at the beginning of their life, and we usually only do so on sale but at strong returns. There's some more detailed information in the appendix of this presentation.

AMS income increased over 10% as the uplift from acquisitions came through. And as guided at Q1, this growth rate slowed as we begin to hit run rate contribution from M&A activity. Underlying growth was flat as we continue to cancel less accretive contracts to free up capacity for higher margin ones. This, combined with the higher fund management contribution from Norfin, helped AMS margins increase to 23% from 19% in the first half of 2018.

Our internal plan also anticipated contribution from further funds raised at a local level in our Norfin and EI businesses. However, as Lee and Zach have highlighted, we're instead focusing all our efforts on capital partnering at a much greater scale at a group level and would push ensuing volume through the fund management business at that point. We also had a number of one-off due diligence fees in the first half of the year that are a regular part of the business mix, but can't be predicted to recur from a second half perspective.

On a gross basis, AMS now contributes 34% of group revenue, a 2% increase and demonstrates good progress towards our medium-term target of 50%. Cost-to-collect reduced due to further efficiencies and the collection's curve-shape contribution from secured assets that had a higher upfront cost-to-collect but lower ongoing costs. Total collection costs for the year are likely to be more second half weighted in line with the increase in activity in the asset mix we expect to usually see in H2. However, we continue to guide to a generally improving downward trend in the collection activity costs percentage in line with the guidance we gave at the CMD. The growth in other operating expenses mainly reflects increased overhead from M&A and our investment in the Italian businesses.

In aggregate on a total cost-to-income basis, this remained flat at 65% with revenue growth slightly ahead of the increase in overhead. And as Lee noted earlier, our cost review program aims to deliver tangible benefits here creating positive jaws between the growth in revenue and costs. All of this led to a solid increase in operating profit of nearly 7%. As I mentioned at the beginning, there are certain aspects distinct from the operational performance of the business that impact the bottom line.

Firstly, finance costs increased significantly by 16% resulting in a flat underlying PBT result, and this is principally driven by the noncash impact of IFRS 16 on lease accounting and the noncash treatment of deferred consideration relating to the M&A activity that we've done over the past few years. Taken together, this means that the finance charge for the full year will be in the mid-GBP 50 millions, the business invested guided levels of capital intensity.

Secondly, the tax charge also increased by 4.5% to 24% from 19.5% in the first half of 2018. And as Zach noted and as Slide 24 demonstrates, the business has successfully diversified into 5 key markets and different asset classes. As a result, we've generated a greater proportion of earnings from European jurisdictions with higher tax rates than the U.K. We expect to finish the year with a tax rate at around the mid-20s level. And finally, there is a noncontrolling interest charges around GBP 2 million that we expect may modestly increase in the second half but should not recur in 2020, and this relates to a position we inherited as part of the EI acquisition.

If we turn to page -- Slide 34, this is a slide you've seen before. And in line with the strong operating performance discussed on the previous slide, collections in the investment business increased strongly by over 13% to GBP 202 million. And this is a key driver of our free cash flow result, which increased by over 28% to GBP 115 million. Similar to last year, we expect total collections for 2019 to be second half weighted, which correlates to the higher anticipated H2 collection costs already discussed.

Slide 35. This is the cash generation slide many of you will be familiar with. And moving from left to right, you can see how collections and AMS revenue are the main drivers of cash generation. The growth of our AMS business continues to increase the cash contribution from the capital-light part of the business, and this is up more than 1/3 year-on-year. Importantly, the AMS segment will contribute a greater proportion of free cash flow once the platform is optimized and the fund management business operates at scale. After deducting expenses, cash interest, cash tax and CapEx, we're left with significant optionality about how we deploy the remainder of our cash.

If we look to the investments just at the average replacement rate of GBP 85 million, which is the maintenance CapEx required to hold our balance sheet in a steady state, we'd be left with GBP 30 million of cash. And in fact the replacement rate in CapEx gives free cash flow of GBP 115 million. However, given the attractive returns available to us, we generally invest all the cash generated into new portfolio assets at strong returns. Nevertheless, this provides a good indication of the amount of cash the business generates and the options we have for its deployment.

Slide 36 shows the segmental disclosure for the business that we first introduced this time last year. And as you can see, there's a notable increase in the AMS margins assisted by the addition of higher-margin fund management revenue from Norfin and the impact of canceled contracts that I highlighted earlier. IB margins improved on a gross basis helped by the improving returns environment we've seen over the last 12 months, and IB margins were static on an EBITDA basis due to the additional costs taken on from the M&A activity. Group function costs increased by just over 8%, again, due to M&A. However, we expect the results of the costs review to have a positive impact on this line.

Slide 37. So this shows our estimated remaining collections against our debt maturity profile. It's particularly pleasing to note that our weighted average cost of debt reduced 0.2% to 3.7% and the 10-year ERC increased to over GBP 2 billion for the first time. Leverage reduced by 0.1x to 3.6x and this is a reduction from year-end, but a slight increase from Q1 and is a result of a return to normal purchasing volumes as we delayed deploying capital at the beginning of the year into what was a rising return environment. We remain committed to reducing leverage to within our new, lower guided range of 3x to 3.5x by year-end.

We also successfully announced the new ABS facility in Q1, further underlining the quality of our book. And I continue to believe that when viewed in the context of the low cost and long duration of our debt against the quantum of cash we estimate to collect in the IB business alone, Arrow has an exceptionally strong balance sheet.

We have the longest financial runway in our industry. No competitor has a longer duration funding structure than Arrow, and this attractive liability management approach means we can optimize our market position with all of the levers in our control.

I'd like to end by saying what a great business Arrow is, and what a pleasure it is to work with such talented colleagues. And I'm also pleased to be handing over to a very capable CFO, Matt Hotson.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [4]

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Thank you. And I guess I'd to take this opportunity as well to thank Paul for his huge contribution in the business in the last couple of years, and I know that Matt's looking forward to meeting everybody over the coming weeks.

So I'm going to keep this short. I hope it's clear to you all today that we're really excited about our prospects when you consider the benefits of the accelerated strategy for the fund management business and the conclusions of our cost review. Not only does that approach increase the quality of earnings and reduce leverage, but it also has the potential to remove our reliance on market funding, should we so wish. This materially strengthens our investment proposition and bodes well for future growth.

At the same time, we're delivering increasingly strong returns in our Investment Business as evidenced by the IRRs we've updated you on today. And we're hugely positive about the opportunity to deliver attractive returns for both Arrow and its capital partners in a massive, growing market as we have been saying. We're of course mindful of the fact there are macro headwinds that may affect the external environment, including Brexit. However, we believe we're well prepared for all eventualities and don't anticipate a material impact on our business.

So taken together, Arrow is a business with a compelling strategic vision, a compelling purpose and also still reporting strong financial results, continuing to generate high return on equity and pay a healthy dividend.

So that's all I'm going to say for now. We've got some time for Q&A, so I'll throw it open to the room.

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Questions and Answers

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [1]

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Gary.

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Gary Greenwood, Shore Capital Group Ltd., Research Division - Research Analyst [2]

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Gary Greenwood at Shore Capital. I've got 3 questions. So first one on the debt purchase on the improvement in the IRR, how much of that was driven by actual underlying market pricing improving? And how much of it was just you being more selective around what you buy? So that's the first one.

Second one on the asset management margins. You've talked about how you're expecting to accelerate the margin towards the mid-20s as a result of the cost savings. If I look at some of the other businesses that operate models out there such as Intermediate Capital, the sort of operating margin they generate on third party is well over 50%. So should we think in the longer term if this business is successful, that mid-20s margin is just a staging post? And then just a -- sort of an operational question really on how the fund management business might work. Do you anticipate earnings fees on committed capital or invested capital?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [3]

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A lot in there. I'm going to let Zach comment on the returns. Let me pick up the asset management point. I mean a couple of things, Gary. I mean it's early days, and it's clearly SEC and other regulatory restrictions in terms of what we can specifically say about the business. I mean the thing I would like to say about margin guidance is we only just set out the 5-year target. Hopefully, you've got the tone of today that we're confident in hitting, if not, outperforming those margins. Clearly, there's a business mix element to the margin. So the vast proportion of our AMS business right now comes from traditional collections-based servicing fees, and it's really only the mix towards the fund management business starts to shift materially that you should expect materially higher margins on those sorts of levels.

But you've seen already, as Paul pointed out, buying a small fund management business in the form of Norfin whose margins are closer to the levels you talk about not at those levels, but probably closer to 40% [the impact second half]. So I'm very, very confident in a mid-20s number absolutely. Though I think we'll get there much quicker than the levels we set out. Absolutely. A lot of that depends on the successful execution of our fund management strategy and obviously, it's early days. But yes, we'll update you more when we can say more, I guess, is the point I would say now.

Zach, do you want to pick up the point on returns and whether it's due to the market or our strategy?

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Zachary Jason Lewy, Arrow Global Group PLC - Founder & CIO [4]

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Yes. So on returns, it's largely down to selectivity and mix. So in effect, the rough math is we see a large series of deals. The average of what we see is not off-market, but 80% of what we buy is off-market. And so when you look at our ability to drive pricing power to 18%, it's a function of taking the deals that we like across that wide footprint to choose from and in particular that on those smaller deals, we really have a unique situation. Our ability to be the servicer, be the buyer, have the historical track record, do it from 110 repeat clients, that franchise position allows us to drive IRRs.

And so as -- I think the Capital Markets Day got kind of a plumbing return and then a cyclical return, that 18% is still effectively the range for owning a plumbing. There's still -- if the market were to turn, there would be an opportunity to, in that supply/demand, buy things from -- for sellers and in a dislocation. I think the last time, you're talking IRRs in the 20s and 30s back when you're sitting in '09, '10, '11, '12. So there's a big upside if the cyclical piece ever comes back. In the meantime, we just keep trying to drive the plumbing return higher.

Do you want to take the committed versus or the...

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [5]

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I don't think we can comment on that at this stage.

Yes. Anthony.

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Anthony Da-Costa, Peel Hunt LLP, Research Division - Analyst [6]

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It's Anthony at Peel Hunt. Just an accounting question. The income from portfolio investments is down year-on-year. Could just give us a little more detail about how -- I think you spoke about sort of cash collections, the amortization in more detail and why that was down year-on-year.

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Paul Cooper;Group CFO & Executive Director, [7]

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Yes. Well, I think if you -- the way that we look at the portfolio investments is in the round so in total, and that's actually up 5%, 6% for the year. So you recall, if you go back a year ago to this time last year, we actually announced due to sort of changes in accounting how we have to split out, and you've got to change it between fair value and amortized cost. But in aggregate, really we see no difference between those 2 asset classes. They are an accounting classification. They're not how we look through the business with that lens at all. So in essence, what you're seeing again is as I said, you got good underlying growth. It's backed up by the returns that you're seeing, the 2% that will come through in the future.

But you've also got good underlying collection. I'll come back to the point where we're delivering 104% of collections versus this -- an issue underwrite. And don't forget, we've only -- I think we've got a conservative balance sheet, and what you will naturally get is that roll-in from the year 8 into the year 7 that really does benefit both of those accounting classifications but the IB business as a whole.

So I think in aggregate, it's the half year performance. And looking at it more expansively, it's entirely consistent with what we said at the CMD. What you will see is slightly less capital intensity and single-digit growth on the IB business and that's come through at 5%. And then on the AMS business, you'll see far stronger growth. And I think the optimism that we've got in -- between the 3 of us for what we've said into the future is quite strong.

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Zachary Jason Lewy, Arrow Global Group PLC - Founder & CIO [8]

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I'd like to say one thing on that. We run the business to maximize cash. So we buy something from an underwriting perspective whilst we look at the accounting consequence of quarters. The main question is I'm putting x amount of cash out, I get y amount of cash back. Given the risk return on that asset type of that exact deal, do we like that effectively cash out, cash back analysis? I'd say over the 15 years we've run the company,

I've seen accounting recognition be behind that, ahead of that. There's -- you go through these accounting cycles where you initially had this initial cost recovery where back in 2005, you basically bought it and then 100% of what comes back pays back what you paid for it and everything after that is profit. You've had all of the different -- there's SOP 03-3 in the U.S. It's effective yield here, EIR, you have amortized cost where in effect, you're recognizing the revenue on a consistent yield across the entirety of the asset life. And now you've got some asset classes where basically, you can only recognize the revenue after effectively the back end of that's been sold and effectively the tail's has been converted to cash as oppose to recognizing the yield over a fixed rate over the end of life.

You just can't change your strategy of running the business based on the accounting or in backloaded, front-loaded, smooth and then backloaded again. I think that's just an output. So effectively, the input is we want to make really good cash returns on every euro, pound we put out. The output is in IFRS calc that is obviously important to everyone in the room, but it's an output. It's not an input.

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Paul Cooper;Group CFO & Executive Director, [9]

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Well, your point on cash is correct. You see free cash going up, what was it, 28%? It's a good move in the right direction from a cash.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [10]

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Good. Okay. Any other questions? Yes. One over there.

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Unidentified Analyst, [11]

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Can you just -- can you give more detail on the fund business? Are you changing your guidance on portfolio purchases in any way? And on the cost, the 20 million cost cut, should we think about it as absolute cost cut to the cost base in 2020? Or is it -- what's the underlying inflation you're expecting for the cost base between now and then net of these savings?

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [12]

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Yes. That's a good question. I'll let Paul pick up the second point on cost. On the first point, we're not changing our guidance at this point. Obviously, there's a way to go as I've said before execution. What I'm trying to say was we have options as we go forward about the degree of capital intensity and how hard we lean in with our own balance sheet versus how hard we choose to grow the fund management business. In the early days of that, growing the fund management business franchise is going to be really important to us. And so we may choose to ease back the amount of capital invested that will be leverage positive. We're very focused on getting the leverage down well into the target range we've set. But at this point, we're not changing any guidance that we put out.

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Paul Cooper;Group CFO & Executive Director, [13]

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And for the costs, in terms of the simplification program, we're pleased with the shape of it. So we think spending 20 to get 20 back on an annualized basis is good and positive. So really the shape of that is you'll see a lot of effort going in, literally we started now over the next sort of 12 months. And then you'll see the sort of back end of next year starts to get the cost out, and then that would be on an annualized basis of the back-end of the year equating to the 20 million. And then you'll see it on a progressive -- at full calendar year basis in 2021. So clearly, it's a sort of inflation of going from '20 to '21 would be limited.

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Lee Rochford, Arrow Global Group PLC - Group CEO & Executive Director [14]

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Good. All right. We've slightly overrun, so don't think we'll take any more of your time. Thank you for your questions, thank you for listening, and we look forward to seeing everybody on the road in early September. Thank you.