Judo Capital Holdings Limited (JDO) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Judo Capital Holdings Limited, Judo Bank 1H ‘23 Results Webcast. [Operator Instructions] I would now like to hand the conference over to Mr. Andrew Dempster, General Manager, Investor Relations. Please go ahead.

Good morning, and welcome to the Judo Bank results briefing for the half year ended 31 December 2022. My name is Andrew Dempster and I am General Manager of Investor Relations at Judo. I'd like to begin by acknowledging the traditional owners of the land we are meeting on today and my respects to Elders past and present. Our results material was launched earlier this morning with the ASX. The material is also available on the Investors section of the Judo website. This morning, we will first hear from our CEO and cofounder, Joseph Healy, with an overview of the results and an update on our progress. Andrew Leslie, our CFO, will then discuss our financials in detail. Joseph will then return to provide an outlook and commentary. There will also be time for questions with Joseph, Andrew and our Chief Relationship Officer and Deputy CEO, Chris Bayliss. A replay of discussion, including the Q&A will be available on our website later today. I will now hand over to Joseph.

Thank you, Andrew, and good morning to everyone joining us on the call. We are pleased to be presenting our results for the first half of financial year 2023. These results are the outcome of our strong connection to our purpose to be the most trusted SME business bank in Australia and to our vision to be a world-class SME bank. The disclosures that we have provided today are detailed and provide a high degree of transparency, which underscores the confidence we have in the performance of our business. I'm joined on today's call by Andrew Leslie and Chris Bayliss. Andrew was appointed as CFO towards the end of last year after being with Judo over 3 years playing a key role in the finance team, building on a longer career in investment banking. Andrew's appointment coincided with Chris Bayliss moving to the role of Chief Relationship Officer; and Chris retains the responsibilities as Deputy CEO. These changes highlight our commitment to talent development and succession planning. Today, I'll provide an update on the business before handing over to Andrew to run through the detail of the financials. I will then discuss the outlook and some of our organizational priorities before moving to Q&A. As well as Andrew and I, Chris will be happy to take questions during Q&A on how we are performing in the market and how we are seeing competition.  We consider this set of results to be another blackball performance, which clearly demonstrates the power of our pure-play stresses business model and management's ability to execute against what we promised. Our business has continued to successfully scale delivering revenue growth of 67% and profit growth of over 300% with a profit before tax in the half of 53 million. We are on track to achieve the gains we provided for FY '23, including a loan book of over $1 billion. We're also making steady progress towards our key business metrics to scale that we announced at the time of the IPO in November 2021. Our business is now generating sustainable and growing profit, and we've achieved this outcome faster than any other new bank anywhere in the world. You will hear in the space several times that Judo represents a unique pure-play business model. This is an important aspect of our business that we want the market to better understand. We are truly unique. We're not a fintech, not a new bank and on an NBFI, We are a genuine purpose book challenger bank led by people who know this business inside out. Importantly, as Andrew will detail, we continue to increase the diversity and sophistication of our funding program. We're accessing multiple sources of funding and are not overly align in any single channel. This gives us real confidence in our ability to continue funding growth as well as repay our TFS funding by June 21. Our business model is performing well, and we believe our strong relationship-based approach provides us with a strategic hedge that will enable us to grow regardless of the operating environment. We are not aligned on system growth. We are not relying on macro conditions as we think about calendar 2023. I'll come back to this later. Our strategy has been consistent from when we first architected the bank in 2016, and we remain absolutely committed to it. We are running our own kit planned in time rates, not too fast, not too slow, just the dual bank plan base. We are a young business in a continually challenging landscape. So I want to take a moment to recap on our purpose and vision and reiterate our belief that significant market opportunity exists for Judo, a market opportunity that goes way beyond our message to scale targets.  As mentioned, Judo is a pure-play special Destiny bank. The business is unique, and we cannot find a like-for-like comparable anywhere in the world. In so many ways, Judo is a great Australian success story. Our business was constrained by belief that, that was a market failure with SMEs being poly started by an industry that posted GFC had consolidated and industrialize its approach to SME banking. Competitive forces in SB banking were weak. When we built Judo bank, our goal was to bring back the craft of SME banking, where relationships trump products. where each SME is seen as unique and acquiring a bespoke solution, not an industrialized take it or leave it option. Being a specialist means SME Banking is always think about and always talk about. We see this as a huge advantage when combined with speed, agility and the ability to provide a more individualized service, which cannot be matched by generous competitors who can suffer from this economies of scale in providing the service SMEs to Zena.  This slide shows the progress we have made since being just a PowerPoint only 6 years ago. Our history is short, but our progress has been unique, compelling and sustainable. Since receiving our banking license in 2019, we have grown our loan book to $6.5 billion, $7.7 billion, including undrawn lines of credit, and we've established 18 locations nationally. We are now a credible alternative to other banks with a clearly differentiated story and value proposition. 6 years ago, we had a clear vision on how the bank would evolve over 3 broad horizons. Horizon 1 was to build a bank and proved the CPP and EVP and it was give to profitability within 3 years without compromising on sound risk reward economics, ensuring that our lending was cognizant of our cost of capital. Horizon 2 was to scale the bank setting it up for a sustainable path to becoming a world class. Horizon 3 was to demonstrate world-class quantitative and qualitative metrics. We are now firmly in horizon 2, executing a clear plan to realize the scale benefits that are enhanced in our model. This includes investments in technology that will better enable our bankers and improve our customer experience. It also requires developing a culture and embedding our risk management frameworks. We have come a long way quickly and a very volatile period that included the pandemic. While we still have a lot to do, we have a strong team and are never been more confident in our ability to execute on our strategic agenda and achieve our vision.  Turning to the key operating metrics. As you can see, we have delivered strong performance in all measures. Gross loans and advances reached $7.5 billion on 31 December. Our underlying net interest margin for the half was 3.56%, well above our guidance. Our CTI of 54% is well below the CTI of 71% in the last half and puts us on track to deliver a full year CPI of below 60%. Credit quality was strong, and our profit before tax of $53 million equates to an annualized ROE of 5%. We are on track to our aspiration of delivering an ROE in the low to mid-teens at scale. This slide highlights some dimensions of our progress in scaling. The demand for our relationship-based customer value proposition has continued to drive lending growth and pull out into new regions and markets. Over the last 6 months, we've established a presence in 4 new locations, Bunbury, Rockhampton, Orange and Albury. This is consistent with our belief that to have a genuine relationship with our customers, we must have a physical presence in the region. We have seen our banker numbers continue to increase, albeit as signaled in our full year results last August at a consciously slower pace following a significant increase in banking numbers last calendar year. We have sufficient late capacity in the existing workforce to continue growing our loan book as well as stay close to our existing customers in the challenging environment we see for 2023.  Underscoring demand for lending is a growth in our AAA pipeline, which at 31 December was $1.3 billion, up from $1.1 billion in June. We continue to see great opportunities for growth, notwithstanding macro conditions. Importantly, our Net Promoter Score at positive 66 is by a country mile, the very best in the banking market. There's much to beat about the economic outlook, but I'd like to reiterate that this is not our portfolio. Our management team and our Board have seen many cycles and have built Judo from a blank piece of paper with risk management at its core. Commercial banking is in the business of risk management. It must be a core competency. Our high-touch business model with a comparatively lower ratio of customers to bankers means we remain in close contact with our customer base and can proactively manage any emerging issues. The benefit of our model is demonstrated by continued strong credit quality. We have just 15 customers that are in 90 days arrears are impaired out of approximately 3,300 customers. Andrew will discuss credit quality in more detail and the opened to this deck provides a considerable detail on our portfolio.  Before passing to Andrew, let me just summarize the headlines on these results. First, we are on track to meet our guidance for financial year '23 and to deliver our key business metrics at scale. Secondly, we are more confident than ever in our CBP and the market opportunity available. Thirdly, risk management is a core competency within our business. We have seen no decimation in credit quality and have prudently bolstered our provisions. Firstly, our approach to growth is measured and sustainable. We are running our own ways. Growth for growth's sake is not our strategy. The economics of growth are important to an owner mindset management team. Lastly, we have moved beyond the first phase of starting a bank to the next phase of scaling our bank, and we're delighted with the progress we're making. I'll come back later to talk about the operating environment and our outlook. So in the meantime, I'll hand over to Andrew.

Thank you, Joseph. For those who don't know me, my name is Andrew Leslie, and I recently took over the CFO role in November '22, having joined Judo's finance team back in 2019. Over those years, it's been great to see the business grow, and it's with great pleasure on here today to present Judo's first half 2023 results. Our headline results for the half is a profit before tax of $53.2 million, significantly up over the half and 3x the PBT generated over the entire '22 financial year. Lending volumes and margins both grew strongly, contributing to a 67% increase in revenue. Expenses increased 27% to support this growth, whilst PTI reduced by 17% with overall very positive jaws for the half. Pleasingly, asset quality has continued to remain benign, with the increase in impairment expense over the half, largely reflecting provisioning from growth in the loan book. With strong lending growth and low write-offs for the half, we maintain a prudent provisioning coverage level now at 104 basis points. The fact that we are generating strong PBT means we're now also generating organic capital at a meaningful rate. And as Joseph highlighted earlier, we remain on track for all of our '23 guidance and our key business metrics at scale.  We've seen another half of strong growth across all lending product lines. GLAs were $7.5 billion at the end of December, and momentum has continued throughout January and February, with the pipeline now over $1.3 billion, clearly, putting our June '23 target of $9 billion plus were within sight. As a reminder, we typically expect about 90% of our AAA pipeline to convert to GLAs. On top of the GLA balance, we have around $200 million of undrawn lines of credit on which we hold liquidity and provisions, but also earned fee income. Portfolio mix in the first half has remained relatively stable. SMEs still prefer that flexibility of floating rates with 10% of our book on fixed rates. Security levels have also remained broadly unchanged with 86% of our portfolio fully or partially secured by real property. We've included some further detail on our sector concentrations versus the broader SME market in the attends. In terms of channel split, we've seen a slight increase in the portion of flows directly originated, consistent with our longer-term objectives. And we remain focused on balancing the split of originations with a greater portion of direct over time.  Turning now to margins. On this slide, we show the key drivers of underlying NIM since June through December '22. A reminder that underlying NIM is a measure of NIM, excluding the impact of our TFF preservation strategy. So this is where we preserved an amount of TFF funding, using treasury securities as collateral to subsequently utilize as we grew the loan book. Underlying in for the first half was 3.56%. Now that's above the top end of our guidance range with a strong 72 bps expansion predominantly from funding. As you can see from the slide, there were several key components driving this increase, which are just worth unpacking. Firstly, our lower cost of deposits on a hedge basis, which continued to improve over the half. Secondly, the benefit of our structural leverage to rising rates from fixed CFF funding and equity funding. Partly offsetting these tailwinds was the lower lending margin, which I'll touch on shortly. And finally, the impact of rate rises on fixed rate bonds and the drag from holding higher liquidity as we took advantage of favorable TD pricing. I'll run through each of these elements in more detail over the next few slides. But before we leave this slide, I'm going to give some guidance for the second half NIM.  As many of you know, our expectation is to deliver a NIM of over 3% at scale. Consistent with this, we expect our underlying NIM to moderate in the second half to between 3.1% to 3.3% as some of the current tailwinds abate. Next, the funding mix. Term deposits remain our primary source of funding for loan growth and now sit at $5.3 million, having grown $1.2 billion over the half. While a significant amount of our term deposit growth came through the retail channel, growth was also supported by the recent launch into the direct SMSF canal, which we expect to grow into a material new channel over time. We continue to execute on our TFS funding strategy with an additional $740 million in low-cost TFS funding deployed to support SME loan growth over the half. Funding from warehouses increased slightly as our optimization program progresses. We also executed our inaugural public senior unsecured benchmark deal in September '22, which was well supported by fixed income investors and an important milestone as we progressively build our presence in debt capital markets.  As you can see, we have proven our ability to access a wide range of different funding sources and channels, which we think positions us well to continue to fund growth and replace TFS funding. So let's now turn to the TFF. As of the end of December, we have self-securitized $2.3 billion or 80% of our total $2.9 billion TFF allowance. We expect peak sales TFF utilization during the second half of 2023, with repayment to be progressively made ahead of June 2024 to ensure an orderly and efficient transition. Over the long term, we expect our funding stack to consist roughly 70% to 75% term deposits, 15% to 20% wholesale funding and 10% core equity, which will continue to be supplemented with organic capital generation. Based on this mix, we expect our overall through-the-cycle funding costs to settle at roughly 100 bps over BBSW. Our committed warehouse capacity was $1.75 billion at 31 December, on which we currently pay market baseline fees. And we are in advanced discussions with several banks and are well progressed towards our $2.5 million target by 30 June 2023. We -- most of our committed warehouse lines remain largely undrawn, and these will provide a significant amount of funding flexibility ahead of the TFF repayment window.  As I mentioned earlier, term deposits are a core part of our funding strategy. Our at-scale NIM of above 3% assumes term deposit funding margins of 80 to 90 to the swap through the cycle. The cost of our new TDs for the first half was only 47 bps, down from 66 bps in the prior half, so well below our upscale assumption. This has been supported by our hedging strategy and the rapid increase in yield curves. Looking forward, we do expect repayment of the TFF to drive additional competition. As we've shown on the slide, we have, in fact, already entered the major bank's TFF refinance window. Consequently, we are seeing the majors compete more aggressively in certain segments. Notwithstanding some recent pricing increases in the market, pricing in our key markets remain at or below historical averages. And as a result, this means we continue to have headroom in our assumed the margins to work through this period of funding transition and also flexibility across tenors and channels to optimize the margin. In addition, we are uniquely positioned to price competitively for our TDs given our lending margins are higher than the sector who are primarily mortgage lenders with NIMs below 2%. In terms of outlook, we have assumed the TD pricing reversed to 85 bps over the BSW for the rest of FY '23, which is the main driver of our underlying NIM moderating back closer to 3%.  I'd now like to turn to lending margins. As noted earlier in the NIM waterfall, we saw some pressure on lending margins this half, which is worth unpacking. The most material driver on margins was fixed rate loans. As a reminder, 10% of our GLAs had fixed rates, predominantly the asset finance book, which do not reprice as rates rise. The impact of fixed rate loans was a 12 bps drag on underlying NIM over the half. Refinances for existing customers and lower margins on new lending also had an impact in total a 7 bp drag on underlying margins. We attribute lower lending margins in part to the recent lower funding costs across the system with the sector using favorable deposit costs to fund lower lending margins whilst managing overall NIM. And as sector funding costs increase, we expect this will be reflected in asset pricing. We remain focused on a disciplined approach to pricing credit risk. We continue to see our long-run lending margin assumption of 450 bps over 1-month BBSW is achievable given the premium customers are willing to pay for our high-touch service.  Turning now to operating expenses. First half CTI reduced by 17 percentage points to 54%, demonstrating improved leverage as the business continues to scale and a strong NIM we delivered this half. The increase in expenses over the half predominantly reflect growth from new recruitment, including additional specialist staff, some new offer sidings and a normalization of travel activity. After a successful period attracting new bankers to Judo, we have a very strong team with ample capacity, and we expect banker numbers to stay relatively steady over the remainder of this year. In terms of guidance, we remain on track to deliver a full year 2023 CTI of under 60%. Our December '22 run rate OpEx was $15 million, which we expect to increase in the order of about 10% from continued investments in growth and some lingering inflation. We expect second half 23 CTI to rise by 2% to 3% of the first half, largely due to an assumed normalization of NIM.  Turning now to credit quality, which remains sound. Impairment expense for the half was $22.3 million. Now as a reminder, as a high-growth bank, most of our impairment expense is provision billed in accordance with accounting standards, which require us to take our provisions upfront for new lines. We've previously provided cost of risk guidance for full year 2023 of $50 million to $60 million, which we expect to meet. There were no write-offs over the first half and in the absence of write-offs over the second half, our bias is to continue to build provisions. Our days past due in ads remain above levels. Whilst we saw a slight uptick over the half, this was due to a small number of customers across various industries with no discernible trends, which will continue to monetize. Note, we've included the industry breakdown of credit quality in the bending. Clearly, the 16 bps of 90 days past due and impaired assets that we reported in the second half '22 was a normally low with some normalization expected, which we're now starting to see come through. Given the continued build in collected provisions over the first half and no write-offs, total provision coverage has increased to 104 bps at GLAs. Specific provisions also increased over the period, which was driven by a small number of headlines.  I do want to spend a moment now on our collective provision overlays. This half, we raised a new overlay of $3.7 million for vulnerable sectors. This reflects the heightened uncertainty in industries more adversely impacted by reduced discretionary spending, namely accommodation in food services, discretionary retail and arts and recreation services. The overlay reflects a one-notch downgrade to customer risk ratings in the relevant industries. In addition, we continue to hold a large customer overlay, which was first raised in September 2020. Overall, we believe our current level of provisioning is prudent for the risk in our book and the current economic outlook. Now let's turn to capital. Our very high capital ratio continues to support our growth. Pleasingly, and as noted earlier, we are now beginning to generate organic capital at a meaningful rate. This half contributing 70 bps to CET1. This trend will continue as we grow and see the full benefits of scale and investments made. I also want to provide some comments on the revised APS 112 capital standard, which took effect on the 1st of January. For us, this provides a pro forma benefit of about 9% reduction in credit risk-weighted assets, resulting in a pro forma CET1 of 19.2% on December '22 numbers. This is a very strong capital ratio to support our future growth.  Finally, I'd like to close with a summary of key considerations for the second half to give you all the good sense of where we expect to land at 30 June. On revenue, we expect net interest income to be higher in second half '23, reflecting higher volumes and benefits of scale as well as the ongoing benefit we received from rising rates as an ADI. The NII tailwinds will be partly offset by lower second half underlying NIM due to the normalization of TFF margins, line fees on new warehouses and the drag from temporarily carrying higher liquid assets as part of the TFF refi strategy. Other operating income, which is largely fees charged on bank guarantees and undrawn lines of credit will be broadly flat half-on-half. On expenses, we expect an increase of around 10% of the December 22 run rate of $15 million, with a corresponding increase in second half CPI of around 2% to 3%. Holding for guidance. Cost of risk is expected to be between $50 million and $60 million in FY '23. And lastly, as discussed in my previous slide, our CET1 ratio will benefit from APRA's revised APS 112 standard, which results in a 9% reduction in credit risk-weighted assets and a pro forma CET1 of 19.2%. Thank you once again, and I'll now pass back to Joseph.

Thank you, Andrew, for that excellent update. I might spend some time discussing the operating environment and outlook together with some organizational priorities. While speculation about the economy remains a hot topic, we are optimistic about the outlook for our business. We're cautious about how the economy might evolve in 2023. We are in uncharted waters, but we do not see a severe downtime. We still appear to be on a narrow path to achieving a soft landing. High interest rates and the potential for consumer discrete is clearly a key risk to the economy, and we continue to see the household sector as an area of concern. Accordingly, as Andrew discussed, we have raised an economical belief or sectors we consider to be vulnerable predominantly those sectors aligned on discretionary consumer expenditure. As always, context is important. While the official cash rate has been increasing quickly, the consensus for the medium-term peak cash rate of between 3.5% to 4% is consistent with the long-term average. We are returning to normal settings, albeit at an extraordinary pace, and the transition will undoubtedly prove challenging for some households and businesses, while also drafting with broader inflationary pressures.  It is well understood that household leverage is high, a consent for the economy that I've been voicing for some time. In contrast to the growth in household debt over the last decade, which has been both eye-watering and concerning, SMEs have deleveraged, as you can see from the slide, and are generally well placed to withstand an economic slowdown. Turning next to our organizational priorities. We have 4 clear areas of focus as we continue in building a world-class SME bank. First, maintaining our unique cut, which is founded on an owner's mindset. The importance of this cannot be overstated. I know that culture as a source of competitive advantage doesn't lend itself to our financial model input, but it is real and it can be defined. The [ uni truth ] is to create businesses for great cultures. Second, keeping our customers front and center in everything that we do. Our reason for being is to arrest the market failure. This is more important relevant today in times of potential economic stress. Third, maintain a challenging mindset and consistent with that, avoiding the mini risk of sleep walking into becoming a smaller version of the big players. Again, culture matters. Fourth, continuing our journey in building a world-class bank through a strong commitment to investing in technology. We will have a lot more to say about this at our next investor meeting scheduled for May 2023.  All businesses face challenges. We believe in transparency and that extends to being candid about against our assessment of the top challenges facing our business. Our primary challenges are unchanged from what we discussed 6 months ago at the full year '22 results. Over and above credit portfolio management, which is critical in the context of the economic outlets I've just mentioned, we see 4 top challenges. First, a shortage of specialist talent and certain key functions such as information technology. Secondly, the increasing burden of regulation. Thirdly, the real risk of infringed inflation; and fourthly, preserving our unique culture as we grow. We spend a significant amount of our time on our people, their well-being and our cultural agenda. Our organization will either fail to achieve this potential or achieve success based on these factors. We are developing a strong culture as a young company, the culture concrete is still wet. We must work hard to ingrain the culture we want before the concrete sets. Once it sets as it has in most mature organizations, it's very difficult to change absent our life-threatening crisis.  Our unique culture is underpinned by a strong sense of purpose and our core values of accountability, performance, teamwork and trust. We undertake weekly engagement tracking, which provide real-time feedback on employee morale and enables rapid resolution of any issues. We believe that this is unique in our industry. In terms of talent, our focus continues to be on hiring top talent to a passionate modules purpose and align to our core values. Our credit cash remains an essential step in hiring new bankers and the pass rate on the test remains stubbornly below 50%. We celebrated 19 internal promotions in Korean rods as part of our investment in developing and growing our people in calendar year 2022, including, of course, Andrew's promotion to CFO. Promoting from within I see is thankful to our culture on future success, as is maintaining an ownership mindset. Importantly, knowing that incentives influence behavior, our reward structures are based on the core principle of driving long-term shareholder mindset via equity ownership for our employees.  Over 80% of the equity in the company is owned by employees and directors. We are fortunate to have a management team with deep domain banking expertise and significant equity ownership as I've just mentioned. Several of the management team have fell senior risk management roles through their careers, not to mention our Chairman, who is Group Chief Risk Officer wanted major banks. I've said before that this is the best management team that I've worked with. The recent changes to the team have augmented the skills and capabilities we need to optimize our pathway to scale and strengthen our sealing. We plan to make the management team available to meet with investors more frequently through the year to provide more insight into their prospective areas. Now to guidance. We are reiterating our FY '22 targets. This includes a loan booking see $9 billion. Importantly, though, and as can be seen from our rate of growth, we are not looking to grow the loan with much beyond this target. Our current rate growth balances the lending opportunities we see with the current operational bandwidth and capital requirements of the business. We do not want growth for growth's sake. We want to manage and protect the sustainable economics of the business. We have no appetite for pricing credit risk below our cost of capital. That's what our ownership mindset means.  Our guidance on underlying net interest margins, CTI and cost of risk remains unchanged and respect through the considerations for each of these lines in detail already. And delivering on our FY '22 guidance for lending growth, we will be happy through our key business metrics at scale. We believe any questions regarding validity of our CVP have been emphatically answered. It then it becomes a matter of execution to achieve the remaining metrics. Correct this year, we will provide strategic dives on our CPI, including the role that technology plays and on credit quality and our culture. These are still in some of the blanks in terms of our pathway scale. We anticipate our CTI update will be in early May, and we will hold a credit quality and culture update later in the second half of the year. In conclusion, our business model is on plan. We are doing what we said we would do. We are growing profitability with a structural bias to rising rates and continue to execute against our commitments. We have a strong funding optionality that gives us confidence that we can fund growth and manage our TFF payments. While the environment is uncertain, we do not see ourselves as a macro play. We have a strategic case inherent in our relationship-based model that position us to continue growing regardless of the operating environment.  Our group opportunity is not correlated to system growth per se, but to the pulse customers sitting on the books of other banks. The stock of SME loans sitting in the banking system is approximately $450 billion that churns at approximately $125 billion per annum. As a specialist pure-play bank, our team of experienced bankers and risk executives gives us a significant competitive advantage as we can exercise speed and judgment for large banks with the industrialized approaches, often involving contact centers, a bank is managing hundreds of customers simply can't match. As I mentioned, we are not divesting leverage to the housing market, which will undoubtedly be challenged in 2023, but we are very cautious of contagion risk and the risk of spillover into the broader economy. We believe we have a compelling customer value proposition, and we have established ourselves as a viable opening other banks. We remain confident we can continue to grow and support the economy and build the world-class SME bank. We are hugely excited about the future of Judo Bank as a genuine and credible challenger bank. Thank you. We remind us to Q&A, and I'm looking forward to your observations and questions on another black but performance by Judo.

[Operator Instructions] Your first question comes from Andrew Lyons with Goldman Sachs.

Just 2 questions, firstly, on capital. At the FY '22 result, you explicitly said that you had sufficient core equity available to achieve metrics at scale. Now while you have reiterated your at-scale metrics today, that very explicit comment around capital sufficiency does appear to have been removed from the various 1 releases today at the same time as you've consumed 320 basis points of CET1 in the half. Now I can say you'll enjoy a 1.9% tailwind from the adoption of the new capital standards from 1 Jan. But just in light of all of this, can you just comment on your comfort around your capital position and its ability to fund the business as it reaches self-sufficiency? I think I got a second question on margins.

Now look, there's no change to our position on capital. We're still very confident that we have sufficient organic capital to achieve those key business metrics at scale. The APS 112 benefit is obviously a component to that. But I think the other kind of key thing that we're very excited about is really the organic capital generation we're now starting to see come through. As we think about capital consumption going forward, I think the rebate under the PS12 is helpful in that regard. And whilst you've noted what we've used in the first half, we expect that, that net kind of capital consumption on an absolute basis will be smaller going forward. So there's no change to that position at all, and we're -- we stand behind those comments.

And then just a second question on your NIM. You're expecting your underlying NIM to be in the range of 3.1% to 3.3% in the second half. I just note that the gap between your reported and underlying NIM shrunk from 61 bps last half to 33 bps in the current half. Can you maybe just help us to understand the extent to which that gap will continue to shrink in the second half of '23. And therefore, just the extent to which your underlying guidance implies a flattish trajectory for NIMs or -- sorry, reported NIMs or will reported NIMs also be down in the second half? And just also confirm that, that gap between reported and underlying should be 0 by the June 23 run rate.

Yes. Andrew, you're right. Those -- the NIM and underlying NIM will ultimately converge just as we continue to use the TFF. So the underlying NIM is our way of, I guess, providing some visibility or like-for-like on that. But they will converge. And at the point where we have a TFF draw or utilization rather, that will ultimately see those margins kind of come together. So that's really the impact that you're seeing in comparing those 2 numbers for the first half.

And will you be any more explicit just in relation to that gap. As I said, the underlying verse NIM -- sorry, reverse reported was 33 bps in the current half down from 61 any sort of quantitative guidance as to the extent to which that will shrink in the second half?

Look, ultimately, they will all converge together. And it's just as we start to use the preserved component of the TFS. So we obviously used kind of $740 million of that, and there's a bit more to go. But they will ultimately converge as we get to that point of pack utilization.

Your next question comes from Jonathan Mott with Barrenjoey.

Just another question on margin, if I could, and on that guidance on TD pricing. Are you assuming that it widens materially through the rest of the second half back through the so 80 to 90. A question on that, where you get that number is that gut feel that will revert to the average, why you think it just automatically revert to mean situation? How do you get that number? Can you give us a feel for that then to the second question.

Yes. Thanks, Jonathan. I mean, ultimately, I guess, we look at what the dynamics that we've kind of seen in the TD market. And we're quite open that we have seen an increase in competition there. And that's come in selective channels. So it's really an extrapolation, I guess, of where we see that competition I think the other element here is we're not kind of linear in terms of how we do that origination where we can be a bit nimble. We took some larger volumes in the back end of the first half. But as we run into June, there are always kind of big origination months for us. And so naturally, there's some increase in the deposit activity. So it is an extrapolation ultimately, John, in terms of kind of what we're seeing in the market. And also, I guess, as we play around with that price elasticity to take the volumes that we're looking at for the rest of the half. It is in line then with, I guess, what we have always seen as a long-run origination assumption for us for TDs. And that's based on ultimately being in a bit of a premium to where we see the long-run average for the branchless banks, and we think that's appropriate kind of given the normalization, I guess, as Joseph talked about in terms of the interest rate environment. So we expect to kind of ultimately see that comes through on funding costs as well.

And just a follow-up question. Just sort of what's the backup plan? Let's just say competition gets very intense, which is some people thinking about as the major banks have to roll over the TFF funding becomes a challenge. If you had to prioritize it, would you prefer to draw down the warehouse facilities? Do you just pay up for TD to make sure that you maintain that funding mix? Or would you slow down loan growth? How would you prioritize it as a backup if competition gets very intense?

Look, I mean, ultimately, we have a view that there has been this very favorable funding environment for TDs and -- and ultimately, over time, as that normalizes, I think we'll see normalization in asset pricing. So there is an element of normalization here. But specifically to kind of your question tactically, as we look at that on a more day-to-day basis, one of the real benefits that we've been -- in our treasury team have been working very hard at is the warehouse optimization program that we've got. And so we've got committed warehouse lines of $1.75 billion today. We've got a target to take that to 2.5 by June, and we're very well progressed with a number of banks on -- that will take us towards on August. We pay line fees on those undrawn committed warehouses. And so the marginal cost of them drawing them versus our long-run TD assumed cost is actually not that different. And so I think if we see, for some reason, there's a massive low add in TD pricing, we've got that flexibility of looking at warehouses. And it's really interesting. In the middle of the early days of COVID, we actually did see that the marginal cost of some of our warehouses cheaper than deposits for a couple of weeks. And so we have that flexibility. We've used that before and it's something certainly that we have in our arsenal in terms of funding over time.

Andrew, I just might add a footnote to your comments. Certainly, a slowing down lending growth is not something that we're contemplating. I mean one of the benefits of being an SME bank is the pricing flexibility that we have in coping with higher than planned and deposit costs or funding costs. So we do have the ability, if we do see a significant systemic shift in funding costs in the deposit market to ensure that that's passed on through of our lending. And that's a big strength for the company versus a mortgage-based lender.

Your next question comes from Richard Wiles with Morgan Stanley.

I've got a question on capital and also a question on the lending margin. So I'll start with capital. Andrew, you say you've got 70 basis points of capital generation, but you also used more than 350 basis points of capital to support your RWA growth even with the benefit from the new framework, that ratio is going to keep -- that common equity ratio is going to keep coming down. So can you give us some guidance on what sort of level of capital you might need in a couple of years' time? Should we be thinking it's 11% to 12% common equity Tier 1 ratio? Or does it need to be meaningfully higher than that given that you remain in a high growth phase?

I mean we've -- we do believe that at the point where we, I guess, get to scale, that we will have a CET1 of between the regionals and the majors. And I guess a premium to the regionals given the potential for future growth. I mean, we'll always calibrate that, I think, based on the opportunity that's ahead of us. But that's always been our at scale assumption. You're right that you've seen us consume capital for growth over the half and the 300-odd basis point assumption is correct. I think what I would say on that, though, Richard, is that with that reset under the new APS 112, all other things being equal because of that rebase that kind of capital consumption certainly that we expect going forward now under the new rules will be less. And then continuing to offset that will be growing profitability as the business continues to scale. So you can kind of look at that, I guess, to some guidance around the near term, but that will kind of start to converge as we continue to grow and scale kind of beyond the next 6 months.

Yes, on the lending margins, you expressed this confidence that you can do 4.5% in the medium term. These fixed rate they must be generating pretty low margins now given how quickly the funding costs have gone up. There's also a lot of competition every single major bank wants to do better in this space. Maybe they don't have the customer service, but they do have a price lever. So when can we realistically expect to achieve a 4.5% lending margin? And how much longer will that drag from the fixed rate book be there for your lending margins?

Richard, it's Chris. I might take that, if that's okay. I mean, yes, I mean, look, as we've disclosed in the past, the fixed rate book, predominantly our fixed rate book is asset finance, right? So the nature of that product as it amortizes relatively quickly. And so that's not a concern, especially given the proportion of the overall book that is represented by that, as you know, our overall fixed rate loans are less than 10% of our entire portfolio. So the underlying 7 basis points drop in the first half. I think as we've already said, yes, absolutely, but a high degree of competition using the price lever that they've always used. Smell was also a factor during that half. And also, we talked about the tailwinds from the funding cost benefits of the major banks have been using, particularly as 2 banks, in particular, have become -- been very public about their aspirations for growth in that sector. But the reality is that we believe there's still a significant loyalty tax being paid by a significant number of customers out there. It's interesting to note that the Pixar refinance index is at an all-time high in terms of the likelihood of customers looking for refinance opportunities, matched with the fact that the NPS scores of the major banks has not moved at all either. So we're very confident in our underlying assumption around that 4.5%. And I would expect that by the time we report sort of our exit NIM in the full year results, you'll be seeing -- starting to see the benefit of that sum to come through. But of course, it largely depends, as Joseph said, in terms of where the economy goes as well. We do believe that the banks will start to pass on increased funding costs to their customers. But the exact timing of that, of course, is in front of us. But the long-term thesis of 4.5% is still an assumption that we're very confident in.

Your next question comes from Nick Dalton with JPMorgan.

A couple of quick questions from me. Firstly, just in terms of your guidance. Working through the second half guidance would seem to imply revenues of a bit under $170 million improved provision profit of $75 million. Is that in the ballpark correct?

Yes. I assume, Nick, that you've been triangulating off the CTI and some of the other guidance that we've given. But yes, look, that's broadly in the ballpark.

Okay. Perfect. And then just in terms of your medium-term targets, do you place any greater importance on any single metric. So for instance, would you forgo growth to achieve your target ROE? Or do you all kind of view them as equally important?

Well, Joseph here. The question broke up a little bit, but what I heard was, will you grow and sacrifice...

Sorry about that. It's potentially the headset. So in terms of your at-scale metrics, do you place any greater importance on any single metric. So would you, for instance, forego one metric to sustain another one? So would you reduce your growth to achieve your ROE target?

Well, we're committed to those metrics at scale that we've outlined, and we don't see the need. We don't see -- right now, we don't see trade-offs. We're not going to -- as I mentioned in my remarks, we're not going to engage in lending that does not achieve the economics that we've set for the business. We don't think we need to do that. That's why it's important that as we think about growth that we're running our own race that we can be selective in where we're lending and not get involved in lending at sub cost of capital, not get involved in taking on excessive risk. I mean the aspirations of getting to $9 billion, which we're on track for. And then if you think through metrics at scale, $15 billion to $20 billion in a market that is over $60 billion, $450 billion of current stock and then mortgage and other opportunities. We -- our aspiration is actually at scale are not blue sky aspirations, and we believe that by running our own race and managing the economics of the business that we can achieve what we said we would do without compromising on risk or on ROE. So certainly, we could say to the market that we're going to set our metrics at scale at $25 billion, right? But we don't want to do that. We want to say that we can demonstrate over the next number of years that we can get to what we promised back in November '21 and do it in a way that's sustainable and protects the economics of the business. I mean I've been in this business so long, and I do not ever see price of credit compromise as a sustainable strategy. Their campaigns give you some market share, but they destroy the economics of the business, and that's not what we would do.

Your next question comes from Josh Freiman with Macquarie.

Just 2 quick questions from me. Just the first on that fixed lending margin compression. I mean, this really sort of appears due to a balance sheet mismatch. I'm conscious you guys may partly naturally hedge that using deposits over 12 months or even part of the TFF that you guys have been allocated. But for the delta of mismatched loans, how should we sort of consider that moving forward? Are you guys sort of considering that to be something that you guys will hedge moving forward? Or should we consider that to be perpetually mismatch?

Yes. Thanks, Josh, for the question. So yes, you're right, we've kind of called out, I guess, that impact on the first half of those fixed rate loans. And -- and look, that is an element that we have been, I guess, naturally hedging against kind of what else we have across the liabilities side of the balance sheet to date. Our hedging program has been very much focused on, I guess, the -- in part of the TFF, but also the lending side using deposits. So that's been really the priority for us in terms of the hedging program to date. I think going forward, we will look at more actively managing that component of the lending book, so those fixed rate loans. And we've got a little bit against that today, but we'll probably look more actively at kind of matching those specific parcel of assets just going forward. So from an outlook perspective, I think as you kind of look at the NIM waterfalls and think about what might the impact of that portfolio be on the book going forward. It was in the first half, effectively a 9 basis point drag. And I think we'll see something -- sorry, in the first half, it's a drag of the order of about 12 basis points. And I think we'll see that a little bit lower in the second half and going forward.

Perfect. And I guess just to sort of follow up with my second question, still on hedging, I guess, no surprise for me. I'm conscious in that you sort of mentioned you have been focused on the TFF with hedging. And on Slide 36, you sort of note, 35% of that is swapped back to be probably 1 month I'm not sure if any of the remaining balance was naturally sort of matched with any of your lending. But given it's sort of not entirely clear what proportion of the TFF was in total matched or swapped back. What do you kind of see is that overarching longer-term headwind adding to FY '25 versus TFF fully rolls off?

Yes. We'll keep hedging on the TFF pretty stable and has been fairly stable following the initial hedging activity that we've got. So we've got $1 billion of hedges sitting against the TFF, and we expect that to be continued, I guess, going forward. And that's just all around, I guess, in managing Josh, how the repayment profile of that TFF will ultimately come through. So we're quite kind of comfortable, I think, with the level of hedging we've got there. We think kind of where we are in the rate cycle and also given the repayment profile of that, but that's kind of where we want to be. And so there's no intention to kind of change that materially as we approach peak utilization and then ultimately repayment.

I guess just sort of touching on that. I mean, if you could sort of provide a quantum in how you guys think of that like the $1 billion hedge, what's the continent of the margin drag for the unhedged portion?

Look, we're not kind of giving detailed guidance on that at this point, Josh. But I mean in terms of, I guess, as we think about the impact, I guess, of having this fixed portion of funding and kind of net of, I guess, the hedging that we've got it got against it in terms of kind of second half outlook, for example, we'll still continue to get a benefit from that in a rising rate environment, it will probably be in the order of about 15 basis point benefit in the second half, net of the hedging that we've got against that funding line.

Your next question comes from Brendan Sproules of Citi.

I have a couple of questions on asset quality. Could you give us a little bit of information around what you're showing on Slide 21 for the 90 days past due, the pickup there. Is there certain sort of industries that are overrepresented, I guess there? And I guess have you got any statistics on the 30-day past due and whether that's higher than the '19? And then I have a second question.

Thanks, Brendan. I mean in terms of, I guess, what we're seeing in that -- for the first half, there's no kind of particular trends, I guess, or particular sectors of stress necessarily. I mean we have as we talk through, we have taken an overlay kind of proactively, I guess, based on the outlook in terms of what we see for discretionary or sectors that are impacted by discretionary spending. But we are -- that level of dose past due and impaired I mean it's 18 customers or 15 customer groups in a pool of 3,300. So it is a very, very small number. And in the appendix, we have a little bit more detail about where they sit in terms of particular sectors. But it's 1 or 2 customers across most of the different segments.

There's 5 customers in manufacturing, but that largely reflects supply chain problems that were kind of building up, but actually a nice start to ease. So we expect to see some of those accounts the remedy themselves in the coming weeks.

And Brendan, on the 30-day, nothing material to report. I mean still sort of roughly around about 70 basis points and that includes the 90%. Obviously, it's over 30 days. So I think in total, we've got about 60 customers, which are over 30 days. So you can subtract from that the 90-day numbers as well. So you can see nothing of any materiality coming through at all. And as already commented, no sector concentrations there at all. It is the law of small numbers. Even if you look at our discretionary retail, for instance, the GLA balance is only $200 million. So even at 1.26% of over 90 days, it's $3 million spread across 3 customers. And in arts and recreation, again, it's diversified. It's gym, it's tourism. There's no concentration issues at all, and there are no discernible things coming out of any of the areas data.

That's very helpful. My second question is on Slide 23, where you show in the capital waterfall that there was a deterioration in the average risk weight on lending across the whole portfolio. I imagine that's across your whole 3,000 clients despite the fact that leverage, as you point out, in the sector has actually been declining. Is this -- what sort of drove this? Is this because you're writing slightly lower credit grade business in the current period and the average is pulled down? Or are you seeing a broad-based deterioration across, I guess, the pre-geared profit of these businesses that's leading to a lower risk weight on the lending book.

Look, Brendan a minute. It is a factor that we've got there, but there's nothing particular kind of driving that in terms of any material change to the portfolio. So I don't think there's anything that we feel we kind of need to call out on that. It's a very small delta overall.

There's been no shift in our risk appetite. We're not and we've been very disciplined on in terms of executing against the Board-approved risk appetite, no deterioration. We monitor our average credit rating and average and security classification every month on the lending that we're doing and in the pipeline, and we pull levers. So we're not seeing any deterioration.

No. I mean it's -- look, it's a point in time metric on a rapidly growing book. If you look at our new segments in health and agri in particular, we are seeing skewed the other way, a very, very high-quality credits coming out from both of those 2 new segments that we've entered in the last 12 months. So as Andrew said, it's just -- it's 0.3%. It's not something that we're concerned about at all, particularly with the pivot to APS-112, where the different security mix will have a bigger impact as well in H2.

Your next question comes from [ Adam Cohen ] with E&P.

A couple of questions from me. First one on capital. So the pro forma CET1 ratio, that's got a 1.9 percentage point benefit from APS 112. Have you changed your internal CET1 ratio target range at all? Has that been shifted upwards under the new framework?

So has there been any change to the -- you just cut out?

To your internal CET1 ratio target range. So obviously, under the new framework, you've got a 1.9 percentage point benefit, but are you changing your targets at all?

No. Look, no change at all. I mean we -- there's been no change to how we look at the book and the consequence in terms of how the risk weights come through. So there's no change at all there.

So all of that 1.9 percentage point converts to excess capital?

That's right. I mean it's really just -- what it reflects, I guess, is just how some of the different parts of the portfolio and some of the new 112 standard change in terms of the credit risk weights. And the biggest impact is really, I guess, in the corporate counterparties bucket, which is the largest kind of component to our -- in terms of our gross credit exposure. And that really benefits because that portfolio effectively under the old standards was close to 100% risk weighted. But what we do is we get the benefit then, I guess, of when -- under the new category mappings that we get under APS 112 in terms of, in particular, I guess, kind of SME retail and SME corporate where those risk weights kind of come down. So that's really where the bulk of that benefit comes through. And it is then just an overall step-up in terms of the CET1 that we get under the new standard.

Ziv, it's Chris. I mean this wasn't a surprise. I mean, we've seen APS 112 coming for the last 2 years. So in the guidance that we've always given the earlier comment around that we have enough capital to execute on the metrics at scale. This has always been part of our equation, if you like. So there's no internal pivot. We knew it was coming. We're pleased that the standard is finally in and it's part of the -- part of one of the levers that we've been using in terms of the previous guidance that we've given.

Just got another question on margins. So you've obviously called out lower new lending margins in the half. Is it fair to say those new lending margins are about 50 bps below the long-term assumption of $450 million of the swap?

No, no. They're not that now. They're not as low as that.

Sure. And on the TD margin, so you're guiding to 85 bps over swap on that front. You've recently been paying about 40 bps or 40 bps premium to major TD pricing. Does that -- is that 85% predicated on roughly a 40 bps premium to the majors or something lower?

No, no. I mean we -- our -- we've always had a view, [ Azita ] when we look at where the branchless banks originate at around over the long term through the cycle at about 75 basis points. We've always made the assumption that to be the price leader in the order of kind of 10 basis points above that. And so it's very much kind of predicated, I guess, on where we see those long-run TD costs for branchless banks, which is kind of our, I guess, our closest peer set and a 10 basis point premium above that, which is the 85 basis point through the cycle assumption. So there has been a lot of movement in terms of some competition as we referred to earlier from major banks in certain segments. But we're kind of more focused on where are we with the branch less banks and where we need to price for our tenors and our channels.

Yes. I mean we would be, on average, about 50 points above on 6 months' money or 6-month TT above the average of the major banks. That's a very defendable position in the market. I mean there's got to be a limit to how aggressive major banks can be on TD pricing, just given what it would do to the economics of their partners.

And I think this is early to John's earlier question around the 85 basis point assumption. But the branchless banks that Andrew referred to are retail banks, they're lending with home loan lending at a maximum of 2% over swap. So that assumption of 85 basis points, which is a 10 to 20 year through the cycle where you might see some short-term spikes, but you're not going to see that average fundamentally change.

Can I just push my luck with one more question. Just one consultation. On the 12 bps drag from the fixed rate equipment finance book, is that -- can I confirm that that's just a timing issue? I mean Chris has said that, that book amortizes pretty quickly. So as it rolls over, do you have scope to reprice those rates in line with the interest rate increases and make up for the drug?

Yes, completely. I mean today, the equipment finance that we're writing today is based off today's swap rate. So we will amortize very quickly. We pulled it out, as Andrew said, we do have an actual hedge with the TD book. We could have just netted them off in terms of the way that we showed it in the waterfall, but we chose to break the 2 components down. But it is naturally hedged against the 2D, but it will amortize quickly. And absolutely, we can't reprice midway through a contract, but the loans we've been writing for the last 6 months have been reflective of the swap curve that's prevalent at the time.

I think we're going to come to the end. I just want to thank everybody for their participation on this call and for the questions. We look forward to continuing the dialogue in the next days and weeks. We mentioned at the beginning that this is a set of results that we're absolutely thrilled with demonstrates the quality of the business and the potential in the business. I hope all of you feel that the level of disclosure and transparency that we provided in this half results is reflective of our approach to keeping the market well informed on how we are thinking and how we are planning and performing. So on that note, again, just thanks, everybody, for your participation in the call. Bye.

That does conclude our conference for today. Thank you for participating. You may now disconnect.