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Edited Transcript of CYBG.L earnings conference call or presentation 20-Nov-18 8:30am GMT

Full Year 2018 CYBG PLC Earnings Call

London Jan 15, 2019 (Thomson StreetEvents) -- Edited Transcript of CYBG PLC earnings conference call or presentation Tuesday, November 20, 2018 at 8:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* David Joseph Duffy

CYBG PLC - CEO & Executive Director

* Ian Stuart Smith

CYBG PLC - Group CFO & Executive Director

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Conference Call Participants

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* Amandeep Singh Rakkar

Barclays Bank PLC, Research Division - European Banks Analyst

* Azib Khan

Morgans Financial Limited, Research Division - Senior Banks Analyst

* Charmsol Yoon

UBS Investment Bank, Research Division - Equity Research Analyst of UK and European Banks

* Christopher Cant

Autonomous Research LLP - Partner, United Kingdom and Irish Banks

* David Lowe

Deutsche Bank - Analyst

* David Wong

Crédit Suisse AG, Research Division - Research Analyst

* Edmund Anthony Biddulph Henning

CLSA Limited, Research Division - Research Analyst

* Fahed Irshad Kunwar

Redburn (Europe) Limited, Research Division - Research Analyst

* Guillaume Desqueyroux

Tideway Asset Management - Analyst

* Guy Stebbings

Exane BNP Paribas, Research Division - Analyst of Banks

* John Cronin

Goodbody Stockbrokers, Research Division - Financials Analyst

* Robert Ian Sage

Macquarie Research - Research Analyst

* Victor German

Macquarie Research - Analyst

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Presentation

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [1]

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Okay, we'll get started. Good morning to everyone in London, and good evening to those of you joining our webcast from Australia, and welcome to CYBG's Full Year Results Presentation for 2018.

I'll briefly take you through the progress we've made in our strategic execution. Ian will then talk through our performance for 2018. And I will return with some thoughts on the opportunities ahead. And Ian will close with some guidance for 2019.

So our presentation is a little longer today because we're trying to do the stand-alone performance and our initial thoughts on the combination. So if you bear with us, I'm sure we'll get everything covered for you.

Okay, so on strategic execution. Before Ian talks about the specifics of '18 in detail, and given we have new shareholders and analysts at today's presentation, I thought it would be useful to provide you with some context around our strategic delivery since the IPO. So following our IPO in 2016, we outlined a 3-year plan, which you're all familiar with or most of you, where we promised to deliver sustainable customer growth; secondly, to reduce our cost base; and thirdly, to optimize capital; and all the while transforming our digital capabilities.

Turning first to customer growth. We have delivered on -- an above-market 6% CAGR in our mortgage lending over the past 3 years, and this demonstrates our ability to take market share consistently from other players. At the same time, we're continuing to develop our core SME franchise with an above-market 6% CAGR growth rate and are on track to meet our goal of GBP 6 billion of lending over the 3 years to the end of 2019, so delivering against the promise.

Our prudent balance sheet model means that we have funded the majority of this growth through customer deposits, building on our strong current account base across both retail and SME and utilizing our diversity of funding sources. All of this growth has been delivered in line with our mid-single-digit guidance following our Capital Markets Day in 2016.

And if I turn to efficiency next, we committed to delivering over GBP 100 million of net reductions in our total cost base by year-end 2019, and we are running ahead of that target. Our cost-to-income ratio has therefore reduced from 75% to 63% over the past 3 years. And importantly, we expect this trend to continue going forward.

The success of the combined initiatives means that we've delivered a total return on tangible equity of 10.6% in 2018, and this is in line with the target we published for double-digit returns.

We have also begun, importantly, our journey of providing a sustainable return on equity to our shareholders with our first 2 years of dividend payments.

In October, we also announced the successful receipt of IRB accreditation for both our mortgage and SME portfolios. And we still remain focused on further optimizing our capital position. And we will continue with the IRB application for our unsecured personal lending portfolio as well.

From a performance perspective, I'm actually really quite pleased. We've managed to deliver on the majority of our targets that we published ahead of schedule. And our successful completion of this stand-alone plan has enabled us now to take our next strategic step of creating the first true national competitor.

Back in 2016, we made the strategic decision to invest GBP 350 million in our iB platform. We've already migrated around 2 million retail customers onto the platform, and we've had no migration issues. And we expect our 2,000 hundred -- or 200,000, excuse me, SME customers to be on the platform by September 2019. This platform is open banking ready, full open API capability, and this has enabled us to be the first in the market to deliver a current account aggregator service.

We've also launched the B store, which will in time contain a full range of products and services to support our customers. And we'll be seeking to leverage the much broader Virgin Group companies as part of that proposition. We've already launched B currency, the only live augmented reality app by a U.K. bank, which enables customers to instantly convert currencies when purchasing items abroad.

B Smart is coming next and that's a utility price comparison app and that will be launched quite soon.

And if you look at B in over -- just over 2 years, it has grown to in excess of 190,000 accounts with over GBP 2.1 billion of deposits and a very strong NPS score.

We've also signed strategic partnerships, large tech players such as PayPal on cards and FinTech such as ezbob on SME, and just last week, Salary Finance. And I think what's important is these partnerships demonstrate both our willingness to collaborate with third parties and the attractiveness of our digital platform in the marketplace.

So when I look at the franchise in simple terms, we now have a national brand, a full suite of products, an integrated open API platform for 6 million retail customers and SME customers and a proven partnership capability.

We also intend to deploy a proposition which I think will be unique using other Virgin Group companies through our marketplace. And we're confident that we'll be able to drive growth across all of our segments and (technical difficulty) going to take market share as we have in the past.

Frankly, when you look at this franchise, I think that our advantage is that we are more innovative and agile than our large competitors and more capable of competing effectively than our smaller competitors.

And I'll talk further about our growth ambitions in detail towards the end of the presentation. But before that, let me hand you over to Ian, who will talk you through our stand-alone performance.

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [2]

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Thank you, David. Good morning. It's a pleasure to see you here this morning, and good evening to our friends in Australia. I'm going to run through the stand-alone results for 2018, but I'll keep it brisk because I'm sure, like us, you're much more interested in looking forward than looking back.

Now before I get into the specifics of the 2018 performance, I first just wanted to highlight how the strategic execution that David spoke about has translated into improved financial performance over the past 3 years. Sustainable customer growth has been a consistent feature. And while the income environment has been tough, we've outperformed on costs, delivering a 14% reduction in underlying expenses. Taken together, our actions have driven a significant increase in underlying RoTE, hitting our double-digit target a year early.

Now I'm very pleased to be able to report a 13% increase in underlying PBT this year, and we continue to deliver improved business performance. Key contributors to the profit growth were increased net interest income, commensurate with growth in our balance sheet; costs which were 6% lower year-on-year; and once again, a very low cost of risk.

Now in terms of KPIs, our net interest margin was 217 basis points, in line with our guidance of circa 220. We continue to improve the cost-to-income ratio, which now stands at 63%, with positive jaws of 5% in the year. And our underlying return on tangible equity was 10.6%.

The strong underlying performance has enabled the board to recommend an increased dividend of 3.1p per share payable to all shareholders.

Now before I move off this page, a few words on noninterest income as we don't cover it elsewhere. After stripping out fair value movements, most of which are nonrecurring, and the GBP 6 million cost of the PCA campaign in October 2017, noninterest income is broadly flat year-on-year. And I think the key takeaway from this slide is that our core business performance remains solid.

Now turning to statutory earnings. After conduct charges and other items, we recorded a loss of GBP 145 million. The charge for legacy conduct of GBP 396 million includes the GBP 220 million we took in the first half with a further GBP 176 million charge in the second half.

GBP 150 million of that relates to PPI, and I'll talk you through the assumptions behind this in detail shortly. The core message on PPI though is that we believe the endgame is playing out largely as expected back in May, but we've topped up our volumes to cover us out to a time bar in August 2019.

The additional GBP 26 million charge for other conduct matters in the second half relates to further costs in relation to the small basket of non-PPI issues we've been managing. We do not expect to incur further substantial costs in relation to these matters. And I can deal with any other items on this slide in the Q&A as required.

We continue to see the benefits of our broad funding base and lower cost liability mix. We increased our deposits in line with lending growth in the year. And stripping out the impact of base rate increases in November '17 and August '18, we actually saw the underlying cost of deposits come down fractionally year-on-year. And that's a great testament to our management of mix and pricing when you consider that we saw strongest growth in our savings products.

Our all-in cost of funds last year was around 80 basis points, up 5 bps year-on-year, and the net increase was driven by base and other rate hikes.

In line with our strategy to deliver sustainable customer growth, we've seen good asset growth in the year across all 3 of our asset classes. In delivering this growth, we have not compromised on our underwriting standards as evidenced by our origination KPIs.

In mortgages, our origination LTVs and LTI multiples have held steady or improved slightly. And in SME, our internal eCRS risk rating on new business is consistent year-on-year.

Now as you know, mortgages started the year with a great tailwind from a healthy pipeline, but things slowed a little bit in the third quarter due to the impact of the changes we've made to our broker servicing model. Now these have been addressed. I'm pleased to report that Q4 volumes did bounce back as expected, and if anything, we're a bit of ahead of what we were expecting.

The result is we've delivered 4.5% growth in mortgages, getting onto double the markets in 2018 while maintaining our discipline on margin.

In terms of mix, the home mover market has been flat with growth primarily stemming from first-time buyers and remortgaging. The buy-to-let market remains subdued and the business being written in that space is predominantly remortgage. With base rate having increased, it remains very much a fixed rate market and we're seeing 5-year fixes growing in popularity.

In SME, we had a slightly stronger second half given the pipeline coming into the period, with above-market growth of 6% in core balances for the year. And this is due to our consistent and disciplined focus on serving the SME market and our specialist sector offerings resonate particularly strongly with customers.

Now drawdowns were ever so slightly down on last year at GBP 2 billion versus GBP 2.1 billion in 2017, and we think this reflects just that slightly lower confidence amongst our SME clients given the economic uncertainty relating to Brexit.

Unsecured lending grew by 4%, which is about GBP 40 million absolute, and that was driven by growth in personal loans following the improvements we made to our capability that I talked about at the half year, basically enhancement of our smart search capability for aggregators and the launch of preapproved in-app functionality.

Looking into 2019, the pipeline is solid for both mortgages and SME, and I would expect us to continue to take market share going forward.

So we grew net interest income off the back of sensible asset growth, albeit at a lower margin year-on-year. The NIM, at 217 basis points, was in line with guidance and consistent with the margin compression we had flagged in the mortgage book.

In mortgages, the average portfolio yield was down 18 basis points year-on-year and that was really reflecting front book pricing pressure and also mix changes. The shift in focus from buy-to-let origination to resi, the attrition in SVR balances that are now 9% of the book compared to 11% a year ago have all contributed to this.

SME continues to do well. Stripping out the impact of rate increases, and most of the SME book is tied to LIBOR, we've seen a few basis points of real improvement in average book yield over the last 12 months.

Our SME business continues to be a good counterbalance to margin pressure on retail lending and brings better asset pricing, and importantly, a source of low-cost deposits. Retail unsecured is still a competitive space and we've seen the average portfolio yield come down from almost 900 basis points to 835, although slightly less than the decay we experienced last year.

So to summarize. Retail pricing was disappointing and that drove margin compression that we've offset with good performance in SME and some great work on the deposit side, allowing us to manage to our NIM guidance for the year.

We delivered underlying operating expenses of GBP 635 million last year, ahead of market guidance. I'm pleased to say that Project Sustain has been completed, delivering the promised run rate savings of more than GBP 100 million, a year ahead of schedule. I'm also pleased that because we overdelivered on gross savings, we've been able to reinvest a good chunk of money into improving our customer and colleague proposition along the way.

We'll see the full year benefit of the run rate from this year's sustain initiatives flow into next year's expense base. But now that sustain is closed, our focus moves on to integration.

Cost of risk ticked lower this year down to 12 basis points and all key balance sheet asset quality metrics are improved compared to 2017. The key driver of the reduction year-on-year is that we saw lower specific provisions in our SME business. Now SME is always a little bit lumpy and we'd expect to see next year's SME bad debt charge return to more normal levels. Although given this is the point at which we say a fond farewell to IAS 39 and welcome in IFRS 9 from the 1st of October, we may need to recalibrate what we think of as normal.

We've been soft guiding on the impact of IFRS 9 for the last couple of years, and today, we've published our estimate of the day 1 position. The details are given in the preliminary announcement on Page 43, but the headline is that we estimate an increase in provisions on day 1 of GBP 21 million after tax, well within the previously indicated impact. The effect on capital is negligible as we will benefit from the transitional relief offered by the PRA.

Now looking ahead, we can't ignore Brexit. We've done as much work as we can to identify and mitigate areas of risk in our portfolio that might arise in an orderly Brexit. We focused on customers in EU-exposed sectors such as agriculture and those in all sectors that are exposed to the risk from supply chain disruption or other impacts from leaving the European Union. And we consider that we're well prepared to manage an orderly outcome but the risk posed by a hard or disorderly Brexit is much more difficult to plan for.

We're taking another substantial top-up to the PPI provision today, largely reflecting revised assumptions on complaints volumes out to the time bar. While PPI is disappointed once again, as I said at the beginning of my remarks, it does feel like the endgame is getting easier to call.

When we discussed the provision 6 months ago, I talked about the key assumptions that drove the numbers: complaints volumes, uphold rates, the redress amount and cost to do. Over the last 6 months, volumes, uphold rates and redress were pretty much exactly as we modeled. We said we expected to see 60,000 complaints, but we saw 63,000. So what's driving the GBP 150 million additional provision top-up is extra volume between now and the time bar and some additional cost to do.

Starting with volumes, we'd assumed that we would see complaints run at 10,000 per month on average to the end of the financial year and then step down once the CMC fee cap began to bite. We actually saw complaints tick up in our third quarter with a weekly average of 2,600 and a peak in the month of May of 12,000. And we saw that as CMCs accelerating before the fee cap in July.

Since then, we've seen the weekly average come down. And the October monthly run rate dipped below 8,000 for the first time since 2017. We've seen this reducing trend despite further advertising bursts from the -- at the FCA and the fee cap only having been in place for a short time.

However, we've had another go at projecting how complaints run from here and we think it's sensible to allow for higher volumes than we modeled back in April. So we've topped up to create capacity for 83,000 new complaints in the 11 months' time bar compared to our projection of around 50,000 6 months ago. And in effect, this more or less flatlines our latest experience.

We've also seen some unforeseen increases in overhead and indirect costs. There's been a couple of things that contributed to that. We had some quality assurance rework in relation to the PVR and closed case remediation exercises. And we had planned to do that over a longer period of time, utilizing spare capacity in our Glasgow site.

But the FCA wanted us to deal these cases quicker, and so we kept one of our third-party sites open for a few months longer than originally budgeted. And in addition, the introduction of GDPR this year has added extra steps and costs to what we have to do to process complaints. So the GBP 150 million top-up takes the provision level to GBP 275 million as at the end of September.

Now I'm going to do something I've never done before on PPI and go a little way out on a limb. I think this is the last material provision we'll be required to take on PPI, and I know you all want me to be right.

Underlying capital generation of 63 basis points compares with 13 basis points last year with improved gross generation combined with lower drag from investment and asset growth. However, the key impact on capital and the capital ratio has been legacy conduct cost, which absorbed 182 basis points of CET1 and reduced the CET1 ratio on a standardized basis to 10.5% at the end of the year.

As you're aware, shortly after the end of the financial year, the group received IRB accreditation from PRA in respect of its mortgage portfolio and ahead of schedule also for the SME book. IRB accreditation delivered a reduction of over GBP 5 billion of risk-weighted assets and resulted in a CET1 ratio on a pro forma basis at 30 September 2018 of 14%.

Now as we've consistently stated, attaining IRB is a critical strategic benefit for the group. It puts us on a level playing field against our peers and eliminates a competitive and capital disadvantage. We're extremely pleased to have delivered on our promises here.

And I guess that's a good point for me now to hand back to David to talk about the future.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [3]

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Thanks, Ian. So before I speak a little bit about the ambitious future, I suppose I should acknowledge as well as Ian the current environment. It is a tough one. There's a huge amount of political uncertainty, as we all know, and the outcome remains hard to call. We talk about no deal as being a very bad outcome. I don't think we can say much more illuminating things than that.

Clearly, we're seeing it having an impact on the economic performance and outlook for the bank. And that's really a broad macro U.K. theme, and at the same time, on a positive note, credit performance has remained benign.

Now having said that and looking past the doom and gloom to the medium-term opportunities for us, I'm going to be running slides like this rather than Brexit slides, I think, is going to be the way we go.

If we look at the acquisition of Virgin Money, I think what we have now is generally a best of both leadership team in terms of experience and a proven track record of complex multiyear transformation. We've also added tremendous bench strength from Virgin Money to our business at all levels.

Peter Bole, formerly the Virgin Money CFO, has joined as our Group Integration Director and will lead the group-wide integration program covering every aspect of the bank and will also cover the delivery of the RBS alternative remedies package schemes.

Hugh Chater, the Commercial Director from VM, has also joined our LT in his current capacity and has day-to-day oversight of the VM leadership team alongside myself. Hugh importantly will also lead our commercial planning around the combined mortgage business as we move towards full integration.

I'm also, given the circumstances, particularly delighted that Fraser Ingram has taken on the role of COO on an interim basis. Fraser and his team were the executives that built out our digital capability, and I look forward to working with Fraser and our new Virgin colleagues, who also have great expertise, to build on the great achievements of recent years.

The combination of the expertise and the cultural similarities of both banks gives me a lot of confidence in our ability to deliver the integration plan over the next few years. And we're already working jointly on quite a number of initiatives. And frankly, I think we're making a lot quicker progress than I would have expected at this stage.

So while we have a lot to do to obtain our combined group license under Part 7, I'm very excited about the future of the combined group and in particular the potential relationship with Virgin Group companies. We have an iconic national consumer champion brand in Virgin Money. It has a high awareness, 99% across the U.K. When you take that brand and you combine it with the technology platform and the capability we have built, I think you get a genuinely differentiated proposition in the marketplace.

In addition, we'll be now able to offer a full range of products, as we discussed before, and services to all 6 million of our customers. For a practical example, we can offer a strong current account proposition, which didn't exist before, with an exciting digital capability to the Virgin customer base and significantly increase product penetration as well as benefit from associated low-cost funding.

We can also leverage there the Virgin Money network, which doesn't do sales, as you know, to increase our overall sales ambitions on a national basis. Our SME franchise, as Ian has described, is primed to be scaled nationally through utilizing the RBS alternative remedies package schemes and the capability and innovation award at a Pool A level.

And as I said, I think we're the only realistic challenger, if you define that by someone who can break through the critical 5% market share threshold to provide a real challenge. I think we're the only credible challenger in that space.

I think when I look at it, there's -- the expansion of our SME franchise, both in scale and geographically, is a key part of our strategic development over the next few years. And I think this will bring a lot of diversification and in particular funding benefits. And this RBS package, I look at this as really the first step in our strategy before we develop a national technology-driven strategy for SME for the combined group.

So when I stand back from what we've developed here with this acquisition, I think we have a unique advantage. We have a national iconic brand that has ubiquitous recognition and does not have, importantly, for me, a legacy banking connotation. We have sufficient scale and products and services to be competitive, and we'll deliver those to 6 million customers, as I said, and all of that through a national distribution platform.

We have a brilliant digital platform and data mining capability, which will be deployed across our entire retail and customer and SME base. We have an opportunity, as I said, to develop the whole SME platform nationally, a scaled national competitor with a great digital offering. We'll also be able to offer many of the benefits of the other Virgin Group products, which -- when we're developing our proposition model.

And what does that translate into? It gives us a low-cost customer acquisition capability, and uniquely, we'll be able to acquire customers by tying all of this together with the Virgin Group loyalty program, which is under development.

This banking as a platform as it's referred to model will all be delivered uniquely through a single brand, an integrated brand of Virgin. So unlike others who have friends and family that they have to get together, we'll do it through all one brand association. And I don't think any other bank can replicate the innovation, the diversity of product and proposition delivery that we can create through this combination.

Effectively, when we stand back, we will deliver a technology-driven integrated bank with a single brand, with a single brand around open banking and that's unique. So when I stand back, we're extremely well positioned to deliver on our ambition to become the first true national competitor to the status quo, and I think that's real and tangible and we'll demonstrate it in the next year.

I'll now hand you back to Ian, who will talk you through our 2019 guidance for the combined group.

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [4]

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So I know you're all aware that we only took control of Virgin Money 5 weeks ago, and being reasonable people, you won't expect us to have had enough time to develop detailed guidance by now. So we're going to come back to you in 2019 with comprehensive medium-term guidance. However, I'm sure you'll be delighted I'm going to say a little bit now about how we expect the group to perform in 2019.

Now before I start on the outlook for the enlarged group, I'll say a few words about Virgin Money's third quarter, which concluded just before we took control on 15th of October. VM had a solid Q3, with asset growth, margin and profits in line with expectations and the guidance given at the half year. The margin compression that had been well flagged continued and we see that coming through in the plan for the year ahead.

We're pleased to reaffirm the integration plan, cost synergies and cost to achieve that we outlined on 18th of June. Everything we've seen since the 15th of October has increased our confidence in the delivery of our plans. In addition to the announced synergies, David has spoken about the focus on growth initiatives as we bring the 2 businesses together. I won't repeat those here, but I'll underline our confidence that this affords us a truly unique opportunity to deliver growth over the medium term in what may be a more challenging operating environment.

I want to remind you about the sequencing of the integration process that will determine the pace at which we build out the growth opportunities and realize cost savings from the combination. A key gating item is the approval of the Part 7 transfer. Before Part 7, we need to maintain the separate integrity of the 2 banks with some regulatory restrictions on our ability to approach things on a combined basis.

Our target is to get the Part 7 approved towards the end of calendar 2019. And Part 7 approval allows us to bring all our customers' products and business under a single banking license. From that point, we'll be able to rebrand and progressively offer our full product range to all our 6 million customers on a single platform and through a unified branch network.

We planned the integration with the Part 7 in mind and our guidance on cost synergies reflects this. Our integration effort in 2019 will be focused on planning and preparation, which will be considerable, and on securing cost savings focused on third-party contracts, property efficiencies and senior management headcount reductions.

The group starts life with a robust capital position. The CET1 ratio is 15.2%, more than 3.5 percentage points above the fully loaded CRD IV requirement of 11.6%. And you can do the maths, that's about GBP 1 billion and a pretty strong starting point, which I hope you'll agree.

Now what's not included is the impact of the IFRS 3 acquisition accounting adjustments as that work is ongoing. Now this is important because it helps us deal with an issue that's become -- it's been a matter of some interest and comment, the EIR accounting in the Virgin Money credit card book and the capital impact of any adjustments we might be expected to make to the accumulated card's EIR asset, which stood at circa GBP 190 million at 30th of June this year.

Now IFRS 3 requires us to bring the assets and liabilities, all of the assets and liabilities of Virgin Money, onto our balance sheet at fair value. As part of that process, we'll eliminate the EIR asset completely and reset it to 0. And we recognize the cards portfolio in our balance sheet at its fair value based on the NPV of the contractual cash flows in the book without the requirement to estimate the benefit of material forward income and include that on the balance sheet today.

So the key thing to understand about the VM card book is that going forward in our hands, the book should not be as sensitive to the risks of EIR accounting in the way that Virgin Money was on a stand-alone basis. We've acquired a more seasoned back book where customer behavior is much better understood, and over time, front-book origination will be less reliant on interest-free balance transfer offers, and we can set the income recognition assumptions on a suitably prudent basis.

Now coming back to IFRS 3 and the acquisition accounting, the work is not complete and we won't have a final answer until early 2019. But we expect that the net outcome of all of the puts and takes on the assets and liability, including the cards book, will not have a material impact on the group's capital position.

So how do we feel about capital? Well, as you know, we expect the group to be capital-generative over time, so I guess the key questions will be, where do we expect to operate from a capital perspective? And does that result in excess capital? And if so, what do we intend to do with it?

So the board likes where we are right now from a capital perspective. 2019 looks like an interesting year, both at a macro level and also for our business. We hope to get a sensible resolution on Brexit but some uncertainty remains and that's casting a shadow over economic growth prospects in the U.K., and CYBG is sensitive to U.K. macro, as you might expect.

In our own business in 2019, we'll see the unveiling of an updated strategic plan, the commencement of our integration, the outcomes of the Williams & Glyn RBS alternative remedies process, and we'll see the closure of PPI. And that's really just to name a handful of key strategic developments in the months ahead.

Facing into that from a position of capital strength seems to be the right thing to do. Importantly, the PRA wants us to undertake an ICAP assessment for the enlarged group, which we'll do in the first half of next year. We don't expect that to throw up new risks for which we'll need to hold capital, but it is a key determinant of our capital requirement. Unfortunately, we're not going to try to answer those 3 questions definitively today. That will be determined over the coming 12 months, I reckon.

Regarding the capital operating level, we'll target holding a sensible buffer over the regulatory minimum, and I wouldn't expect us to be out of line with our larger peers. The answer to the other questions will be much clearer towards the end of this financial year.

And finally, a signal of the board's confidence in the strength of the business and its prospects, notwithstanding the macro uncertainty, is the decision to pose an increased dividend this year of 3.1p per share and to reaffirm our commitment to progressive increases in payout over time. You will recall that we paid an inaugural dividend of 1p per share last year and so that's a fairly material increase year-on-year.

Before I guide specifically on NIM, I need to do a bit of recalibration with you. The new group NIM is quite different from what you're used to seeing. And we've shown on the slide here the 2 heritage NIMs on a stand-alone and comparable basis. And so let me be clear about the basis of the Virgin Money margin figures.

Firstly, they've been converted to a September year-end, and most importantly, they show the real NIM rather than the banking NIM convention that was used. You can see the difference between the 2 heritage business models come through quite clearly. Both businesses have been exposed to NIM compression over the past 12 months, largely due to the mortgage market dynamics of competitive pricing and reducing SVR balances.

The compression has been less severe in the CYBG heritage, but NIM has been more resilient given our low-cost funding base, our slightly richer mix in mortgages, and critically, the benefit of SME. Going forward, we'll focus on the combined NIM. And in FY '19, we're guiding to a range of between 160 and 170 basis points.

Margin compression in the mortgage portfolio is expected to continue. And along with some upward pressure on savings rates, that will drive a reduction in the net interest margin. This is offset by growth in current account funding, helped by the RBS remedy package, which I'll talk about in a moment, and a positive contribution from non-mortgage lending yields.

Now the reason we're expressing guidance as a range this year is because we've owned the business for 5 weeks. And in addition to the overall economic uncertainty, there's a number of upside opportunities and downside risk that may impact our ability to land NIM on the head of a pin. These risks and opportunities mirror what we're already seeing in our plans. We've baked in some competition impacts, but we can't rule out further pressure.

On the other side though, we may see stronger results from Williams & Glyn switching than we have in the plan, and we will find opportunities for managing the combined balance sheet that are not yet baked into the guidance. Initially, we put together 2 heritage plans that have been devised separately, and we're confident that integrating the balance sheet management of the enlarged group will yield income opportunities.

Of course, the big unknown is what happens to interest rates, which no doubt will depend on the political outcome. So last -- or no, not last, an important point to make is we're facing the current period of political and economic uncertainty with higher levels of liquidity that we might hold in different circumstances, and that in turn dilutes the margin. And we think that's the right thing to do for now. And if we get a little more stability in due course, then we'll look at that again.

Before I move off NIM, there's a very specific point I need to address, which is MREL. There is a wide range of estimates out there as to how much MREL we'll need to raise and its impact on the margin. Now we've got a slide in the Appendix that talks to this in a bit more detail, but here are the headlines.

Today, we already hold more MREL than our 2020 interim requirement. The end-state MREL requirement will be set by reference to our Pillar 2A buffer in 2021 and that's likely to be lower than it is today. We're planning on senior unsecured issuance of around GBP 2 billion to GBP 2.8 billion over the next 3 years at a rate of 1 or 2 trades per year. And this issuance is factored into our funding and margin plans at prudent spread levels and doesn't present any concerns.

Turning now to one of our strongest core competencies, costs. Now we expect to make good progress in managing down cost in 2019. We'll see the full year benefit of the final Project Sustain initiatives coming through, and we'll begin posting the initial synergy benefits from the Virgin Money transaction. So as ever, that demands that we set a target for the year.

Now in trying to establish a starting point for the group's cost base, I guess, we have 3 components to consider: the GBP 635 million we've reported today, the Virgin Money core cost base and the last publicly available consensus estimate of that for 2018 was circa GBP 350 million, and then also the cost of running the Virgin Money digital bank, which was expected to launch in 2019 and running costs were estimated at circa GBP 35 million incremental. The VMD project is being shut down and so that is no longer a factor.

From the start point, I've outlined that -- from the start point, I outlined having avoided incremental costs relating to VMDB and focused on integration. We expect to deliver a combined cost base of less than GBP 950 million in 2019.

So after a bit of a wait and a number of false dawns, the process for delivering the RBS alternative remedies package is about to begin. Now it's worth recapping what the European Commission and U.K. Treasury is seeking to do here. It's all about competition, finding a way to move meaningful market share away from the incumbents and create additional investment capacity for banks such as CYBG to strengthen their competitive threat in SME banking, and all applications will be looked at through that competition lens.

And that's why it's necessary to focus on both material elements of the remedies package, incentivize switching and capability. I think all too often people focus on the free money part, the capability grants. Incentivized switching delivers on the competition objective because it is designed to cause at least 120,000 SME customers to leave RBS and go to another provider amongst a limited field.

We expect to be a major winner in the incentivized switching scheme, which kicks off pretty soon, and you can see the key dates on the slide. We've invested heavily to ensure we're ready to seamlessly onboard a substantial proportion of the 120,000 customers that are expected to move. We've built a dedicated switching factory in Leeds and recruited close to 50 new relationship managers, many directly from Williams & Glyn. We have both a compelling proposition and the capability to give these long-standing customers of RBS exactly what they need.

And as we said before, we think of incentivized switching as a really important source of low-cost funding at scale. The pool of customers from which the switches will be drawn contains around GBP 11 billion of deposits, and this is a number you weren't familiar with but RBS have allowed us to talk about. And RBS have been fantastic throughout this process in helping us get ready for the switching process.

We therefore expect this part of the package to yield a couple of billion of low-cost liabilities for CYBG over the 2 years the scheme is expected to operate. Of course, what's hard to predict is the pace and scale of customer acquisition given it's all driven by customer choice.

Now part 2 of the package is the capability and innovation fund. As David said, we're a Pool A applicant eligible for the largest grants, and the key dates in the application title again -- timetable again is shown on the slide.

Coming back to competition, the authority's key objective, we think it's pretty clear that we're best placed to invest the capability money for the most beneficial impact on competition in SME banking. The Competition and Markets Authority are clear that a 5% market share is the minimum requirement to disrupt incumbents, and therefore, to have that meaningful beneficial impact on competition.

Santander and the big 4 banks are already well above that level, and then there's us. At 3.5% market share of business current accounts today, with the other potential applicants a long way behind, we are the only bank that can credibly break through the CMA's 5% threshold and deliver the necessary impact on competition. And we're ready to go on this, too.

We worked through in some detail how we expect to invest the money and the growth that it will help deliver and our application is ready to submit. However, there is the small matter of convincing the judges and so we haven't yet baked this element into our financial plans for 2019.

So there's a lot going on for CYBG in 2019 and so you'd expect a busy schedule for substantive market updates. In the first half, we'll get some clarity, we hope, on Brexit. We'll learn the outcome of the RBS alternative remedies process. We'll build out our integration planning, including the Part 7 and the rebranding. We'll do an ICAP, and we'll complete our Strategic Planning for the enlarged group.

And that will enable us to deliver Capital Markets Day in June 2019 to share the medium-term performance targets for our business. And thereafter, things should settle down into a more regular reporting cycle and we can all have weekends off again. Currently, we have no plans to move from a September year-end.

So taking a step back, here's how I'd summarize how we feel about the road ahead. There are lots of positive things to work on as we bring these businesses together, but they're going to take patient, focused execution and that's something that we've been quite good at in the last 3 years. We're very focused on what's in our control, and we have prepared as best as we can for what's not. And quite frankly, we're really looking forward to getting stuck in.

So having provided the detailed update today and the promise of lots more to come, I'll end there and hand over to Q&A.

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Questions and Answers

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [1]

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Okay. Thanks, Ian. And we're going to handle questions in the room, and then we're going to go to the people who are on the phone. So starting with the room first and I think we have some mics. We have right here.

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Amandeep Singh Rakkar, Barclays Bank PLC, Research Division - European Banks Analyst [2]

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Aman Rakkar from Barclays. First question on net interest margin, sorry. You alluded to the guidance that you've given for next year. Can I just ask what -- how many base rate hikes, if any, you have in your capital plans -- sorry, in your guidance?

And on that theme as well, could you give us any color about what benefit the combined group had from the most recent base rate hike? Can you talk about what kind of deposit beta you pass through and any kind of numbers you can kind of give us on the benefit that you enjoyed there?

And then the second question was about the mortgage market. Just interested in, clearly, key source of margin pressure for the combined group going forward, And both CYBG and Virgin Money have basically lowered their market share of gross lending this year. Kind of interested in whether you see that materially recovering from here.

Just the kind of back of the envelope calculation I've done, I think you are somewhere probably about 5.5% market share last year of gross lending. I think that's probably come down 1%, something like that, this year. Do you see that materially recovering from here? And I guess what I'm trying to unpick is basically what kind of growth rate can we expect from that business going forward?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [3]

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Sure. So we have no base rate hikes in our plan for FY19. I think the first one we see next happens sometime in the following financial year.

In terms of deposit beta, we're pretty much in line with the other banks. And I think they've broadly talked about passing on about 60% of the last rate increase to depositors and we wouldn't be out of line with the rest of the industry there.

In terms of mortgage share, and therefore, how that translates into growth, yes, you're right, and that reduction, I guess, through 2018 largely came from the Virgin Money side. So they grew very, very strongly through 2017, and then in 2018 took a bit of a step back. So that's where CYBG broadly maintained its share of flow and a gradual tickup in stock by the end of the year. So as I say, it came from the Virgin Money side.

Our view on where we expect to go from here, look, I think we're going to stay as flexible as we can in what is quite a difficult market. We've demonstrated our ability to take share. I would expect that unless pricing was absolutely crazy and it still makes sense from a return on equity basis, we would continue to grow ahead of market. The key question is what's market going to grow at? And I think that's what we've all got to guess.

So really, what I'm saying is that Virgin Money have taken a bit of a step back from their previous strong growth in mortgages. We've held our own. And I think we'll continue to take market share in 2019. I just don't know what that is yet.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [4]

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Okay. We have one over here at the front. He is coming right to you.

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Robert Ian Sage, Macquarie Research - Research Analyst [5]

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It's Robert Sage from Macquarie. Just a quick one, sort of looking at the expected margin decline next year to 1.6 to 1.7 down from 1.78. If you were to sort of try to sort of look in terms of the primary driver, is it correct to sort of assume that it's largely mortgage market pressure on the asset spread side that would be causing your view that this will fall? To what extent might it be sort of also attributable to other factors? I think you referenced the sort of upward pressure on deposit spreads, but is it largely mortgages that we should be looking at there?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [6]

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Certainly, on the VM side, and we're still -- I'm looking forward to getting to a point where I don't talk about heritages, but it's early days. So certainly, the bulk of the net interest margin compression from the VM heritage comes from the mortgage market. Our own is much more balanced. We've got a broader business that allows some puts and takes that help us to manage the overall net position. But yes, a lot of that pressure comes from mortgages.

The other opportunity we have coming into this is really to start working on the liability mix. Virgin Money, without a current account base and without SME, has focused heavily on the savings market. We have the opportunity over time to sort of drive a more balanced position.

And the other thing is liquidity. Liquidity is an important part as we talk about liquidity dragging our business. And the group is in a strong liquidity position at the moment, which I think you'd expect given market conditions.

Now just again to reinforce, our guidance today is base case. I can't emphasize enough that having been in charge of our new business in Virgin Money for 5 weeks, our ability to influence that is something that we'll work through over time.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [7]

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Any more questions from the room? We'll go into the front here and we'll come back in a second.

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Unidentified Analyst [8]

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Guys, just a follow-up on NIM again. Just in terms of your assumptions on the EIR on the credit card book. Is your NIM guidance particularly for Virgin Money on its own predicated on the fact that there's going to be quite a lot of compression on the credit card margins as well because of the way you're going to account for it going forward? So has that had a bit of an impact? Or is it particular -- is it mainly still the margin side of things?

And secondly, on the SVR book, I mean, have you any idea at what rate the SVR book sort of contracts further from here in terms of -- it's obviously gone down from 11% to 9%, so that will obviously have another impact on NIMs as well going forward.

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [9]

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Sure. So the group net interest margin is not particularly sensitive to EIR assumptions. What we're talking about is it's over a much bigger income base in the enlarged group, so not a huge impact there. And I think that gives us, as I said, the opportunity to be a bit more prudent on EIR.

And then sorry, the second part of your question? Yes, so it's hard to call because it's so much driven by customer and competitive behavior. Our base case is to -- probably for that to settle around about where it is now, but who knows? And I think you have to go back into history to sort of see that certainly in our case something sort of sub-10% was a steady-state.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [10]

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Okay. We have one over here.

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Guillaume Desqueyroux, Tideway Asset Management - Analyst [11]

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Guillaume Desqueyroux from Tideway. Two question, if I may. The first one is on the comment you made on the broker services adjustment that you had to go through Q3 -- that you were expecting like a slowdown in the volume but actually it was quite a positive. So if you can comment a little bit further on that.

And the second question is on the IRB applications that you have in front of you. So you said the next one in the unsecured lending cost for CYBG, so it should happen within the next 12 months, I guess, something like that? But the big, the next one after the part -- Part VII you said. You said end of '19. So is it like a 3-year program for you to have an aggregated IRB application for the overall group and to have a meaningful impact on your RWA in 2022? Is it the way we have to think about your RWA reduction going forward?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [12]

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The first part of your question? Sorry, it was a long one.

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Guillaume Desqueyroux, Tideway Asset Management - Analyst [13]

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You made a comment on the broker arrangements.

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [14]

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Yes, okay. So we talked about at the half year that we had brought our broken mortgage processing onshore from India. And we'd experienced some operational problems in bringing that onboard, which meant that our applications through the broker channel were much reduced. So we worked hard to fix those problems and to partner with our brokers to solve those. And we flagged at the time that we thought we would see a difficult third quarter and return to growth in the fourth quarter.

We actually expected our mortgage balances to go backwards in Q3. They were, I think, GBP 13 million up, so that was better than expected. And then we're back to normal in the fourth quarter. So really put that behind us. It was a frustrating episode, but put that behind us.

Unsecured IRB and I guess the relationship between that and integration, so unsecured IRB we now have to factor in our book, which the general expectation is that we would see an increase of a few hundred million in respect of risk-weighted assets, but nothing more than that.

We also have the unsecured book in Virgin Money, which is also where we have an IRB application in process. That's sort of standardized and we expect to see a beneficial impact on RWAs from that application. We're going to sort of bring those 2 together because -- make sure that we've got a sort of coordinated and cohesive approach to the PRA on those.

And I suspect that process of putting a foot on the ball means that we're probably later in the year in terms of submission of the application. I'm hoping that we're not going to see a big impact on net RWAs as a result, and it's not dependent on Part VII.

The IRB modeling process, we've got 19 mortgage models, and those really look at particular segments of the portfolio. Easy example is buy-to-let or a current account mortgage or something of that nature. So they're much more segment-specific than entity related.

So I think, I don't know how many mortgage models Virgin Money have actually, but I would expect that we can bring some of those together where they makes sense. And that's not dependent on a regulatory process in any way. But I think we'll continue to operate a range of mortgage models that manage the different parts of our book. So Part VII and integration is not a barrier, if you like, to getting on with the IRB process.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [15]

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We have one here in the middle, and then we'll come back to you afterwards. Yes, thank you.

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David Wong, Crédit Suisse AG, Research Division - Research Analyst [16]

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It's David Wong from Crédit Suisse. I just have 2 questions. The first is just a quick follow-up to your comment about the degree of control you've got over the Virgin Money business. So should we expect that basically for the large part of 2019 before all these Part VII transfers get affected that Virgin Money still sort of remains slightly on its own as part of the combined group and you don't have full control -- you haven't got as tight a control over the business as you would expect to have post integration?

The second question I just had was on your mortgage distribution. I guess you're probably still primarily relying on brokers, third-party brokers to distribute mortgages. But I wonder if you would hope to do more direct distribution over time rather than relying on that third-party channel?

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [17]

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Great. Maybe I'll pick up on the control issue. Just to be clear, the Part VII requires you to run 2 separate entities for a period of time, but there will be levels of integration that we will negotiate along the path with the regulator. But in terms of specific control, I am the CEO of both legal entities with full regulatory responsibility; the same for Ian as the CFO, and our CRO is now becoming the same.

What that means is that think of us as having full control. So we have full control of 2 separate entities that we're running in parallel, if that makes sense --- sounds a bit like an oxymoron. And then what we do is we at the group board level, we run a Virgin Money board and a group board, but we bring it together. And so our Chairman and myself and the rest of the board members manage the entity as one. So that's the way to think of it, one group entity being managed, 2 run separately but with full control at the key executive level.

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [18]

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Yes. And David, the only impediment that gives us into Part VII is -- I'll give you a couple of live examples. We can't -- a Virgin Money customer can't walk into a Yorkshire Bank branch and transact business until we get to Part VII and we get on to a common platform. It's the customer side that we can't integrate. We can do all of the functions, and as David says, we have absolute control over the business.

Okay, mortgage distribution. So at the moment, CYBG is about 80% broker, 20% branch. Virgin Money is 100% broker. We are -- both heritage businesses, we're developing a direct proposition through digital channels, and we're now able to combine our efforts on that. And I think that's key. It's key to a better customer experience and also to reducing cost to serve.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [19]

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It's certainly to add there. And when you think of the Virgin Money network, it wasn't a sales network, so they gathered deposits but didn't have a sales capability. So across all the products suite, we, as I mentioned in my comments, we will deploy a full product capability through the full national network.

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Charmsol Yoon, UBS Investment Bank, Research Division - Equity Research Analyst of UK and European Banks [20]

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Charmsol from UBS. Do you have any expectation in terms of market share and how much you target to take from the market remedies impact just the reaching range of 120,000 to 200K customers? And secondly, can I quickly follow up on NIM side? Do you understand what's driving the rapid decrease in the Virgin Money's NIM in '19? Is it going to back book?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [21]

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So our expectation of share of the 120,000 customers, I wanted to avoid us getting dragged into a link table discussion, so I haven't put a number up there. But you can expect us to take a significant proportion of the overall total. If you think about how many meaningful banks are in that process, ourselves, Santander and a couple of others, so that should give you a bit of an indicator. The Virgin Money NIM, there's a lot of sort of that snowball effect of business written in 2017 in a very competitive part of the mortgage market than feeding through into 2018 and 19's margin, so it's that sort of snowball effect of back book. I think that some of the sort of taken foot off the gas on front book in 2018 from VM will help a little bit in terms of stemming the decline. Yes, they did not grow as strongly in that competitive space, but it's back book related.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [22]

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And one to the left here.

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Guy Stebbings, Exane BNP Paribas, Research Division - Analyst of Banks [23]

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It's Guy Stebbings from Exane BNP Paribas. First question was just on how you think about the relative preference on growth between mortgages, unsecured and SME as we stand here today with the very competitive mortgage market, both given the economic uncertainty and how that might play through to unsecured SME? So how would you kind of rate growth between those 3 segments, if you like? And the second question, if I can push you on material book, because you use the term not material for two very important items, the accounting impact from IFRS 3, and any further PPI top-ups, so people's views on what not material might be could be vastly different. So is there any color you can give whatsoever around that, are we talking 100 basis points, more than that or anything else, that would be very helpful.

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [24]

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Okay. So the relative preference on growth is a really good question. So without giving you precise numbers because I'm going to fight shy of that, our emphasis -- and again this was all on a base case, which says that people stop messing around and we get a sensible answer on Brexit, is that we receive much stronger growth or much more of a focus on growth in SME in unsecured and much less emphasis on growth and mortgage market. SME, both SME and unsecured are better for the margin mix. And if I think about both of those businesses from a heritage CYBG perspective, clearly, OTC being mixed with SME as Virgin Money didn't have it. We've made fantastic strides in SME from a place where back in 2014 the business was mothballed. It's reinvigorated. It's got new people. We're taking market share from the likes of Lloyds and Barclays and others. The biggest competitor we see in SME in the region is actually HSBC. So we're taking a share off the incumbents, and it's at good margins, good pricing. Unsecured, you know as well, Guy, we've not been particularly relevant in that market because of a lack of capability primarily. We saw some decent growth in personal loans in 2018. And I think unsecured, through our PL business things like the salary finance, joint venture and others, will just help underpin that. And again, much better margins in that space. On the VM side, well, we talked about a bit of a step back from the mortgage market and you'll continue to see growth in the cards business there, it's a really good business. We've got to make sure we get the income assumptions right. But they're still stronger than you're seeing in mortgages. So hopefully that gives you a bit of a sense of where we're placing our chips, but it is, as I say, predicated on a sensible Brexit outcome. Material. The way we think of material is it doesn't cause us to break our stride. It's just how we think about the business. We're strongly capitalized. PPI has been a very painful episode for this business and primarily our former shareholders. But currently, our shareholders today, as I say, it's something where we'll -- maybe have to deal with some last bits of pieces on closing out, but we don't see it causing an interruption in what we want to do and similarly on IFRS 3.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [25]

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We have one over here.

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David Lowe, Deutsche Bank - Analyst [26]

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It's David Lowe from Deutsche. I just have a follow-up on PPI. Can you just clarify a little bit because of course the deadline is in August and you quite all have the numbers about the weekly customer complaints, but if I make a complaint or I make a claim on the last week, I presume it's going to take a few months for me to actually get paid out. But if you have a sudden rush of people in the last week, how long will actually the cost take to come out of the business? So can you just give a bit of clarity as to that provision? What is exactly is that? Is that to the August deadline? Or is it a little bit beyond that?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [27]

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So the way we think about the provision, David, is until we're done. And we have a regulatory obligation to deal with claims in 56 days, so it's a 2-month process so -- and unless there is a deluge, and I don't think any of us is expecting a deluge of complaints at the last minute, I mean, goodness me, how many people are out there that need to find out about PPI in the world? So unless we have a deluge, we're well able to cope with those volumes within the 56 days. So when we sit down in 12 months' time, we would expect to be able to show most people that we have on the pitch dealing with PPI are now doing other things so.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [28]

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Maybe -- might be trying to go to the phones, and we'll come back to the room if there's any at the end. So Andrei, do we have come calls coming in?

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Operator [29]

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We have the question from Edmund Henning of CLSA.

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Edmund Anthony Biddulph Henning, CLSA Limited, Research Division - Research Analyst [30]

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A couple of questions from me. Firstly, can you just confirm in your NIM guidance that the potential change in EIR is actually in the guidance?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [31]

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Given that we stated a range, Ed, you can expect that any changes in income recognition on the cards book is -- we can absorb within that.

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Edmund Anthony Biddulph Henning, CLSA Limited, Research Division - Research Analyst [32]

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Okay, that's okay. And just a second one, David, you talked about obviously building out and needing to invest in the business and technology. Firstly, why is it taking so long to get the SME customers across the iB platform? And how quickly can you roll out if you've built all of the tech around SME also the current accounts around B to roll it out with the Virgin brand name on it?

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [33]

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Yes, it's really a question of prudence. So we've moved across 2 million customers, and if you look at all the issues in the U.K. and sensitivities around that, we decided to do retail first and SME second. We built out that capability, and with 200,000 customers, we don't see that as a major complexity. We will have all of that done during the coming year. If you think about it, we can't really do integrated offerings with Virgin Money until the following year, so it allows us complete on to our offering this product to the following year. Equally, we're rhyming as fluid on Williams & Glyn, and so the switching begins in 2019 before our Part VII is done first. And so we have made it in our own SMEs, but at a manageable population. We will then have a large switching incoming activity on SMEs. And then we'll be deploying significant new technologies further than those built today with the funding if we get the right level of funding from the category A. And then as we get agreed to the Part VII, we'll be able to deploy that rapidly into the Virgin Money territory. So it's a combination of series of activities, but underlying prudence, Ed.

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Edmund Anthony Biddulph Henning, CLSA Limited, Research Division - Research Analyst [34]

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Yes. So that you basically affirmed Virgin Money-branded SME product really, it's not to laugh at the Part VII? And is that the same for the current accounts?

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [35]

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That's the same. Basically, what Part VII does is protects against customer detriment. And what you have to do is convince the regulators that you have done enough to protect the customer and the processes you've engaged in will guarantee that. So what we have is a [Peter Boll], who is our Integration Director, is looking across the entire spectrum of activity in the bank, whether it's technology or it's just communications with the customers, every aspect of that, and then the rebranding process being done in the right way, and that the plans for that are robust and coherent for the regulator and that we have proved that we are not going to do customer harm. That takes usually 12 months, Ed. What we're hoping is that along the way, we can make progress. I think it was a pyramid. You can start slicing things out of that pyramid and executing them ahead of that as long as we can demonstrate they're not directly impacting the customer. So it's trying to get operational execution momentum, and then anything for the customer waits for post Part VII, Ed.

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Operator [36]

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Our next question today comes from John Cronin of Goodbody.

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John Cronin, Goodbody Stockbrokers, Research Division - Financials Analyst [37]

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The first question I have is just to understand better the -- your guidance on IFRS 3 impact, the precision if that's preliminary and work is ongoing and how that dovetails with the NIM guidance in Virgin Money's case? I note your comment to the effect that the domination in margin on the credit card book for Virgin isn't a major driver of the NIM dilution. But just trying to understand better if you take -- if you effectively eliminate the EIR assets as an acquisition, then does your NIM implicitly continue to assume significant margin deterioration in the credit card book for Virgin even though that's not the primary driver of overall group on NIM compression or indeed Virgin Money compression? So I appreciate there's a lot going on there within that, but any more color you could give to marry up the 2 on credit card specifically would be helpful. And then secondly, on the CET1 guidance in terms of where you'd like to be. From a target ratio perspective, I note your comment around in line with larger peers. Specifically, what should we be thinking in that respect -- so 12 or is it with 13 or potentially even higher given the currently elevated P2A?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [38]

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Okay. So IFRS 3 and NIM, unfortunately, John, I'm not going to be particularly helpful. We're not done on IFRS 3, so there'll be a bunch of those fair value adjustments that do feed through into the net interest income line. We haven't yet included those in guidance, and we'll talk about them when we come back in the first quarter. I'm not particularly concerned about it. And again, I think I'll just steer away from worrying too much about EIR or its impact on margin. We get a back book that is probably earning better today than the assumptions that were made sort of early on in terms of cash and therefore, the bridge to EIR is much shorter. So you're going to have to be patient with that. We'll come back on the impact of all of those adjustments early next year. On CET1 guidance, I mean, I can't -- it's one thing to say where we expect to sort of target, i.e., be above x percent. And as I say, I can only point toward some of our larger peers, obviously make any adjustments for the fact that we're not a SIB and that sort of thing in terms of requirements. But we're going to come back at our Capital Markets Day and give much more clarity around capital and the capital trajectory. At the moment, we're going to sit on a big pile of capital, and we'll tell you what we're going to do in 6 months' time.

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Operator [39]

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Our next question today comes from Victor German of Macquarie.

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Victor German, Macquarie Research - Analyst [40]

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I apologize in advance. You've had a lot of questions on margins and I'm not going to break the trend here. If I look at your CYBG guidance for margins and I know that you issued MREL debt in September, which is obviously going to cost some additional money in '19, yet you're guiding to your pretty much broadly flattish margin -- in fact it looks like margin is actually pretty stable in the brand, yet Virgin Money contraction is 17 basis points, which is higher than previous year. And the base impact, given the base is different is basically 12 percentage points decline. I'm just hoping you could provide a little bit more color in terms of why we're seeing that margin decline? And is it sort of -maybe some comments around the potential MREL impact, potential TFS, any sort of additional color you can give us on the trajectory kind of as we exit 2019? Where can this margin can actually go?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [41]

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Okay. So Victor, I'm not going to tell anybody about where we expect to go after 2019. We're very clear that after owning the business for 5 weeks, and given all the stuff that's going on in the outside world, 2019 is as far as where we're prepared to go today. Now all roads lead to Capital Markets Day, and those kinds of things will have a much clearer perspective when we get to June. So I know I'm just going to frustrate you. In terms of the CYBG heritage, sure, we raised MREL at the back end of FY 2018. But we are very confident about raising cost-effective funding throughout the year, so I wouldn't focus on a particular element of the funding mix in CYBG. We've proved ourselves pretty good at managing the different pressures in margin up until now, and I wouldn't expect that to change. TFS refinancing, combined group, is probably going to -- we'll probably aim to refinance TFS in 2019, and we'll refinance that from a combination of deposit and wholesale funding, all factored into our plans. The Virgin Money business and the impact on margin there, first of all, what I say is we knew that Virgin Money was facing into margin compression. We factored that into our planning when we were constructing the deal, so it's no surprise to us. Their business model is very different to the CYBG heritage. They competed in a much lower-margin space in the market and competed fairly strongly there and grew their book strongly as a result. And therefore, that is baked in some of this red compression that we're seeing. So Virgin Money funding model is also different to CYBG and a bit more dependent on refinancing savings year-over-year and being pretty price-sensitive in that regard. We're very confident that as we get to grips with the combined business that we'll be able to drive through a broader liability mix much more similar to what we have today over time. But it's going to take time. So I see this as an FY '19 challenge for the heritage Virgin Money business that we'll be able to work on through the year. I talked about what we might do on liquidity. I think some of the balance sheet management opportunities we have before us will deliver stronger income. So I'm pretty optimistic that as we put these businesses together, we'll drive to a much stronger position. But at the moment, what we're seeing in 2019 is a result of how Virgin Money has built its business over the last couple of years as something that we were well aware of when planning acquisition.

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Operator [42]

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Our next question today comes from Fahed Kunwar of Redburn.

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Fahed Irshad Kunwar, Redburn (Europe) Limited, Research Division - Research Analyst [43]

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I just have one question, really, and it's following on from the comments you made there, which I thought very important. Have you made any assumptions at all on any shift of the funding mix of Virgin towards kind of Clydesdale funding mix within the 2019 guidance? And I guess, following on from that, should we think of 2019 really as a transitory year in terms of what the margins look like thereafter? I'm not asking for guidance post 2019. Just an idea of kind of is this guidance really not the steady state of the combined entity is even more of a factor of the way that Part VII is working? I ask the question obviously because the shares are down pretty significantly today. And I imagine most of it is to do with what is the cost of your growth, so it would be very useful if I guess we could get some color in that '19 guidance if there any revenue synergies or any kind of benefit from being a combined entity within that margin guidance? Or is this all going to be a 2020 story in terms of the strategic benefits coming through on revenue, particularly funding for Virgin Money?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [44]

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I think you're spot on. There is -- for 2019, the biggest -- because we have to wait for Part VII to really bring the 2 customer businesses together and to start driving the revenue benefits from the combination, what you're seeing in 2019 is really the 2 heritage businesses perform. And as I say, we reap what we sow in terms of the 2018 business feeds into the 2019 margin. So that's what you're seeing come through. We think of 2019 very much as a transitionary year. We'll have the opportunity on the income side, as I say, to get into optimizing the balance sheet. And I sort of keep saying that. One of the things we've been pretty good at in CYBG is just making sure that we're very tight on managing our average interest-earning assets and picking and choosing our spots to compete. We would expect to do the same across the large group, and we're confident that will have some benefit to come through. The key focus of the integration effort for 2019 is on costs and it's cost are some of the functions. The real opportunity revenue-wise and growth-wise, we'll start to see come through after that. So I think you're spot on there.

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Fahed Irshad Kunwar, Redburn (Europe) Limited, Research Division - Research Analyst [45]

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Can I ask one quick follow-up question on CYBG? I think current accounts is the really key part of this whole merger. But in 2019, for CYBG, how much did -I think you talk about it briefly in the RNA, but how much did B contribute to the current account growth? And how much of the current account growth is from Clydesdale time deposits going into current account as we've seen across the market? The reason I ask the question is just to get a sense how powerful a proposition B is when you do eventually kind of pull it into the Virgin Money customers?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [46]

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Yes. So the bulk of our current account, personal current account, so the current account includes business as well. But the bulk of our current account, personal account growth came from B, and B has always been a mixture of retention of customer balances as well as delivering growth. And what we have said consistently and we repeat today is the majority of the deposit growth is new to bank, so an important engine for growth that offsets some of the attrition we might see in some of our older current account proposition products so.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [47]

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I think we have more on the line. More calls?

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Operator [48]

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We have a question from Christopher Cant from Autonomous Research.

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Christopher Cant, Autonomous Research LLP - Partner, United Kingdom and Irish Banks [49]

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I was going to have to come back to your NIM slide, I'm afraid. I know you've taken a few questions on this but it obviously is of significant interest to all of us. Could you confirm what your exit NIM for Clydesdale stand-alone was for your 4Q '18? I think that was below the 215 you guide for 2019. And on the 250 -- sorry, the 125 bps NIM expectation for Virgin in 2019, can I be clear, is that post expected EIR changes or not? You've given us the specific NIM for Virgin within the group. I appreciate your comments about at a combined entity level, EIR change is not being a material driver. But is the 125 you're guiding us for Virgin 2019 inclusive or exclusive of any changes to EIR, please? And it would also be great if you could give us an exit NIM although I can understand if you're reticent to do so. And finally, your flagging liquidity pressure on NIM. Some others have been flagging this with 3Q results. I guess this is largely optical or denominator-driven impact on your NIM. Just to allow us to contextualize that, could you give us a sense of what the combined group NII was for the period covered on Slide 23, please, so we can get a better sense of how much liquidity drag there might be for the combined business?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [50]

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Okay. Thanks, Chris. So the exit NIM for CYBG has put through that we might take, and I'm not saying -- very sort of important commercial decision we're not going to rush our fences on that in terms of just how we think about it. So what I would say is be comfortable that Virgin Money under its own steam was trying to take some of the heat out of that, and therefore, that is helpful and included in the 2019 guidance. But it doesn't include anything we might do. But I'm pretty confident that we've got plenty of capacity at a group level to make necessary changes and stay within our guidance range. I'm not giving VM figures today. So I'm afraid I can't give you an exit NIM and I can't also give you the combined NII. We're going to have to wait for that. One of the things we will do in early 2019 is provide some fairly detailed pro forma comparatives so that can be factored into people's expectations, but we're not talking about VM numbers today.

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Christopher Cant, Autonomous Research LLP - Partner, United Kingdom and Irish Banks [51]

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If I could just follow-up then on the comment you made in response to the first part of that question on the exit NIM. You're indicating that you don't consider that representative of the running NIM. Was that some kind of a one-off adjustment in the quarter that impacted your NII? Or is it to do with this liquidity drag, which you're assuming goes away next year? Why is it exactly that you don't consider your 4Q NIM representative? Because I think for most peers, people tend to look at the exit NIM as a spear for the next year. Obviously, you're talking about a subdued or competitive environment in terms of mortgages in particular, so it does look like you're assuming an improvement there. Was it a specific one-off that you can call out? Or why is it that you think that wasn't representative?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [52]

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Because, look, and this is the weakness in net interest margin, okay? In some respects, it's useful, and in some respects, it's not. It can be heavily influenced by the denominator. So if you increase your denominator by raising money in wholesale markets, then you go walk over the road and put it on deposit at the Bank of England, you get inflation in your average interest-earning assets. You don't grow your net interest income. So that's really a big driver of that. I guess I actually can't remember as I sit here what our third quarter NIM was, but it was higher than 217. So if you take -- I would resist focusing on a particular quarter's performance, other than as you quite rightly say, Chris, it is a bit of a steer. And we're steering that we would expect to see our margin come down a bit over the next year or so. But it isn't representative of what we see as a whole year's performance. I mean, as I say, the CYBG net interest margin in the third quarter of FY '18 was a few basis points above the 217 we reported for the year, so it's puts and takes.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [53]

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We've got one last one I think on the call, Andrew?

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Operator [54]

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We do. We do have a question from Azib Khan of Morgan Financial.

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Azib Khan, Morgans Financial Limited, Research Division - Senior Banks Analyst [55]

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Ian, you mentioned earlier, look, I've got 2 questions on PPI. Ian, you mentioned earlier that the second half '18 PPI experience was in line with your 31 March provisioning function. But when I take a look at the data, about 2/3 of that 31 March provision was utilized in the second half, which is a pretty high utilization rate. So can you please reconcile that high utilization rate with your statement? And the second question is can you just clarify whether the added retails and future walk-ins that you're assuming? Or are they just the walk-ins where you expect claims to be upheld?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [56]

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Okay. So utilization rate was higher because we were coming down to -- we're managing a higher rate of claims across 3 different sites. We've now shut 2 of those sites and are processing claims entirely through our Glasgow operation, and we're also processing fewer claims. So it's really about the downward trajectory. I would focus on what does the 275 we have in the provision and how does that translate. We're actually allowed for a little higher sort of cost per claim then we have up until now. The 83,000 is the number of people that walk through the door, if you like. And we have an uphold rate on those claims that has come down month-after-month in the last sort of 12 to 15 months, indicating that the quality of claims walking through the door has been much lower and people that don't bank with us or have never had PPI.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [57]

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Okay. I think we'll move to the - there's a question in the room, just here now, so just up at the back here. Put your hand up so you have a mic, and then we're done.

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Unidentified Analyst [58]

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[Justin Lee] Of UBS. Two, and I'm afraid the first one is on NIM once again. The product slide on 12 was particularly useful I think giving us the yield on the CYBG books. Of course, there are annual numbers and they've changed and although I'm not a huge fan of quarterly anything, I just wonder whether you could give us an indication of front to back book gaps just on mortgages for your business? So the MREL data suggests that the business done in the last quarter was at about 2.2%. The yield here was about 2.7%. Presumably, your gap is narrower. And perhaps you could talk about whether there are any mix reasons why your portfolio might yield more than the sort of market average set on mortgages? And then secondly, turning to Brexit. The decision that you've taken to run a liquid balance sheet in a well-capitalized bank into Brexit obviously makes perfect sense. I wonder whether you could talk to whether you see any behavioral change or actions of that kind of nature amongst SME clients? Are they asking for bigger undrawn facilities to cushion themselves as the delayed CapEx or anything you can say about the real economy would be helpful.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [59]

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Sure. I'll pick up the real economy while you're - you have some numbers for the first question.

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [60]

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Yes.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [61]

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The reality is I think interesting with the, I suppose, the SMEs, if they see a hard Brexit, they're better off in their world they think just in terms of being able to invest and have clarity. It just puts a whole smorgasbord of uncertainty in the road of progress. So they're all agitating very strongly for whatever we have today, it doesn't matter. It's infinitely better than no deal, so they're starting with that premise. But they're not expecting no deal. So what they're doing right now is waiting for a decision, but that waiting is significant in terms of inertia. So less in the credit or need to draw down in cash flow's territory and more in the capital investment profile. So we -- and I'm not just saying I'm suggesting we do a lot of engagement around the entire of the geography, and when you're talking to people they're not going to be hiring and they're not spending, but they're fine with running their day-to-day business across the location or locations they're in, so that's why it's translating into a more benign credit outcome, it's because it's really about the investment or the hiring, and so that's what's happening there. And I think what you're seeing around the consumers no particular stressors yet, but you're seeing, again, a consequent slowdown in spending and willingness to take on any more debt given the fears that have been created. So it's that inertia of activity across all sectors that we look at that is driving most of this. The housing sector is the same, the number of houses available. Retention is the big strategy right now, which I think is well flagged, so again, same principle. So I think what will be very interesting is when you pick out all the uncertainty and get some outcome. And when that outcome is there, and it's not a hard Brexit, I think there could be a relief rally and a little bit of a resettling of the economy. Certainly, some people are predicting very strong shifts in sterling after that, all pointed towards general factors of more positivity because we're into a really negative dip just now. So Ian?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [62]

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Yes. Jason, I can't - I'm not sure I'm going to give any numbers here, but you're right to observe that our own portfolio is a slightly richer mix than the market average. I would say the Virgin Money attracts much more the market average or is probably slightly more diluted and that's what you see say the difference in the heritage business models coming through in a margin planning. Our richer mix comes from - some of the factors that are probably going to be diluted over the next couple of years. Our buy-to-let premium, for example. When we focused on buy-to-let business, particularly in 2014 and '15, that was at a significant premium to resi and we've seen that mix gradually feed through. I think that's kind of baked in now. We've been very focused on first from that space and, again the reasons of standardized capital ratings and others, we preferred the margin in that space. It's good business, but it's at a higher margin than others so.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [63]

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Okay. Okay, we just have one more question here and then we'll wrap up after this and we can mingle a bit if you need, but everyone wants to get out, I see, too.

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David Wong, Crédit Suisse AG, Research Division - Research Analyst [64]

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This is David from Crédit Suisse again. Just a quick follow-up question on costs. Is the incoming environment less evolving than you thought? How much, how prepared would you be to just sort of grip the cost base size for this year, is my question. And are -- is there pressure to reinvest any gross savings that you extract in to either to protecting the franchise or to counter things like wage inflation, which, I guess, in the U.K. is probably going around 2.5%, 3% now. So I'm just curious, how you're thinking about the flexibility of manage costs for 2019?

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Ian Stuart Smith, CYBG PLC - Group CFO & Executive Director [65]

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Yes. Thanks, David. So I think there's plenty to go for in the cost base. As evidence, the art to this is making sure that you approach it at the right pace and in the right sequence, so there are some things we just can't do until Part VII and until a bit later on. But we're definitely looking at opportunities to accelerate savings. And I think it's a good -- it's a helpful hedge against income weakness. So look, I think there are opportunities there, but we don't want to throw the baby out with the bathwater so.

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David Joseph Duffy, CYBG PLC - CEO & Executive Director [66]

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Okay, I think we're going to wrap it up there, but thank you to everybody on the phone for participating and in the room and we'll call it. Thank you very much.