Bendigo and Adelaide Bank Limited (BEN) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Bendigo and Adelaide Bank 2020 Half Year Results. [Operator Instructions] I'd now like to hand over to the Managing Director, Ms. Marnie Baker. Thank you. Please go ahead.

Good morning, everyone. And welcome to the market briefing for Bendigo and Adelaide Bank's financial year 2020 half year results. I'm Marnie Baker, the Managing Director of Bendigo and Adelaide Bank. And presenting here with me today is the company's Chief Financial Officer, Travis Crouch. I'll start today's briefing with an overview of the 2020 interim results and an update on the business. Next, Travis will take you through our financial results in detail. I will then talk to the outlook, considerations for the second half and our priorities in the short to medium term. We'll then open up for questions. I'll start by providing an overview of our results for the 2020 half year and some of the key highlights during the period. Standouts for the half have been our above-system lending growth and continued uplift in net customer numbers, which speaks directly to the effectiveness of our strategy and the executional capability. Total lending continued to grow to $62.9 billion, up 2.8% on the prior corresponding period and above system. In the half, residential lending was well above system at 7.7%, reflecting strong customer demand driven by our strategic focus across our retail and third-party businesses. Importantly, this growth has not come at the expense of margin or asset quality but reflects strengthened executional capability, success in partnering and an effective marketing strategy to transfer customer consideration to acquisition. Additionally, the 15.6% increase in small business lending growth reflects the strong focus we have on feeding into the prosperity of communities through the growth in businesses across Australia. We continue to be the bank of choice to many small to medium businesses who value our relationship style of banking, our deep expertise and capability. We expect to continue to exceed overall lending system growth over the next half, and we will accelerate our actions to automate and reduce operational complexity to deliver scalable improvements in our cost-to-income ratio at both the business segment and bank level. The trust in our brand and our people is what sets us apart. We remain in the top 10 most trusted brands in Australia and have a Net Promoter Score 27.2 points higher than the average of the major banks. These factors have helped drive the strong growth we achieved in customer numbers, which increased 4.9% in the half, taking our total customer numbers to more than 1.8 million. Importantly, our service model across direct partners, online and digital, delivered a further increase in customer retention up to 97.3%. Our focus on telling our story, digitization and investing in capabilities to meet future needs has seen the average age of our customers continue to decrease. The average age of new customers continues to be more than 10 years younger than the average age of our customer base. Our investment in Up, the first digital or neobank to launch in Australia, has delivered strong customer growth, contributing 44% to all new customers in the half. Staying on digital, our partnering with Tic:Toc continues to provide us with sustained growth in residential lending, one of our core target markets. For the first half of 2020, we are pleased with the growth in customers, what we have achieved in lending growth and the segments that this growth has come from. We are confident that we can continue to deliver sustainable growth, building on our current momentum and connection with our customers and communities, which is a core strength of our model and one which we don't take for granted. Overall, our results affirm our multiyear strategy to be Australia's bank of choice. Like all Australians, it's been heartbreaking to witness the devastation caused by the bushfires across our country and the tragic impact they have had on individuals, communities, businesses, wildlife and environment. Bendigo and Adelaide Bank and its Community Bank partners play a vital role in supporting Australian communities, which is never more obvious than in times of hardship. We provide a range of measures to ensure dedicated short and long-term support for impacted customers and communities from severe weather events such as floods, fires, drought and storms. This additional support is a natural extension of our deep connection with Australian communities. As well as making available emergency funds and financial assistance packages to our customers, we launched a national appeal to help those devastated by the bushfires. The appeal to date has raised more than $35 million from over 140,000 generous donors. Most importantly, 100% of the funds raised will be distributed directly to affected communities, with distribution decisions being informed by local communities for local communities. The grants are already making a real difference and include providing financial support to families who have lost their primary place of residence or tragically lost a loved one. There's funding for power generators for essential electricity, funding fence equipment trailers and other localized programs. The funds generated by the Bushfire Disaster Appeal will be just the one -- just one step on a long road to recovery for affected communities. As with any disaster response, the community need will extend well beyond the immediate focus. The bank's branch and Community Bank network are well placed to support these local communities in their recovery. Our agribusiness customers, a number of whom have also faced a multiyear drought, are also being supported on an individual basis. So their specific individual needs are considered with regards to their immediate requirements and the longer-term sustainability of their operations. This is being delivered via our national network of Rural Bank relationship managers, many of whom live and work in the affected areas and have a deep understanding and experience of the impacts on their customers. We've also rolled out resilience and well-being training to our own bank staff in drought and bushfire-affected areas. Members of our Board, executive and broader team have been out on the ground, meeting with staff and customers impacted by the fires to support them and to hear firsthand of the challenges they are facing and how we can assist in their immediate needs and their longer-term recovery efforts. From our lived and hands-on community experience, we know it can take many years for communities to rebuild and get back on their feet. A long-term approach with a continued effort is critical to the rebuild process, and our bank is committed to providing this support to Australian communities in the weeks, months and years to come. Turning now to an overview of the financials. We have achieved a solid result in what continues to be a challenging environment of low rates, increasing regulatory pressure, low consumer and business confidence and growing competition. Statutory net profit of $145.8 million was reduced by two material one-off adjustments in the half: an $87.1 million impairment expense following a review of our software assets; and a $19 million accelerated amortization charge associated with the increase in our capitalization threshold. A write-down of the costs associated with advanced accreditation and the new payments platform account for 79% of the impairment expense. The majority of the past investment relating to advanced accreditation has been impaired as the expected capital benefits from IRB accreditation have diminished significantly from original expectations due to regulatory changes. Whether there are any substantial capital benefits remains very challenging to forecast, given the relevant standards are currently being revised. Notwithstanding, we continue to progress towards meeting the requirements for advanced accreditation for credit risk. We will continue to evaluate the impact of the regulatory changes as these become clearer and more certain and make any final decision or more complete information. Noted also is the impairment of the new payments platform, which is due to the delayed rollout of the platform across the industry and the resultant impact on benefit realization. Cash earnings for the half was $215.4 million, down 2% on the corresponding period and up 10% on the last half. The half was impacted by ongoing technology investment, regulatory and compliance costs and staff investment to support mortgage growth. The cost-to-income ratio at 59.3% is marginally up on 12 months ago and still higher than where we want to be. Total income of $814.7 million is up on both last half and the prior corresponding period. However, the increase in costs to support the business growth creates a drag until the full benefits of the improved processes and digitization come through. We recognize that to continue to compete in a highly competitive and highly regulated market, we must get our costs down. We maintain our ongoing focus to sustainably reduce our cost base, targeting a cost-to-income ratio towards 50% in the medium term. Net interest margin continues to be well managed, increasing 2 basis points when compared to the prior corresponding period. And our capital position has improved over the course of the year, up 24 basis points on 12 months ago to 9%. Cash EPS was 43.7% -- $0.437, sorry, and we will pay a fully franked interim dividend of $0.31. The solid result for the half speaks directly to our executional capability and the effectiveness of our strategy. Our vision to be Australia's bank of choice is being shared by more Australians as evidenced by over 1.8 million people choosing to bank with us. Customers are attracted to us by our demonstrated purpose, track record and customer service, innovative and competitive products and services and meaningful community outcomes. We are also viewed as the main alternative to the big 4 banks, which we promoted with our targeted Better Big Bank campaign. The strong growth that has been achieved is a direct function of more effectively investing in capability and telling our story. We are reducing complexity, but this takes longer and needs greater investment and careful risk management. In the half, we successfully completed the post-saletransfer of Bendigo Financial Planning to Bridges Financial Services, achieving our targeted savings. Within our Business Banking division, we automated the scheduled review process for Business Banking customers, improving the customer experience and productivity by reducing time spent on administration, providing our relationship business bankers with more time to focus on delivering customer value. We continue to rationalize a number of corporate-owned branches based on customer-led preferences for online transacting, closing 5 branches and 1 agency outlet during the half as well as opening 2 new agencies. During the half, we successfully integrated Rural Bank following the handing back of the Rural Bank ADI license, which has delivered cost savings, efficiencies and reduced ongoing and future compliance costs resulting from duplicate regulatory obligations across the 2 ADIs of Rural Bank and Bendigo and Adelaide Bank. We're also rationalizing our legacy platforms and divesting our businesses to further simplify and derisk our business while also delivering cost savings. And we continue to invest in our risk and compliance capabilities across the group to ensure that we can support the strategy and anticipate and respond to future requirements. The shifts in the banking landscape and other external factors such as customer preferences are creating real opportunities for us, and we're actively seizing these market and competitive opportunities to deliver growth in a disciplined and sustained manner. We have focused our investment in the half on reducing complexity in our processes and building new capability and capacity for growth. The first half of financial year 2020 saw an additional $16.9 million invested in systems and process simplification, automation and strengthened digital services and capabilities so that we can drive a consistent and reliable customer experience across all our channels. Investment was also directed towards regulatory change initiatives, including open banking. We invested in processing capacity to support growth, new mobile relationship and business development managers, a new and enhanced third-party white label partnerships with Aussie Home Loans and Connective, which combined to deliver a direct impact on residential lending growth over the half, with lending applications increasing 45% and settlements 35% on the prior half. Investment in our digital capabilities continued with more than 400 in-branch digital coaches trying to support customers in their use of digital assets and services. Our digital partnerships continued to grow with Up, the first digital or neobank to launch in Australia, increasing its customer numbers by 57% in the half to more than 165,000 customers. And Tic:Toc continues to deliver sustained growth, with approvals up 55% on the previous half to now well over $1 billion, with portfolio growth averaging 9% per month. We continue to modernize our physical distribution network based on customer demand. This includes branch rationalization where appropriate, continued investment in mobile relationship managers and clustering specialist capability and management resources to more efficiently and cost effectively manage operations. As part of our commitment to offer tailored customer experiences, we launched 2 additional innovative concept branches in Carlton, Victoria and Leichhardt, New South Wales. This follows the success of Norwood in South Australia, which launched in November 2018 and has seen average foot traffic increase 56% and experienced a solid uplift in lending activity and customer growth. Since opening 2 and 4 months ago, foot traffic in Carlton and Leichhardt has increased 56% and 188%, respectively. We have our sights squarely focused on sustainable, long-term growth. This will be propelled by the adoption of new technologies and adaptive culture and agile workforce and simplifying our business while remaining acutely focused on better customer outcomes. As we continue our growth trajectory, we will accelerate the level of investment in technology and digital initiatives to boost scale and efficiencies, further remove complexity in our business and deliver the banking experience of the future. We will continue to take full advantage of the growth opportunities before us. We have a clear plan for the future, which enables us to continue to invest based on the benefits from the investments we make. As we invest in our long-term capability, we maintain our focus on reducing our cost base, which we expect to increase moderately in the short-term due to our accelerated investment in digital and technology. Our strategic roadmap is focused on delivering step changes across 5 key areas, which drive customer and business outcomes: providing a seamless, consistent customer experience across all channels; strengthening our digital services and capabilities; simplifying our business systems, processes and way of working; leveraging automation and investing in capability where it matters, and embracing regulatory change and meeting compliance requirements. Subject to us continuing to deliver strong lending growth, we will continue to look to invest to support this growth. We'll increase our operational leverage and maintain a leading customer experience. Each initiative within the 5 key focus areas will be assessed before it proceeds, with our net operating expense from the accelerated investment spend expected to peak at $80 million in year 3. And then decline materially as the acceleration phase of investment spend tapers off and cost efficiencies increase. We maintain our ongoing focus to sustainably reduce our cost base, targeting a cost-to-income ratio towards 50% in the medium term. If we are continuing to grow and we make these investments, our cost-to-income ratio is expected to increase moderately in the short term, then return to the first half 2020 ratio in year 3 before declining towards our target 50% thereafter. Turning now to our capital position. Common Equity Tier 1 improved by 8 basis points to 9% over the half. Our continued strong capital position reflects a stable balance sheet and the ongoing movement to lower risk-weighted exposures. Further, we expect to raise $300 million of capital via an underwritten institutional placement and non-underwritten share purchase plan. The proceeds of the capital raising will be used to support continued strong residential mortgage growth, further strengthen our balance sheet and provide an increased buffer over APRA's unquestionably strong CET1 capital ratio requirements. The raising will also provide flexibility to invest in technology and regulatory-related change initiatives as we continue to deliver on a seamless customer experience. We have made the difficult decision to reduce our first half dividend by $0.04 to $0.31 per share. We have a history of rewarding shareholders with a high-yield and long-term returns, and this decision aims to balance shareholder expectations. We feel this reduction was required given the capital raising we are undertaking to ensure sustainability of the dividend, retain funds for growth and to enable us to continue to sustainably deliver our growth strategy. I will now hand you over to our Chief Financial Officer, Travis Crouch, to take you through the financials.

Thank you, Marnie, and good morning, everybody. Starting today with an overview of our financial performance. Cash earnings for the half of $215.4 million was 10% higher than second half '19 and 2% down on 12 months ago. Cash EPS was $0.437. This is a solid result, underpinned by strong growth, margin management and credit quality. Statutory net profit was $145.8 million, and as Marnie said earlier, was reduced by 2 material one-off adjustments in the half: there was the $87 million impairment expense following the review of our software assets; and a $19 million accelerated amortization charge associated with the increase in our capitalization threshold. Also included in the stat profit this half is a $38 million statutory earnings contribution from Homesafe following strong growth in Melbourne and Sydney house prices. When we look at the breakdown of cash earnings, you can see that net interest income is up by over 4% on the last 6 months. Asset growth has been strong, led by residential lending up 7.7% and the active management of margin, resulting in us maintaining our NIM for the half. Other income was lower, although this was driven by the training book contribution returning to more normal levels as we expected 6 months ago and lower commission income following the sale of Bendigo Financial Planning. Total operating expenses are up on 12 months ago as we make investments in the resourcing to support the asset growth we are delivering, and in our risk and compliance and people and culture teams. As Marnie has mentioned, we've also commenced the acceleration of our investment in technology and digital capabilities. The credit expense of $23.2 million was a strong outcome, reflecting our risk profile and remained low and slightly under previous halves. Total lending was up 2.8% for the half, above system growth and driven by the 7.7% increase in residential lending, reflecting strong customer demand and our focus on our retail and third-party businesses. This growth achievement have grown above systems for the second consecutive half now. Our growth is a combination of new lending activity following the success of our investments in our third-party distribution partners and processing capacity and our retail mobile relationship managers. It also reflects the results from our continued focus on retention, with again this half being successful in retaining customers and reducing the level of discharges. Total business lending was down 10.6% for the half. The business and commercial lending portfolio was down 13% driven by what we expect to be the final stage of the commercial property portfolio runoff. Our expectations are that second half '20 will bring positive growth within our revised risk appetite. For micro and small business customers, focused relationship banking strategies delivered growth, with lending for this core segment up 15.6% on an annualized basis. There was also a 6.8% reduction in the agribusiness portfolio, influenced by seasonality and the ongoing multiyear drought. We do expect the portfolio to grow in the second half, underpinned by strong seasonal drawdowns and continued growth in our core markets. Total deposits grew above systems at 5.2% as we funded the strong asset growth, with increases in our core balances, again, showing the strength in our brand and customer value proposition. A key driver behind the 7.7% increase in residential lending achieved during the half can be seen here, with significantly stronger settlement activity across both retail and third party. The strongest lending growth was delivered in our core segments of owner-occupied and principal interest lending. And as Marnie highlighted earlier, 70% of the settlement activity was owner-occupied lending. And if we look at the split between P&I and interest-only, 85% was in P&I. Lending activity was stronger in the last 3 months of the half, providing good momentum as we come into the second half of our financial year. Net interest margin for the half was at 2.37%, up 2 basis points from the prior corresponding period and maintained in line with the last half through the active management of the balance sheet. The chart on the bottom right shows December's exit or monthly NIM was 2.31%, down 10 basis points from the June '19 exit NIM of 2.41%. As I indicated 6 months ago, the NIM tracked down over that fifth quarter as the impact of the June and July cash rate changes are being felt. We then had the October cash rate reduction and saw a further decline in NIM. We've again provided a detailed breakdown on the impacts on NIM for each half. And you'll see in the table on the bottom left that the front book/back book pressure on margin continues across the industry. We saw another 6 basis point impact this half. This includes the impact of the stronger new business flows into lower rate, owner-occupied principal and interest lending. The impact of the free cash rate reductions can be seen across a number of items, with our decision to balance the impact on both lending and deposit customers, meaning there was a positive impact from our variable lending repricing of 10 points when compared to the underlying 75-point change in the cash rate. The 7 basis point reduction in NIM from our customer deposit pricing reflects the net impact of what we pass through to our at-call rates compared to the cash rate reductions and the changes in our term deposit pricing over the half. We also saw a 3 basis point decline from these lower rates impacting the net free liabilities and equity contribution. And we had a similar impact on the treasury liquids from lower rates and a higher average balance over the half. The growth in our core funding was the main driver behind the 2 basis point improvement from the funding mix. With interest rates falling in anticipation of cash rate reductions, our balance sheet management positioned us so that our hedging income over the first 4 months benefit from this repricing and offset the negative margin impact of being unable to reprice our lower-cost deposits. This provided a positive 6 basis point impact on margin for the half. Margin performance in second half '20 will be more challenging in a continuing low and possibly lower rate environment. What we do know is that the front book/back book pressure is continuing as the mix of our expected above-systems lending growth continues to be in the lower interest rate core segments of owner-occupied and P&I that we are targeting. With the market currently fully priced for additional RBA rate cut for August 2020, it is unlikely that second half '20 will see any hedging benefit. Total income was 1.4% higher than prior corresponding period. Net interest income was higher for the half, up almost 3% from 12 months ago, with both improved asset growth and stronger net interest margin driving this outcome. Total other income was down 4.4% on 12 months ago. However, after normalizing for the lower commission income following the sale of Bendigo Financial Planning, other income was steady. We were able to maintain fee income at the level seen last half due to increased lending activity. However, this line item remains under pressure driven by the competitive environment, customer behavior and the product options we now offer customers. These deposit products continue to resonate well with our customers, and we saw this through the growth in the at-call deposit portfolio. Back in August, I spoke about the launch of our retail FX card, and this, combined with the consumer and business customers choosing to do more FX transactions over-the-counter and online, has generated another improvement in FX activity and income. Trading book performance for the half was $4.8 million and back towards the level we expected for the half. This income was generated through a net loan position and continued reduction in benchmark short-term interest rates. The performance of trading positions within the bank's high-quality liquid asset portfolio, predominantly Australian government, Commonwealth government and state government fixed spot rate bonds, also contributed to the result. Other income is up on 12 months ago, with a higher contribution from Government Services income driving some of this increase, and it's also up from the last 6 months given the seasonal Community Bank franchise fee income. Moving now to operating expenses. Our headline cost-to-income ratio was 59.3% for the half, up from 12 months ago, but an improvement on last half. Operating expenses were up 5% on 12 months ago driven by higher staff costs and other upfront investments made to support our strategy. As Marnie mentioned earlier, the operating expense outcome is not just enabling the customer and lending growth outcomes we are achieving but also reflects our decision to accelerate our investment across the 5 key areas she spoke about. This half include the additional $17 million related to the investment in systems and process simplification, automation, strengthening digital services and capability, including open banking, and compliance and regulatory initiatives. Other expenses also included increase in corporate insurance premiums, in line with the increases seen across the industry. There are also additional expenses in this line associated with the stronger lending activity. Fees and commission expenses were lower, predominantly as a result of the new distribution agreement with Elders and following the sale of our Bendigo Financial Planning business. While not impacting operating expenses, the review completed of our capitalized software assets and the impairment of BAL 2 (sic) [ Basel II ], NPP and other assets impacted statutory expenses. Importantly, on Basel II, while there's uncertainty around the potential capital benefits, which have undoubtedly contracted significantly over the last few years given the regulatory changes, the bank views maintaining this program as important. Looking forward to the second half of the financial year and as we continue our growth trajectory, we will accelerate the level of investment in technology and digital initiatives to take full advantage of the growth opportunities before us. I expect total operating expenses, including this accelerated investment in technology, to increase by 2% to 3% to support growth. Subject to us continuing to deliver above-system lending growth and improved business and agribusiness growth, we will continue to look to invest in the 5 key areas Marnie outlined earlier. Each initiative within these focus areas will be assessed before it proceeds and would see us accelerating the investment, such as this annual net operating expense is expected to peak at $80 million in year 3 and then decline materially. CTI is expected to increase moderately in the short term, then return to around the first half '20 ratio in year 3 before declining towards our target of 50% thereafter. Staff costs are up 4% when compared to the last 6 months and have included -- and we've included a breakdown of the key drivers behind this movement here. We've increased our investment in staff levels as we execute on our strategy. This includes the resourcing needed upfront to support the above-system lending growth achieved during the half. And as I said earlier, this growth momentum is expected to continue. Our Risk and Compliance, People and Culture and Technology divisions have also been priority areas for the half. Agribusiness has seen the impact of a full half of the costs associated with bringing new Elders' banking staff on board in May. And we've added additional resources to support the income generated through the Government Services business. The half includes savings from the sale of the Bendigo Financial Planning and redundancies completed in second half '19. We did see increases relative to last half due to additional 2 working days and less leave taken in this first half. Turning to the first of our divisional results. The Consumer division, headed up by Richard Fennell, has delivered strong growth in residential mortgages of 7.7% annualized or $1.6 billion, well above systems. Both the retail and third-party channels are showing good momentum, driven by investment in processing capacity to support settlement growth, new mobile relationships and business development managers and new and enhanced third-party white label partnerships. Lending applications increased 45% and settlements 35% on the prior half. Deposit growth of $1.3 billion was also strong through our core at-call deposit funding customer base. Net interest income increase compared to both previous halves, reflecting the strong asset growth combined with effective margin management. The decrease in other income was driven by the reduction in commission income following the sale of Bendigo Financial Planning, with underlying other income stronger for the half. Overall, there's an improved earning contribution from wealth following the sale of the Financial Planning business. Underlying operating expenses were flat against prior half, with the increase driven by the increase in consumer's share of the allocated expense, reflecting the group's increased investments in our strategic focus areas. Release of the collective provision during the half offset what was a benign half for credit expenses. The Business division, headed up by Bruce Speirs, has undergone a significant transition to a targeted market segment focus over the last 18 months. Full segmented relationship model is now complete and fully resourced. During the half, part of the scheduled review process completed by the bankers was automated, improving customer experience and productivity by reducing time spent on administration, allowing relationship business bankers to focus on delivering customer value. Net interest income was steady for the last 6 months, reflecting the strength in our margin management across both lending and deposits and offsetting the impact of the contraction in the commercial property portfolio. As I said earlier, our small business proposition delivered annualized 15.6% growth for the half, building on prior period momentum and is a clear differentiator within the market. Other income was flat on last half, with another half of stronger FX income offset by lower transactional fee income, reflecting the competitive environment. Operating expenses were higher driven by staff costs, representing our increased investment in risk and centralized support roles and the business division's share of allocated expenses for the group. Credit expenses for the half will get closer to the long-term average and now with a higher provision coverage of the portfolio. The prior 6 months did include a benefit from the release of the collective provision, in line with the reduction in the commercial property lending portfolio. Our agribusiness division is headed up by Alexandra Gartmann, CEO for Rural Bank. The asset portfolio decreased by 6.8% over the half due to the usual seasonal paydowns, with seasonal activity for crop planting and growth in our core markets expected to come through in the last quarter of this half now. Net interest income is up on both halves, reflecting strong margin management and the seasonal asset growth achieved at the end of last financial year. Other income is again higher this half with revenue from Government Services division and new revenue streams from Profarmer and Australian Crop Forecasters, businesses acquired last financial year. Staff costs associated with acquisition of Elders banking staff during the last half and resources required to support the Government Services division have driven the increase in operating expenses. We are starting to see cost savings and operating efficiencies from the handing back of the Rural Bank ADI license. Credit expenses for agri have also reverted back towards the long-term average after historical low credit expenses in FY '19. We recognized a small number of strategic provisions and applied a conservative approach to the collective provision for drought for a $2 million overlay. Looking forward, the long-term impact of drought and bushfires are being managed through the proactive relationship management and where required, hardship assistance. Most customers are expected to operate within existing limits and facilities for the current season. Homesafe's contribution on a cash earnings basis was in line with the last 2 halves, with completed contracts providing another $7.1 million in net earnings before tax in this half. The proceeds we received on the completed contracts during the half exceeded the carrying value by just over $1 million. On a statutory basis, we recognize that nearly $39 million gain for the half, with increases in Melbourne and Sydney property values, income recognized from the upfront discount unwind and the profit on sale, all contributing to this. The 6-month to review the portfolio valuation methodology was completed and the growth outlook was maintained. We will continue to review these assumptions every 6-month and a key test is how much the carrying value of the completed contracts compares to the sale proceeds. And as I said, the completion values exceeded the carrying value by over $1 million this half. As the unrealized gains reflected in the carrying value of the portfolio are excluded from regulatory capital, property values would need to fall by almost 40% for the unrealized gains to be reversed and have any impact on regulatory capital. The strong outcome for credit costs of $23.2 million for the half was only 7 basis points of gross loans and reflects our conservative risk profile. This was down from the 8 basis points in prior halves and still under the 11 basis points we consider as our long-term average. The credit cost for the half include overlays for the impacts of the drought and bushfires. All core portfolios remain well secured and the portfolio performance remains sound. The provision coverage at 31 December is 111.8%, down from 116.7% 6 months ago and driven by an improved outlook on housing price growth, reducing the collective provision for residential mortgages. Loan-to-value ratios remain low, with the average LVR for residential mortgages at 57%, down from 58% 6 months ago. Overall, total impaired loans for the group increased by $4.6 million or 1.5% since 30 June, however, are almost 9% lower than they were 12 months ago. When we look at arrears, which is a key leading indicator, you can see the residential arrears rates continue to fall across the half. There's a slide in the appendix that includes arrears by state and show small upticks in Queensland and South Australia 90-day arrears, however, improvements across all other states including a 14% decrease in Western Australia in arrears. In our consumer portfolios, arrears in both our personal loan book and credit cards fell over the half, and as you can see on the chart at the bottom left, at levels well below those seen over the last 2 years. Agribusiness arrears were up over the half, with a small number of larger accounts driving this increase. However, these customer facilities are well secured and provisioned where required. The increase in the business arrears over the half was again influenced by the declining portfolio balance and an increase in the balance of impaired loans moving to 90 days past due. All loans 90 days past due, including impaired loans, are actively managed and, where required, are appropriately provisioned. Excluding impaired loans, the balance of 90 days past due declined. Overall, we remain comfortable with the quality of the business portfolio and it remains within our risk appetite settings. Our funding position continues to be a strength of the group, providing us with an important customer relationship as well as the flexibility to fund asset growth and the ability to manage our overall cost of funding. You will see that during the half, we completed a review of our deposit portfolios to better align our funding classification to the type of investor rather than the product type. As a result, the retail deposits are now classified as customer deposits to better align to these disclosures. This split is also consistent with how our peer banks show their funding profiles. We completed a $1 billion securitization transaction in November, providing both funding and capital benefits. We also had good demand for the 2 $500 million senior unsecured transactions completed during the half. The decrease in customer deposit funding percentage from 75.2% to 74.6% over the half is driven by the proportionally larger increase in our wholesale and securitization funding. Customer deposit balances increased by just over $1.5 billion over the half, with strong growth in at-call balances and term deposits lower as customers responded to the lower interest rate environment. So funding not only gives us flexibility to fund through our almost 75% customer deposit base, but we're also well placed to be able to tap into demand from the wholesale markets. Our Common Equity Tier 1 ratio improved to 9% over the half, up 24 basis points from 12 months ago and 8 basis points from 30 June. Our capital position reflects a stable balance sheet and the ongoing movement to lower risk-weighted exposures. Our CET1 ratio was impacted by the adoption of AASB 16, the new lease accounting standard, reducing it by 15 basis points back on 1 July as we expected. The capital raising we've announced this morning is expected to raise approximately $300 million in total via a $250 million underwritten institutional placement and a non-underwritten share purchase plan. This $300 million would, all else being equal, take our pro forma CET1 ratio to just over $980 million. This raising supports our strategy of delivering above-system residential lending growth and continuing to invest across the business in partnerships, simplification, automation and risk and compliance. It also provides an increased buffer over APRA's unquestionably strong CET 1 capital ratio requirements and flexibility for us to deal with any industry-wide regulatory changes. We anticipate making further announcements with respect to the placement and the SPP in accordance with the ASX continuous reporting obligations in due course. We are targeting a CET1 range of between 9% and 9.5%, and we'll review this range again after APRA completes its review of the capital adequacy framework. As we said earlier, we continue to progress towards meeting the requirements for advanced accreditation for credit risk, with any final decision made once prudential standards for both standardized and IRB ADIs are finalized. Our interim dividend of $0.31 has been set -- has been reset to a more sustainable level for the current environment, with our target payout ratio range maintained at 60% to 80% of cash earnings. I will now pass you back to Marnie to take you through the outlook and summary.

Thanks, Travis. As an industry, we faced heightened regulatory focus, below average business confidence, increasing frequency and severity of weather events due to climate change, constantly changing and heightened customer preferences, global trade tensions and the longer-term impacts of drought, bushfires and the coronavirus. Despite this, we also continue to see steady recovery in the local housing market. Employment growth up at 2.1%. And then we expect the RBA cash rate to remain below 1%, continuing to support economic growth. The customer trends towards a seamless experience, whether delivered digitally or otherwise, based on high levels of trust, both in integrity in the organization and trust in data, are welcomed by us. And we are well placed to provide Australians with the banking experience they want and deserve. As stated earlier and despite global uncertainties and domestic challenges, we are well placed to capitalize on the opportunities that are present, as demonstrated by our growth. Additionally, the investments we are making will serve to increase our resilience to external shocks and are consistent with our ethos of taking a longer-term approach. We have laid solid foundations and achieved early success. We are looking to the future and are making a positive impact on our multiyear journey to realize our vision, our vision of becoming Australia's bank of choice. In the second half of 2020, we expect our mortgage lending growth rates to continue to exceed system, our small business portfolio to continue to grow at similar rates and our commercial real estate business to revert back towards system growth. The structural changes within business banking are all complete. And the pipeline of business is the strongest it has been for some time. Activity levels are growing across all parts of the pipeline, with applications up 48% on prior half, supporting our more optimistic view of business lending growth in the second half of 2020. The agri lending portfolio decreased by 6.8% over the half due to the usual seasonal paydowns, with seasonal activity for crop planting and growth in core markets expected to come through in the last quarter of the second half. The short-term impact of drought and bushfires is expected to increase bad and doubtful debts, but just -- like Travis said, to stay within our 11 basis points long-term average. Notwithstanding the short-term impacts of the current drought and widespread bushfires, the broader medium and long-term prospects for Australian agriculture remain sound. Margin performance for the second half of 2020 will obviously be more challenging in a continuing low and possibly lower rate environment. The front book versus back book pressure is continuing and, if anything, is expected to increase over the next half as a mix of our above-system lending growth continues to be in the lower interest rate core segments of owner-occupied and principal and interest that we are successfully targeting. In the second half of this financial year, as we continue our growth trajectory, we will accelerate the level of investment in technology and digital initiatives to take full advantage of the growth opportunities before us. I expect total operating expenses, including the accelerated investment in technology, to increase by 2% to 3% to support targeted growth in the half. Our interim results, underpinned by our market-leading trust ratings, strong growth, above-system lending, margin management, asset quality and growth in new and existing markets, affirms our multiyear strategy to be Australia's bank of choice. Both the retail and third-party channels are delivering strong momentum in residential mortgage lending growth driven by our investments and partnerships in this space. As we continue to deliver our strategy, we will accelerate our technology and digital initiatives investment to further build scale, further remove complexity from our business and deliver the banking experience customers are demanding. Subject to us continuing to deliver strong lending growth, we will continue to look to invest to support this growth, increase operational leverage and maintain a leading customer experience. Like Travis said, each initiative within the 5 key focus areas will be assessed against its expected and realizable savings and benefits before it proceeds, with our net operating expenses from the accelerated investment spend expected to peak at $80 million in year 3 and then decline materially as the acceleration phase of investment spend tapers off and cost efficiencies increase. We have a plan for the future, which enables us to continue to invest based on the benefits from the investments we make. As we invest, we are resolute in reducing our medium-term cost base targeting a cost-to-income ratio towards 50% in the medium term. With ongoing growth combined with accelerated investment in digital and technology in the short term, our cost-to-income ratio is expected to increase moderately in the short term, then return to first half 2020 ratio in year 3 before declining towards 50% thereafter. The changing bank environment is creating opportunity for us. And we have had early successes in enhancing customer experience and growing both our customer base and balance sheet in key priority markets. We are just over 12 months into our journey to reshape our business to be adaptive to the future needs and aspirations of our customers. You will see from what is presented today, the positive momentum from the implementation of our strategy. We are amplifying our focus on the markets where we see the best opportunity for our relationship-based style of banking, combined with our proven history of innovation and where trust and authentic relationships are most valued. We are focused on our imperatives and market opportunities. As we accelerate our strategy, we continue to focus on the unique prospects in our key priority markets. To support this, we will continue investing in our people capability to ensure that we have adaptive and resilient staff and a strong agile culture. We will remain focused on continuing our successful and proven track record of innovation, whether through technology or our proud partnership models. Accelerating investment in revenue opportunities, partnerships, reducing complexity, automation and further strengthening our risk management capabilities will ensure improved scalability of the business and flexibility to support sustainable future growth. Our strong customer growth, cost base and commitment to a seamless customer experience through a proven history of technology and partnership innovation, combined with our accelerated digital and technology investment, will ensure we capitalize on the future as more customers choose to join the Better Big Bank. The capital raise we are announcing today will provide us additional flexibility and support in executing our strategy and positioning us for growth. It ensures, as we look out into the year ahead of us, that we are well positioned to take advantage of and seize the opportunities that are there for us. Thank you. I will now open up for questions.

[Operator Instructions] Please note, due to legal restrictions, we are unable to discuss any details around the equity raising other than the basic terms referred to in the announcement and results presentation. Please refrain from asking questions beyond the specific details of the equity raising as we are legally restricted from answering those questions on this call. Our first question comes from the line of Josh Freiman from Macquarie.

Congratulations on the headline results. Just a couple of questions from me. Firstly, would you guys mind providing some further color just on the hedging benefit for the half? And second question, you did call out the additional capital raised as a key support for stronger residential mortgage growth. I do note, however, that after the raising, your pro forma capital is about 9.8%. So could you guys share perhaps what you plan to spend additional capital on, given you have a stronger position now?

Thanks, Josh. It's Travis here. So it's around the 6-point benefit or impact on margin. As I said when I went through that NIM slide, with interest rates falling in anticipation of the cash rate reduction. So in the year, we had July and October, we were positioned long, both through a combination of physical but also derivative positions, that meant we did benefit from that repricing. And that really reflected that our view ahead of those cash rate changes, which proved to be correct and the positioning through the derivatives there. That, as I said, was really the benefit we saw in the first 4 months of the half. But when I look forward into second half '20 to have a think about that impact on NIM moving forward, the market certainly got the -- a next cash rate reduction fully priced in, I think, really around August 2020. So we don't see that hedging benefit. We don't expect that hedging benefit in the second half based on the market view at the moment. So that's how we looked at it last 6 months, and that's how we look at it moving forward. We don't expect that to repeat in this second 6 months. But I think your other question was around the capital. And as you said, we did talk about supporting the growth. I think what we also talked about at a high level was that it does give us the flexibility to manage our capital levels so that we can look to invest. Marnie and I both spoke about the increased technology investment that we'll look to make. It also gives us that additional capacity to respond to any industry-wide APRA capital changes. So industry-wide, we've got the capacity there. But importantly, it provides that increased buffer above APRA's unquestionably strong capital requirements. So I think it really is a combination of all of those.

Just a quick follow-up on the first question. Does that include impact from BBSW?

There will be some impact on BBSW in there.

Our next question comes from Ed Henning from CLSA.

Could we just start on the costs? And can you confirm year 3 as FY '23? And then if you look at the cost out program and the investment you're actually making, what are you going to have by the end of that third year? And why do you think your cost will continue -- will drop out from there?

So Ed, we're looking at year 3 around that FY '22. That's what year 3 is in the way we're thinking about it. Obviously, we're halfway through the financial year at the moment. So -- but when I'm talking about in 3 years' time, I'm talking financial years, so somewhere around the '22 or right in the first half in '22. And then I think your second question was more around the trajectory of costs after that period. So what we are looking at is that accelerated investment over these next few years. And then as we get through the bulk of that program as we see it now, then that investment will actually reduce back down and reduce quite quickly over the next couple of years as we trend towards that 50% over the medium term. So we see this phase as accelerated investment. And then once we get through that, then we will continue to get the revenue benefits over time, and then the efficiencies will start to come through as well. I think, importantly, what Marnie and I both spoke about, though, that investment is predicated on the need or the continuing growth in revenue. And it is certainly not committed spend. It is our intent. And that will be something that we, as we both said, worked through at an initiative-by-initiative basis. But that's how -- the way we're looking at it at the moment.

And Ed, I'll just add something there, too. We are talking about actually getting more efficient as an organization. So the investment that we are making goes to that efficiency. Probably one thing that we hadn't mentioned, but I'll mention now to everyone on the call, is that we have been variablizing our cost base. So in a sense of actually supporting costs and especially in those areas that go directly to supporting the growth, like the processing center, the new staff or the new people that have come on there have been under contract. So that as we get the changes in technology and the automation through, we are able to quickly reduce the costs.

Okay. So what you're going to have after this is a bit of more automation in your processing center. Is there any other systems that will be fully up and running by that end of year 3?

Yes. Yes, there will be. I think part of this detail, Ed, we will actually be coming back to the market with later in the year. That actually does look and give more illustration of the timing of the different components of that. So I just hesitated there just because of the time frame you placed on that, whether I can categorically say the pieces of work that are being done before that time frame or after because we are still looking at the sequencing.

Okay, that's fine. And just one follow-up on the NIM. In the half, there was a 2 basis point benefit from a lower contribution from the Community Bank and Alliance model. Can you just talk about the mix of your business going forward as you grow that third-party channel beyond the Community branch model, that there's no difference in the NIM there going forward? And also, do you anticipate any more mix benefit from running down your TDs going forward?

Ed, so I think the main driver behind the change in the margin share contribution there or the margin share impact, as you said, there are couple of ones. As you said, the proportion of growth through other channels, obviously plays into that. But over the half, just with community banks, the strength in our Community Bank model is deposits and, particularly, the at-call. Now from a revenue share, that margin reduced over the half just based on the changes in the underlying rates and interest rates and the way we share revenue with our Community Bank and Alliance Bank partners. So that really reflected just the mix of their business and then the impact on rates over the half. So that contribution changed by 2 basis points. Looking forward, we don't see any change in the way we think about that Community Bank model and our partners there and, actually, the value they provide to the business. So I think it really reflected just the change in the underlying rates rather than a change in strategy. And then your other question was around the impact we saw, I think, on the funding mix side. So yes, look, I think with what we saw over the half, where at-call was certainly strong growth, term deposits were -- actually went backwards, I could see something like that continuing as at-call growth continues. I think the hard bit is to forecast or to foresee is just the impact on TDs with -- as we fund our growth, how much we actually would like to use term deposits for that. But all else being equal, we actually do see another small benefit from funding mix.

Our next question comes from the line of Andrew Triggs from JPMorgan.

Two questions, please. First one, could you disclose what gap exists between your front book and back book in the mortgage book? CBA disclosed last week theirs is less than 30 basis points. But I note that your half-filling NIM waterfall includes a lot more pressure here at 6 basis points versus Com Bank at 2 basis points. The second question, just on -- a follow-on, on third bank party banking. Slide 14 shows that settlements are now much higher in this channel versus your first-party channel? Just some comments on whether you're comfortable with that mix shift? And whether you expect any change there in the near term? And how much of that relates to new white label arrangements?

Thanks, Andrew. I might talk on the front book/back book first of all. I think what we're seeing -- so this is -- the way we monitor that is on a month-by-month basis, the new business settlements versus the portfolio. And it does move around. I would have said, though, for -- what we are experiencing on average is probably closer to 40 rather than 30. So to your point there, it probably is showing a little bit more of an impact through what we're seeing. But that also reflects the significantly stronger growth in those, what I called before, lower interest rate products in our core strength around owner-occupied and P&I. So that's probably where we're seeing it at the moment. It does move around each month. But on average, that's how I think about it. And then I think your other question was around the increased flows or the increased activity for third-party. Look, I think that did probably reflect a seemingly stronger half through third-party as we invested with our partners more. What I will say, though, is we started to see some really good activity through the retail channel in that last half of the half, so the last quarter. And they both remain key strategic areas for us. But Marnie, did you want to add?

Yes. I think we need to -- just remember, we're sort of just getting back to the levels that we were a decade ago. So there was work that we needed to do to ensure that the service proposition was right. That work has been undertaken. We've put in that investment in, which -- and we'll continue to do more investment going forward. But it does open up to get back to the sort of levels that we were approving and settling a decade or so ago.

And Marnie, just a follow-on. Are you satisfied with the ROE in that channel compared to retail?

Yes, yes. We're about sustainable and profitable growth, Andrew.

Our next question comes from the line of Brendan Sproules from Citi.

Just in terms of the investment spend that you said would peak at $80 million by year 3. What is the total amount that you plan to spend over the whole program? And secondly, how much of that spend do you expect to capitalize on the balance sheet as you've done with previous investment spend in the past?

Thanks, Brendan. So what we're talking about there is we want to provide the market with some visibility with how we're thinking about the pieces of work that we've got coming. That indicative $80 million is the net impact of capitalization and also some direct efficiencies. We're not looking at, at the moment, as a total spend because we're actually not committed to spending anything in total. We are looking at this as an initiative-by-initiative basis that we will progress as -- if the revenue there continues to be there upfront. So that indicative up to $80 million in 3 years' time really is just to give the market some guidance around what we think the OpEx impact will be. To your question around how much we capitalize, we obviously need to make some assumptions when we're looking at this. But that piece of work obviously happens at an initiative-by-initiative. It could depend -- it will obviously depend on the use for life. It could be 3, it could be 5, could be 7, could even be 10 if it was a core banking piece of work. So I think that's the -- it would be hard to say on average for that one because it really is an initiative-by-initiative. But importantly, that $80 million gives some guidance around where we think that the spend or the OpEx impact could get to. And as I said, after that first 3 years, it will then drop off after that, given that accelerated phase that we're going through, but it will go through at the moment.

Our next question comes from the line of Jon Mott from UBS.

Just following on from that topic. I think, Marnie, you said obviously the investment is predicated on revenue growth coming through. In the event that the RBA is forced to cut rates once, twice more, or even go to quantitative aging and the margin would obviously come down pretty quickly in that environment, would you then have to delay this investment spend because the revenue environment wasn't as strong?

Yes. I think we tried to illustrate through the presentation that it is all predicated on a number of things. And any changes to the environment, we are not locked into or committed to any of this. It is our -- it is part of the plan that we have in place, but of course, we'll need to take into account any changes to the environment and adjust ourselves depending on what those changes are.

Okay. And a follow-up question. The risk-weighted assets were lower-than-expected, partly because of the securitization that came through. Is that becoming a better economic alternative as a funding and capital option in this environment?

Jon, it certainly is attractive from, definitely, from a capital and then from a funding point of view. So it is something that we will -- and I've said this before, we look to continue to do every half subject to market conditions. But it is quite an attractive option at the moment given the capital and the funding. But I'll say that -- I'll also say we balance that with the importance of our customer deposits. So it really gives us a balanced way of thinking about our funding moving forward. It gives us a number of options there. But it certainly is -- continues to be an attractive way of funding.

So how large could this program become?

Well, I guess, Jon, that depends on the uptake in lending growth as well. So it's not something that I probably got a view on at the moment. But we will continue to look to do a transaction every half with -- subject to market conditions.

Our next question comes from Andrew Lyons from Goldman Sachs.

Just a follow-on question from Jon's, just around the investment acceleration being predicated on revenue growth. Can you maybe just sort of talk about what you're expecting as far as system growth is concerned over the next couple of years? And the extent to what -- the extent to which you expect it to either accelerate or even slow a bit further. And then just a second question, just around the decision to take the write-down and the accelerated amortization below the line. We have increasingly been seeing your major bank peers taking the equivalent above the line. Can you just maybe talk about the thinking there? And then maybe what the impact on the amortization expense might be going forward? Was that already touching the P&L? And so you will see a reduction in the amortization expense as a result?

Thanks, Andrew. I think I've got all those questions here. But around our outlook for systems, I think, importantly, we start the other way. What do we think our outlook for our own lending growth is? And the momentum that we've seen coming into that -- into this half gives us confidence that we should be able to continue that residential lending growth somewhere where we're seeing at the moment. I -- my view is that systems will probably maybe trend a little bit lower, but I don't think as low as I probably thought 6 months ago when we were looking at the outlook for resi lending. Importantly, though, we spoke about earlier that we do see some growth coming back into our business in commercial book. That's something that's obviously continued to run down over the last 18 months. So we are looking for positive growth in that, both through the property portfolio and our SME area. And agri is strong and it is seasonal. So we do see that reduction in the first half. But coming into the end of this financial year, that seasonal growth will certainly be there. And then I think your second question was then around the write-off and our treatment now. We believe this is a material one-off item that is significant enough for us to actually recognize in the way we did as below the line. We are comfortable with that treatment. And we think that recognizes the significance of the change. When I think about the software amortization moving forward, the bulk of the software assets that we wrote off was obviously the Basel II asset. Now that had some amortization already through the P&L, but the bulk of that was sort of back ended. So we weren't seeing that come through the P&L yet. What I do think, though, if you would have seen that amortization for the half was down about $1.5 million from the prior 6 months, so that reflects some of that change going through. When I look forward, I would expect that second half amortization would be probably another $1 million lower. And then I think as the -- some of the initiatives that we're working on at the moment or have finished recently, that will start to step the amortization up back a little bit, whether it's $1.5 million. So I'm not looking at this as a significant savings in the P&L. This change reflects the view of the value in those assets and, hence, why we needed to make a decision on them.

Our next question comes from Brian Johnson from Jefferies.

Two questions. And I think you might have gone a little way to answering them, but I'd still be intrigued. Just on the credit risk-weighted asset, where we saw no growth during the period. Going back to Jon's question, can I just get a feeling on the drivers because we have not yet got the Pillar 3? So just to put -- if we have a look on Page 23 of the result, it was $33.4 billion. At June, it's $33.2 billion. Could you just step us through the various components and the move in the credit risk-weighted assets?

Yes, Brian. So I haven't got the detail in front of me, but what I will say is that would have been influenced by the $1 billion RMBS transaction that we spoke about. So that would have been a resi mortgage reduction there through that transaction. The continued decline that we did see in the commercial and then even the seasonal agri lending growth, all at 100% risk-weighted, would have impacted that and reduced the RWA. And then obviously, offsetting that was the strong residential lending growth, albeit at a lower risk weight compared to the commercial and the agri. So -- and yet without having the Pillar 3 in front of me, that would be the drivers behind the risk weight change.

Okay. And then a question for Marnie. Marnie, when we have a look at this result, I mean, it is what it is, but we can see a fairly substantial write-down of a capitalized expense. And yet you're asking the market to basically tolerate aiding -- well, a rising capitalized spend going forward over the next 3 years. How should we be responding to the historic practice of the big write-down? I'd just be intrigued to get some comments for you on that -- from you on that?

Yes. I think like Travis outlined before, Basel II or the Advanced Accreditation is a big component of that write-down. So I think there's some extraordinary circumstances around that. And the assessment that we needed to make based on the capital standard is still being unclear between standardized and IRB. So we started with that review and looking at Basel II and whether we did need to make an impairment and decided that we did need to make an impairment there. We then actually followed through and looked and reviewed across our total portfolio of software assets on the balance sheet and decided to make some adjustments to some other slightly smaller scale. But where things had actually -- the benefits hadn't flowed through or where, we had decided not to move forward with an initiative. So I think that sort of -- hopefully, that goes, Brian, to your question. I think Basel II was quite a big lump there and like I said, a bit extraordinary to everything else that we do.