OSB Group PLC

LSE:OSB

Earnings Call Analysis

Earnings Call Transcript 2022-Q2

[Operator]

Good morning or good afternoon, all, and welcome to the OSB Group half year results call. My name is Adam, and I'll be your operator today. [Operator Instructions]

I would now hand you over to Andy Golding to begin. So Andy, please go ahead when you are ready.

[Andy Golding, executive]

Thank you very much. Good morning, everybody, and welcome to OSB Group's 2022 Interim Results. And thank you, as always, for joining the call today. I'm going to start by covering 1 or 2 highlights in terms of the performance for the first half of the year and an overview of the group. April will then take you through some more detail in terms of the numbers, then you'll hear a little bit more from me around how our lending and savings franchises have performed followed by our outlook before we open up to Q&A.

I am delighted that we've had a record half for profit before tax, up 16%, while retaining our class-leading 24% return on equity. This performance was supported by an improving net interest margin and an expanded loan book, all of this demonstrating the strength of our strategy and our business model.

Our lending franchise continues to deliver with a strong flow of applications accelerating during half 1, leading to a record pipeline of new business. We've continued to relaunch products progressively, expanding our criteria to pre-pandemic levels, including the reintroduction of some lending at higher loan-to-values and an increasing number of mortgage products available, underpinned by our underwriting expertise and strong risk management capability.

Credit performance remained strong in the first half with stable arrears. The modest impairment charge reflected an improved outlook as pandemic-related issues subsided, offset by an increase in our downsides in arrear weighting to address the growing cost-of-living concerns. Capital remains strong, and April will cover more around our capital management framework later in the presentation. And also, I will add that we remain well positioned to grow and deliver attractive and sustainable returns through the cycle.

The group intends to target a CET1 ratio of 14% once the capital stack has been optimized fully through Tier 2 and MREL issuance, and April will talk more about this later. In terms of our outlook, we continue to expect full year underlying net interest margin to be higher year-on-year. Therefore, we're improving our guidance and now expect it to be broadly flat to the first half. We also remain confident of delivering our previous guidance of 10% net loan book growth for this year and a marginally higher cost-to-income ratio.

As a brief reminder of some of our core strengths, complementing rather than competing with the high street mass market offers, we are a specialist lending business, offering differentiated propositions to meet the specialized and sometimes complex needs of our customers. Our multi-branded lending franchise, GBP 100 million worth of new deposits, combined with now 22 securitizations to date across the group, totaling GBP 11.1 billion.

Finally, our unique operating model continues to serve the group well. Supported by our colleagues in OSB India, delivering high Net Promoter Scores and contributing to our class-leading cost-to-income ratio of 23%. We operate across a number of targeted core specialist segments. Our proposition ranges from rapid off-the-peg loans delivered through our digital platform and our Precise brand through to more tailored lending offered by Kent Reliance and up to fully bespoke facilities through our InterBay and Heritable brands. The breadth of complementary lending propositions continues to provide a one-stop shop for brokers, offering expertise and convenience that most of our competitors struggle to emulate.

This slide contains our statutory financial highlights. However, I will run through our underlying highlights before handing over to April to talk you through the results in more depth. Our net loan book grew by 3% in the first 6 months, and we are on track to deliver that 10% growth by the year-end, supported by our record pipeline of new business. Net interest margin improved to 34 -- by 34 basis points to 302 basis points boosted by base rate rises during the first half. The loan loss ratio increased to a relatively benign 2 basis points. That compares to a pandemic-related release in the prior period.

And our cost-to-income ratio was extremely low at 23%. And ROE was stellar and stable at 24%, driven largely by the improvement in profit before tax, up 16% to a very healthy GBP 294 million. This resulted in improved basic earnings per share for shareholders of 48.9p, up 17% on the prior period.

April, I'll now hand over to you.

[April Talintyre, executive]

Thank you, Andy, and good morning, everyone. I'm delighted that we maintained the exceptionally strong underlying ROE of 24% in the first half of this year. Our profitability strengthened significantly with underlying profit before tax increasing by 16% versus the first half of last year to GBP 294 million, which is a record half year underlying profit before tax for the group. Both of these were achieved despite the prior period benefiting from a significant impairment credit.

We grew underlying net interest income by 23% versus the prior period due primarily to growth in the net loan book and the strength in net interest margin, which was up 34 basis points to 302 basis points, primarily due to the beneficial impact of rising rates, and more on that later.

Our efficiency metrics remain very strong. The management expense ratio, which is administrative expenses as a percentage of total assets, rose by 3 basis points versus the prior period to 72 basis points, reflecting our expected gradual return to a more normal level of spend post pandemic. However, our underlying cost-to-income ratio improved further to 23% due primarily to higher income.

Looking ahead and as we guided previously, we still expect the cost-to-income ratio for the full year to be marginally higher than in 2021, driven by higher discretionary spend relative to the lockdown-impacted prior periods; our planned investments in technology; and increased staff costs as we continue to fill vacancies, including new roles we're creating as we grow. There is clearly a potential for additional inflationary headwinds. However, we will continue our strong focus on cost discipline and efficiency that we're known for. We recognized a small underlying loan loss equivalent to a ratio of 2 bps in the first half of 2022, and I'll provide more detail on the key drivers a little bit later.

Turning to the income statement. You'll see that we recognized fair value gains on financial instruments of GBP 11 million in the first half, broadly in line with the prior period, with the majority continuing to come from gains on mortgage pipeline swaps prior to the -- being matched against completed mortgages. And that's due to a continuing steepening of the SONIA curve. Underlying earnings per share of 48.9p per share in the first half increased by 17% versus the prior period, and that's commensurate with the increase in profit.

Turning to the next slide, which summarizes our strong secure balance sheet. Our net loan book increased by 3%, as Andy mentioned, in the first half, supported by GBP 2.3 billion of gross new lending. This was down 7% versus the first half of 2021, but that period benefited from higher purchase activity due in large part to the Stamp Duty holiday. Retail deposits grew by 2% to GBP 17.9 billion as at 30th of June as the group continued to attract new favors. We remain predominantly retail-funded with some diversification provided by Bank of England funding schemes and securitizations. We drew down GBP 220 million under the index long-term repo scheme in the first half, withdrawing under the TFSME scheme flat versus year-end at GBP 4.2 billion, following its closure to new drawings in October last year.

The credit quality of our loan book remained very strong with 3-month-plus arrears stable for the group at 1.1%. That includes OSB segment at 1.3% and CCFS segment at 0.8%. Our loan book is secured at sensible loan-to-value. The weighted average book loan-to-value for the group fell to 61% in the first half from 62% at year-end, supported by house price appreciation in the period. The new lending loan-to-value increased slightly to 71% from 69% in the prior period, reflecting our return to pre-pandemic lending criteria as Andy mentioned earlier.

The next slide is always favorite. It shows our NIM waterfall, where you can see the high-level drivers behind the strength of net interest margin. Underlying NIM increased to 302 basis points from 268 basis points in the first half of last year. And as both Andy and I have said, that's primarily due to the benefit of base rate rises. And that includes delays in the market passing them on to savers as well as the beneficial impact of the wider swap spreads on the cost of new retail bonds. These more than offset the fall in mortgage yields due to delays in the rate rises and widened swap spreads being passed through to mortgage pricing.

Other primarily relates to the benefit of increased average funding from Bank of England, our own equity as well as favorable swaps margin core. You can also see equal and offsetting bars in the waterfall in respect of net EIR reset gains in the second half of last year to reflect change in customer prepayment behavior. These were broadly flat in the first half of this year.

Looking forward, we now expect the full year 2022 NIM to be broadly flat to the first half, following last week's 50 basis point base rate rise. There may be additional upside to come from future rate rises, although the market is starting to pass these on more quickly. There's also the potential for mortgage customer prepayment behavior to change as rates rise further and the economic outlook evolves, which could lead to further EIR reset gains or losses.

The next slide provides a waterfall of the movement in the statutory impairment provision in the first half. As you can see from the chart, moving from the left to the right, house price appreciation in the first half outperformed our model assumptions, which led to a release of GBP 4.9 million. As pandemic-related risks lessened in the first half, we released GBP 3.2 million of pandemic-related post-model adjustments and also saw an improvement in the forward-looking economic scenarios used in our IFRS 9 models, resulting in a provision release of GBP 5.9 million. These movements were offset by a 10% increase in the weighting against our downside scenario to reflect increasing concerns around cost of living, and that resulted in a GBP 6.8 million charge. Other provision increases of GBP 7.8 million largely related to new lending, credit profile changes net of write-offs in the period.

You can see that our coverage ratios have reduced marginally in the first half of the year, although total coverage remains twice the level it was pre-pandemic at the end of 2019 as geopolitical inflation and cost-of-living concerns have replaced pandemic-related concerns. We will, obviously, continue to proactively review our forward-looking economic scenarios and coverage ratios as the outlook evolves.

Turning to our capital position. You can see that the group's CET1 and total capital ratios remained strong at 18.9% and 20.4%, respectively, at the half year. We've given you another waterfall. Going from left to right in the waterfall, which explains the movement in the CET1 ratio, you can see the strong capital generation from profitability. This is offset by the full effect of the GBP 100 million share repurchase program we announced in March, the capital utilized to support loan book growth and then the dilutive impact as we continue to amortize the fair value uplift on CCFS' net assets at combination and the IFRS 9 capital add-backs.

Turning to MREL. We continue to plan for our inaugural qualified debt issuance in early 2023, obviously, subject to market conditions. The following slide is a reminder of our existing capital management framework. The group intends to target a CET1 ratio of 14% once the capital stack has been optimized fully through Tier 2 and MREL issuance. We expect to operate above this target in the meantime and as we wait for clarity on the impact of Basel 3.1 and its timing versus our IRB accreditation.

We are confident that the group's business strategy and proven capital generation capability can support both strong net loan book growth and further capital returns to shareholders, including a progressive dividend per share. We intend to provide a further update to the market on our capital management framework once greater clarity is obtained on the impact of Basel and its timing versus IRB. We remain committed to returning any excess capital to shareholders. Base case Basel 3.1 scenario outcome is relatively benign on the assumption that small Buy-to-Let portfolio will continue to be treated as residential exposure. However, we should know more when the PRA consultation paper is published in Q4.

Turning to a quick update on our internal ratings-based application. The models continue to be integrated into key risk and capital management processes and are already informing our strategic decision-making and business planning activities this year. The anticipated delay in Basel 3.1 implementation and the extension to our MREL deadline provided us with the opportunity to enhance our level of end-state compliant prior to submitting our Module 1 application, and we continue to engage with the PRA to agree on submission date.

I'll now pass back to Andy, who will give an update on our lending and funding franchises.

[Andy Golding, executive]

Thank you, April. Originations in our core subsegments, Buy-to-Let and Residential, have been encouraging both in terms of the volume but also the quality of those applications. We've performed well despite the strong prior year comparison boosted by that spike created by the Stamp Duty holiday.

Our lending franchise continues to win awards while focusing on high credit quality. Average interest coverage ratios for new originations in the first half were 211% and 197% for OSB and CCFS, respectively, and our LTVs remain sensible in all segments. The professionalization of the Buy-to-Let market continued with 83% of OSB Buy-to-Let completions by professional landlords in the period, a transition that continues to play to our strength.

Our funding platform continues to serve us well. Our retail savings strategy of attract, retain and satisfy saw over 70,000 new savings accounts opened across our brands with 95% and 89% retention on maturing deposits in OSB and CCFS, respectively. And we've achieved all this while delivering Net Promoter Scores of over plus-65 in each brand. Of course, we continue to enjoy Bank of England funding through TFSME and the index long-term repo scheme. And the group's collateral position continues to improve as last week, we successfully completed a GBP 1.3 billion fully retained securitization of Buy-to-Let mortgages, predominantly to use for collateral purposes.

So in summary, a strong performance across all metrics in the first half. Our high-quality secured lending book continues to perform well, and we have not seen any systemic signs of distress or early indicators of future concerns amongst our borrowers. As we look forward, of course, we must remain cognizant of the inflationary and geopolitical pressure on the macroeconomic outlook. However, with a healthy pipeline of new business and strong new application flows, we expect to repeat the delivery of 10% net loan book growth in 2022.

We've improved our full year underlying net interest margin guidance and now expect to be broadly flat to the first half. And we continue to expect a marginal increase in the cost-to-income ratio as we invest and return to more normalized working and expenditure patterns.

Since our flotation, we have successfully navigated through a series of market shocks. And through each of these, we have consistently delivered strong growth, leading cost management and return metrics, well-managed arrears and overarching credit metrics and strong total shareholder returns. Our latest set of results underline the quality of our business model and the strength of the OSB Group's balance sheet.

Thank you all for listening, and I'll now hand over to the operator to open up for Q&A.

[Operator]

[Operator Instructions] And the first question today comes from Ben Toms from RBC Capital Markets.

[Benjamin Toms, analyst]

Two, please. Firstly, you reiterated your cost guidance, a marginal increase in the cost-to-income ratio '22 versus '21. Guidance has been reiterated despite revenues coming in presumably higher than you'd have expected, which implies that your future cost spending is going to be higher than you thought it would be at the beginning of the year. Can you give some color and a rough split on what [indiscernible], presumably there's some inflationary cost spending here but also some change in the bank investments?

And then secondly, a couple of large retailers have signified intentions to move into the professional Buy-to-Let space over the last quarter. One of your professional Buy-to-Let peers is very likely to achieve IRB approval ahead of you. With that context, can you talk a little bit about how you see the professional Buy-to-Let competitive landscape evolving over the next couple of years?

[Andy Golding, executive]

Thanks, Ben. April, do you want to talk about the cost one and then I'll talk about the competitive dynamics?

[April Talintyre, executive]

Yes. I mean we use marginally. I would say that our -- we expect our cost to be pretty much what we thought starting of the year. There's room within marginal, I guess, too, when you've got growing income to still support that.

We -- some of it is obviously increasing our staff. We're creating new roles all the time as we grow and as regulation gets more complex. We, obviously, have to give strong pay rises, which we do in April to our staff. It's a very competitive labor market out there, as I'm sure you're all aware, and we'll be dealing with as well. And therefore, we've had to look at some key hard-to-get, very popular type of skill sets and do some benchmarking and re-benchmarking just to ensure that we can, as Andy mentioned in respect to savers, attract and retain our key staff, which are our greatest asset.

We continue to invest in our technology. We continue to modernize our technology to ensure that our customers and our brokers have a smooth experience with us and that we can remain efficient. It's nothing we've ever had a real sum and talked about, to be frank. It's constant because with a growing balance sheet, creating economies of scale all the time, we're able to absorb that within our cost-to-income ratio.

And then we have contracts which are linked to RPI, but they're not sort of peak any point in the year. They're kind of throughout the year, so the usual inflationary pressures. So it's really bad. I don't think there's anything one material point to really call out, other than perhaps the sort of same odd story of changing regulation as a PRN/FCA-regulated organization. And there's a lot of new regulations coming out that we have to adapt and evolve but meet, which is why we continue to spend quite a lot in that area there. But again, there's no one thing I can really pull out to you that's individually material, we have broadly in line with what we expected within that guidance, and we aspire to spend it all. We're certainly trying at the gradually sort of get to that normal level of discretionary spend.

But we are -- like the rest of the world, we're suffering a little bit higher attrition than we had perhaps expected. It's taking a little bit longer to fill those roles. No one huge concentrated area. It's kind of across the board. But the great news is we're hiring a record number of people every month. Every month is a record. And we're hiring some really high-quality people. So I'll leave it on that positive note.

[Benjamin Toms, analyst]

Okay. Thanks, April. And Ben, yes, look, I mean, they've always been big retail lenders. And to a certain extent, the space that we're in, you had BM solutions through Lloyds Banking Group, who will dabble in elements of the professional Buy-to-Let market. You've got TMW, which is a high-quality lending output, which is nationwide.

And to pick an example, obviously, HSBC has said they're thinking about moving into the professional Buy-to-Let market. But there's a crossover point of both criteria and flexibility and breadth of offering that we have always managed to hold on to that sort of unique selling point for the distribution community. I mean, HSBC, for example, you can look at any of their product sets and look at where their LTV profiles are. They will be looking for business in their norms of sort of 50% to 60% maximum LTV, whereas our sweet spot tends to be at 65% to 75% LTV.

And professional landlords want gearing. That's why they refinance and take cash out because they're expensive in the way that they look at their portfolios. And also increasingly, professional landlords are looking for a mix and a blend within their portfolio, so inclusive of things like commercial real estate or semi-commercial real estate mixed in with some HMOs or student lets alongside more traditional property. And because of our skill set and the experience we have in those markets, we've always managed to be able to put deals together in a way that makes us not only attractive to the distribution community because the whole offering is not a play for them but also to the borrower because of the sort of relationship that they can have with us.

So yes, we always look at what our competitors are up to and sort of make sure that there's nothing we could do extra that would prevent them doing any harm. But I'm not seeing here sweating over, for example, HSBC saying they're coming into the professional landlord market because I just don't think they will do it in the same way and in the same sweet spot area for landlords that we do.

I think the second part of the question was -- I won't name the competitor, but I think I know which one you're talking about. There's a competitor of ours that is potentially likely to get IRB accreditation quicker than us. That's quite possibly true. I have to say, though, that the date of the sort of early 2000s when you became an IRB-accredited lender and got an instantaneous massive capital release, I think, those days are gone. I think the regulator is much more conservative now, I think, the sort of overlays.

And I don't see and we have never seen IRB for us as an organization as a route to huge capital release. We see it as beneficial in terms of the way in which we risk-manage, monitor and model the credit risk on our portfolio. And we've always pursued that route for exactly those reasons and also as a defense mechanism to what Basel 3.1 or 4 or 5 or 6 or whatever could come out with in the future. So I'm not unduly concerned that there will be a short-term period where one of our competitors has a big capital release and can suddenly outgun us on price. I just don't think that's realistic in the current regulatory environment.

[Operator]

The next question comes from Grace Dargan from Barclays.

[Grace Dargan, analyst]

So firstly, I guess, you set your capital target this morning. How should we think about this relative to the timing and scope of distribution?

And then secondly, on the outlook for RWA growth, noticing, I guess, in this half, you've had RWA increase of 6% versus loan growth a bit by that. So how are you thinking about the evolution of RWAs going forward, and obviously, how that impacts on your RCA going forward?

[Andy Golding, executive]

I think they sound like they're in April's domain. So I'll leave her to answer those two.

[April Talintyre, executive]

Yes. You can have a cup of coffee, Andy, and I'll do these two. So timing and scale of returns, I mean, I think, hopefully, it was clear. The first thing we have to do is optimize the capital stack to get down to the level of 14%. So that would be tiered to an MREL, which are -- which we are planning for in the near future but clearly subject to market conditions when everyone gets back from their August holidays. But we've prepared ourselves. We're ready to go when the markets are conducive.

And the other thing, obviously, is wanting to wait for that consultation paper to confirm that my base case assumptions are correct when it comes to Basel 3.1. So expect us to come back. If the PRA do give us that clarity in Q4, as expected, then you should expect us to come back, I would have thought, at prelim to really lay out our full capital management framework and give more clarity really to answer your question.

So until we get that capital stack optimized and until we get that clarity, we will expect us to continue to run significantly above 14%. But hopefully, look at the clarity we're looking for in the relatively short term. And the thing to watch out for when you see that consultation land, possibly on Christmas Eve, I'm being a bit facetious there, is to look and see whether they carved out small numbers of Buy-to-Let has been treated as residential. That's the key thing for us.

And then on RWAs, I mean, we forecast RWA based on our sort of base case, IFRS 9 economic -- forward-looking economic scenario. So that's kind of what we do. So it's, obviously, impacted by your loan-to-value. It's impacted by your arrears. It's impacted by -- the loan-to-value tier impacted by commercial and housing prices. So I'm not sure if that's hugely helpful to you, if I understood your question correctly.

I mean we're doing a little bit less risk appetite-wise, at the moment on some of the higher-yielding, higher-RWA-type business. We're doing some great business in asset finance and also in development finance. So we've been quite choosy. In development finance, we're really just working with repeat business with the customers we know and love. And there were some great schemes out there, but we are quite choosy.

We've got some appetite for commercial, but we're not quite at the levels we were pre-pandemic yet. And we're quite choosy on the type of commercial property we lend on, and clearly, the loan-to-values as well. So we're probably doing a little bit more actually of the sort of more standard core Buy-to-Let resi business. Does that give you a bit of a sense, directionally at least?

[Grace Dargan, analyst]

Yes. That's helpful.

[April Talintyre, executive]

I mean bear in mind that, of course, we're taking a risk weight charge on our record pipeline as well. It's not just the existing book.

[Operator]

The next question comes from Perlie Mong from KBW.

[Perlie Mong, analyst]

Two questions from me as well. The first is on NIMs. Obviously, very, very strong performance this half. Your guidance is sort of flat to half 1. Obviously, asset yield has sort of gone up a bit more recently. But am I right to assume that you're not really expecting funding costs to go up too much in the second half? And if so, why might that be? Because obviously, some of the larger banks have all talked about what further rate rises they expect to pass on a bit more, et cetera. So that's number one.

And the second question, I guess -- I mean, I can see why your impairments come down. Obviously, your forecast is also based on house prices, et cetera, which has been extremely strong. So I guess just sort of more broadly, how are you seeing this because with the rising rate environment, you can't expect house prices to keep running at plus-10% year-on-year indefinitely. So I guess just maybe in terms of rental yields, that sort of metrics you're looking at, are you seeing any warning signs that the housing market might be turning?

[Andy Golding, executive]

Thank you for those. April, do you want to talk about NIM and then if you want, we can do a bit of two-handed lift on kind of regular demand market versus impairment on HPI?

[April Talintyre, executive]

Yes. I mean I -- let me start with asset yield first because you did mention that in your question. And I think because there were significant delays in the first 2 base rate rises being passed on to savers, and when you're raising fixed rate bonds, you get quite a beneficial pricing if spot spreads are wide. I guess the other side of that equation is why the stop spreads clearly affect your post-swap asset yields.

I think what we have seen is -- on both sides of the balance sheet is the latest rise is being passed on quicker, not in full but being passed on quicker and a sort of a normalization, I would say, of pricing in the mortgage market. I saw something in some of the newspapers this morning about some lenders putting up their pricing sort of 3 times in -- within the month. But it's really just reflecting the people starting to price in the rate rises slightly more quickly on the asset side. But I see that normalizing really at the moment.

But just to explain again why I'm saying flat for the first half because the first half benefited from some really quite long delays and those initial rate rises being passed on. And in fact, some of that wasn't passed on until July. So the first half benefited by those delays.

The second half benefits from the subsequent delays -- sorry, the subsequent rate rises, but they're being passed on much quicker, not in full, perhaps a little bit more than was passed on for the first year. So that's really the dynamic. So you've got a bit of a yin and yang there. So that's why we're guiding flat.

We don't bake in any hope value for future changes in swap spreads or further rate rises, which the market may keep a bit back and not pass on. I haven't baked any of that into my guidance. So if you think about upside potential, yes, upside potential from further rate rises if it's a bit cut back by banks. And we're not a price maker in the retail savings market. We kind of have to follow the pack, so to speak. So there could be some upside there.

I mean the reason I raised this slightly complicated accounting concept of EIR resets earlier is that we've seen quite unusual times where periods -- where product on available periods where load more products available on the market, you've got rising rates. And therefore, it's quite hard to predict customer behavior, and by customer behavior I mean how long people will stay with you. If they're going to prepay before the end of their term, when are they going to prepay because that's important to know how -- over what period to recognize net fee income.

And if you think they're going to stay right away to the end of the product, you then think about, well, how long are they going to stay on our slightly higher revert rates before they choose a new product with us or maybe they decide to take a product with somebody else. And how long they stay back can also impact your revenue recognition. So there's a little -- I think it's sort of unprecedented time, such a period of change in the market in the rate environment that can change.

We don't need that when we see some customer behavioral changes if we wait to see if we think it's going to be sustainable. But I used to say a couple of years ago, we've had a one-off nonrecurring EIR reset. And now it seems to be something I talk to most periods. Sometimes it's positive, sometimes it's negative. So that's kind of sort of the big sort of outlook things. But I think on balance, The outlook is positive.

[Andy Golding, executive]

Thanks, April. And...

[April Talintyre, executive]

Sorry, you carry on. If you want me to chip in on the ECL, then just let me know.

[Andy Golding, executive]

Yes. I mean I'll talk about the market dynamic because I think that's where you were coming from in terms of your question, Perlie, which was the impairments are clearly nicely under control. But of course, we've got quite a lot of house price inflation that we benefited from over recent periods and how long can that keep going and rental market demand, et cetera, et cetera.

I mean I guess you've got a series of positive negatives going on with the U.K. housing market both rental- and owner-occupied. One, there's a lack of stock on the market. Tenants are remaining in situ longer. People, when there's market uncertainty, decide not necessarily to put their property on the market as quickly as they would do. So there is definitely a lack of stock, and any of the big estate agents will tell you that both from a rental and a purchase perspective.

There isn't any unemployment in this country really. In fact, there are more job vacancies than there are unemployed, and unemployment is a huge driver of kind of a reversal of fortune for housing market, and we haven't seen that yet. That isn't to say if we move into deep recession, we might not see some uptick in unemployment, but I don't think any economists are forecasting significantly higher unemployment.

And of course, the other dampener is always rapidly rising borrowing costs. And we've gone from a super-low base rate to a low base rate. I don't think anyone's looking at the rate environment that we're in as being a kind of late '80s, early '90s scenario where it really did spiral out of control. And I'm sure the Bank of England will be cognizant of not wanting to crucify U.K. plc by overdoing it. It's just about trying to control that inflationary dynamic.

And we -- I talk to landlords on a regular basis in grossy little flats in Clapham. You put it on the market, and there are 5 or 6 people clamoring to get it. And they're rising rents, and there is high demand for it, coupled with the fact that the population in the U.K. continues to expand. We're a small rock. We don't actually have enough houses to cope with population expansion already, and the new house builders with supply chain issues and delays and planning -- I mean, planning is a real problem on new housing development at the moment, nitrate issues, energy consumption issues, water table issues. We're just not building houses fast enough, which all kind of brings you back to the underlying kind of fundamentals for U.K. housing stock given that we all do what we've always done, which is fall in love, get each other pregnant, move with our job, et cetera, the underlying fundamentals are strong.

And we don't have a crystal ball, and there may be some impact. I don't think house price is going to run at 10% inflation plus a year forever in a day. But I also don't perceive that we're going to get into heavy negative territory in terms of HPI. Does that answer your question?

[Perlie Mong, analyst]

Yes. That's exactly what I was looking for.

[April Talintyre, executive]

Can I just add one thing actually, which is could you -- you asked this in the context of our loan loss provisioning, and actually in the appendices, buried, but it's on Page 28 of the presentation. We set out all of our HPI expectations, and it's a weighted average of this. But you can see that our downside and severe downside actually assume quite significant HPI. I think we're probably at the conservative end of the pack of banks when it comes to HPI, which means we think we're very well provisioned today for quite extreme scenarios appropriately, but towards the conservative end of the pack.

[Operator]

The next question comes from John Cronin from Goodbody.

[John Cronin, analyst]

A few from me, please. One, on asset quality. Look, I see all the commentary around stable arrears and no signs of credit distress. But what are the leading indicators you look for in terms of distress? And I suppose like going back to your earlier comments, Andy, around unemployment, just kind of stepping back and thinking about how well do you think the current provisioning model cater for the start of downturn we might see in this unique backlog where affordability rather than employment becomes the primary challenge?

Secondly, and just to go back to the competition point as well and look out at that event to HSBC around in Birmingham, too. And I think they kind of pushed out any expectations around entering into professional Buy-to-Let and indicated the amateur would be the first sort of growth focus in terms of their Buy-to-Let expansion. But I suppose more broadly, we've had like banks like Virgin Money U.K., Metro Bank, Bank of Ireland U.K. prior to their retrenchment decision, talk about professional buy-to-let. But yes, we've really seen no meaningful ingrowth on a multiyear view among these new would-be players in that market. What is your kind of prognosis for competition on a more medium- to longer-term view, especially just in light of the perennial question we got from investors around return sustainability and the attractiveness of the returns from operating on this professional buy-to-let market?

And then thirdly, let's just come back on the CET1 point again. Look, clearly, there's a bunch of scope here for capital return. Your fresh target -- or medium-term target rather in terms of an optimal CET1 ratio of 14% is very helpful in terms of kind of thinking about medium-term prospects for capital return, but it is struck at a very high level relative to your own capital requirements and compares to what we're seeing some of the systemically important institutions communication in relation to their own target ratio expectations. So what would you have to say on that? Is there -- look, I get it. Like there's -- you don't want to be trying to follow too much maybe in terms of capital return. But at the same time, 14% is very high. Would that be -- would the scopes come down if were no acquisition opportunities to become available, for example, in due course?

[Andy Golding, executive]

Thanks, John. April, do you want to talk about asset quality and CET1, 14%, et cetera? And then I'll finish up on the competition point.

[April Talintyre, executive]

Sure. So asset quality leading indicators, I mean, I think, it's the usual things. We get a tremendous amount of what we call forward-looking information about our customers every month from the credit bureau. It's not just arrears we look at. We look at personal indebtedness, AM scores, current account turnover, so lots of sort of leading indicators. We look at also whether landlords have got properties up for rental, for sale and perhaps different assumptions to what we might have been modeling. So we're watching all the time for signs of stress. Just haven't seen anything systemic at this stage.

But on unemployment, I mean, I don't think anybody's models -- IFRS 9 models really take inflation of cost of living as a direct input. So we chose to do a lot of bottom-up analysis, a lot of top-down, coverage-type analysis, looking at every aspect of the book. And we come up with an impact, and then we've decided to handle that by putting an extra 10% weighting on the downside. A lot of banks use PMAs to do the same thing. It's just geography really of your waterfall.

So we think we're addressing that, and we think we're appropriately provisioned because IFRS 9 sort of forces you to have perfect foresight, of course, doesn't it? And the fact that we're still double pre-pandemic coverage ratio is, I think, sort of shows you we're well positioned, I believe, for what may come when it comes to loan losses based on what we see today, at least.

And then on CET1, I mean, it was quite a discussion, as you would imagine, at the Board. We -- lots of different inputs to arrive at that 14%. We've got our own internal sort of minimums, as you mentioned. We've got our own risk appetite. We also look at appetite for growth. And as you know, we have a pretty good track record of buying some portfolios of mortgages. If we find ourselves with the RMBS markets a bit illiquid, then we become a bit more price-competitive for anything that comes on to the market that otherwise might have been just securitized. So in our capital management framework in the deck, you can see we continue to think about having enough capital for those sorts of opportunities.

We're not talking big transformation M&A, of course. You wouldn't keep capital for that. And it's also the continued uncertainty of kind of what our medium-term capital requirements are going to be, not wanting to issue more MREL than we might need when we're IRB-accredited, all these sort of factors, which came out at 14%, which is in the pack, but I hear what you're saying. It's towards the conservative end of the pack. But if any of those inputs change, then, of course, we would reconsider. But based on all of the factors we discussed, we landed at 14%.

[Andy Golding, executive]

Thanks. Okay. Thanks, April. John, I mean, I'll touch on the competitive dynamic. We were kind of the first business to really start putting on growth and volume in the professional buy-to-let market and really growing that specialist lending segment in the way that we have. And when we first kicked off OSB and it was a busted building society and we had to get it back to profitability way before we even IPO-ed, it's a bit like you start with a really small snowball and you start pushing the thing downhill. And the bigger the snowball gets, the easier the ride becomes on the way down.

And throughout that journey of -- I mean, I've been running this company for 12 years now. Throughout that journey, we have seen ever-increasing and intensifying competition and lots and lots of bold statements by people saying, "Oh, we're going to do what OSB does." And actually, other than a couple of nips around the ankles and a little bit of proposition that we find we can outperform relatively straightforwardly, we've never really seen it happen. And you mentioned Metro, Virgin Money. I have not seen any credit committee kind of submissions where those names are coming up that we're in competition with it. It's just not happening.

And I'd just come back to our kind of breadth of proposition. We can do quick, we can do slick, we can do comprehensive. But whichever one of those you want, we always do it in a very knowledgeable and borrower-focused way because we've been working with these guys for well over a decade now and understand the needs and the requirements. And whether it's flexibility, whether it's speed, whether it's just being able to understand what they're doing with their business and how we can help them expand it and working on that sort of 2-way street with, of course, their specialist broker as part of that conversation, we have just always been able to kind of stay one step ahead.

I mean, Charter Court, when it kicks off, I mean, they knew us pretty well because they were servicing some of our mortgage books for us years ago. And I think they tried to do a little bit of me-too stuff, and they became slightly irritating as a competitor for a while. And now we own them, and we prove we can grow that alongside OSB as well. So I think there's always opportunity to morph and change a little bit and stay one step ahead. I think one of the strengths that we have is we really understand the market and we really understand the needs of the borrower. And I think that's what makes us relatively unique.

[Operator]

The next question comes from Portia Patel from Canaccord.

[Portia Patel, analyst]

It's Portia from Canaccord. Apologies if you've covered this already, but I just wondered if you could remind me with respect to net loan book growth the reasons for it being relatively slow in H1 versus your 10% target. And I noted some broader market commentary, talking about sale degree pipelines being very high but conversion into completion still being very slow. And I wondered whether an expectation around this resulting was feeding into your confidence for the 10% for the full year.

[Andy Golding, executive]

April, I'm happy to take that one. I mean we came into the year with a relatively lower pipeline than perhaps we otherwise would have done because during 2021, we remained pretty conservative in terms of our criteria. We haven't really opened up into some of the markets like sort of commercial, semi-commercial, et cetera. So our pipeline wasn't the biggest pipeline ever as we came in.

But as we said in our commentary, we've seen our application as we expanded product and we felt more confident in the market opportunity, we've seen our applications accelerate through the first half. And that's why we can confidently stand behind that 10% guidance. I mean at the end of the day, we're over 3 quarters of the way through the year now in terms of what we know the completions are.

Your point about broader market commentary, yes, I mean, like any supply chain, there's been a few issues. I think lots of the valuation firms are a bit under the caution in terms of trying to recruit and keep their numbers up. So there's some lag in valuations, although we have an excellent relationship with our panel valuer and we're a pretty important client to them, so they tend to give us pretty good service. And obviously, we have our own in-house Rick's guys who can do the sort of quality reviews over the top of that as well.

There's always a bit of gum in the legal chain. I still struggle to believe that the way in which we convey property sale and purchase in the U.K. is as it is. It seems to me it could be done online in 20 minutes, but it seems to take 4 weeks of faxing backwards and forwards, but there's always a bit of gum in there.

But again, we have recommended specialists who, if it's complex stuff, we can work with that. So our SLAs have kind of had to offer to completion are perfectly normal in terms of where we'd expect them to be, and I don't see anything at the moment that's massively going to change that. On some of the bigger commercial facilities, the valuations are taking a bit longer, the legals are taking a bit longer, but we're squeezing the pipe and we're getting them through.

[Operator]

The next question comes from James Invine from Societe Generale.

[James Invine, analyst]

Andy, April. You said in the report that interest cover ratio for the new Buy-to-Let business is about 200%. I was just wondering if you could say where that is for the entire stock, please. Kind of what I'm really wondering is how quickly rising unemployment would come through as defaults. So a landlord with 10, 12 more properties with interest coverage ratios, kind of like that, could probably withstand 1 or 2 of their properties not paying. So do you think actually for the first rise in unemployment actually your landlords might feel some pain, but quite little of it ends up being passed through to you?

[Andy Golding, executive]

Yes. I mean I would categorize that as saying if you -- if unemployment goes to 10%, and that's a pretty wild number in terms of unemployment. And if you're a landlord, that might be 10% of your tenants that are in that bucket and don't pay. If you've got 10 properties, that's 1 out of 10. If you've got 200% coverage across your portfolio, you're in pretty good shape to continue to withstand that. I don't believe, April, that we publish a stock number on that, do we?

[April Talintyre, executive]

No. We don't. But I mean we have been fairly consistently at about that level as we've been publishing that statistic over the last 3, 4 years, something like that, at least -- well, since going public really, actually longer, I think, we've been publishing that statistic.

[Andy Golding, executive]

Yes. Yes, we always publish the front-end number. But I mean, for me, the key point is that's why we like multi-property landlords because if you're an accidental landlord and you've only got one and you've got a mortgage on it and your tenant happens to be one of those people that is unemployed or struggles from an affordability perspective, you've got a mortgage to pay and no rent. If you've got 20 properties and 1 or 2 of your tenants don't pay, you've got 18 others that have excess coverage to do it. And that's been one of the rationales behind why we've always liked multi-property landlords, who are looking at it as a business proposition rather than just -- I hope I will eventually make some capital appreciation from the fact that I'm now renting granny's property out that I inherited. So that's why we're in that market.

[Operator]

Our final question today comes from Shailesh Raikundlia from Liberum.

[Shailesh Raikundlia, analyst]

Andy and April. Quite a few of them are answered, but just a couple of follow-ups, actually. Just following up on the NIM, obviously, you discussed quite a lot on the cost of retail funds coming down in terms of improving margins. I was just wondering whether you could sort of talk a little bit about the asset side, whether you're seeing pressure there. And obviously, the differential between the swap rates and so forth, there's been a lot of volatility there, especially post the first half. Are you seeing -- so what are the trends there? Are you seeing some sort of competition coming in, in terms of margin pressure on the asset side?

And the second question is just on the cost side. Obviously, you highlighted several -- a couple of quarters now that your cost synergies are ahead of targets and as well as your integration cost being lower than what you initially targeted at the time of the acquisition with CCFS. I was just wondering whether you could give us some sort of updated numbers or in terms of what the quantum of that would be going forward.

[Andy Golding, executive]

April, those sounded like your questions, don't they?

[April Talintyre, executive]

Well, thank you very much, Andy. Well, I think I've touched on the asset side just a little bit earlier. You're absolutely right, stock spreads have been incredibly volatile. And mortgage product pricing doesn't change every day. So some weeks you win, some weeks you lose. But I think, as I said earlier, I do see a gradual normalization of pricing in the mortgage market. It's broadly going in one direction, which is up. And we happen to be fairly responsive because if other people put their pricing up before we do, we get flooded, and we don't like that because that can impact our SLAs within operations.

So I think it's probably -- on one hand, it's sort of very positive outlook. On the other hand, we have to be very careful that we manage the volumes we do get carefully so we can continue to service the brokers and customers the way they expect from us. Short answer, but hopefully, that helps.

And on the costs, we haven't published an updated integration cost other than saying you can see some -- because we report them as exceptional, that they are considerably lower than we had estimated at the point of combination. And we're already marginally ahead of our synergy target, which was the target for the end of the third anniversary. I think we've met that some months ago, and we expect to come in marginally ahead of that.

But some synergies was never a real driver of this merger because we were very efficient companies in the first place. And probably all I can say, I mean, to date, integration costs of GBP 23.3 million, but I'm not -- I can't give you because we haven't published it is where we think we'll end up. But we are, of course, largely done on the integration we said we would do within the first 3 years.

[Operator]

We have no further questions at this time. So I'll hand back to the management team for any closing remarks.

[Andy Golding, executive]

Okay. Thank you very much, operator. And I would just like to again reiterate our thanks for you all dialing in. The IR team are always available if you've got things that you would want to pick up with us afterwards or clarify. And thanks for your ongoing support, and we'll allow you to have 4 minutes of your calendar back. Thanks very much, everybody.