Pepper Money Limited (PPM) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Pepper Money Limited 2022 Half Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to your first speaker today, Gordon Livingstone, Investor Relations. Please go ahead.

Good morning, everyone, and welcome to Pepper Money Limited's results presentation for the first half of calendar year 2022. My name is Gordon Livingstone, Investor Relations at Pepper Money. I would like to begin by acknowledging traditional custodians of the land on which we meet today, the Gadigal people of the Eora Nation. We pay our respects to each of the elders past, present and emerging. Following the business update from Pepper Money's CEO, Mario Rehayem, Pepper's CFO, Therese McGrath, will run through the financials. After some closing remarks from Mario, there will be an opportunity to ask questions at the end of the session, which can be either via phone or submitted via the portal. I will now pass over to Mario.

Thanks, Gordon. On behalf of my entire team at Pepper Money, I would like to thank everyone who has joined us today. Therese and I are proud to present our first half calendar year 2022 results, which again demonstrates the ongoing ability of Pepper Money to deliver sustainable growth. The strength of Pepper Money's first half financial results is down to our ability to deliver on our strategy. As you have heard me say, at Pepper Money, our mission is simple, it's to help people succeed. We focused on creating financial inclusion by challenging the way loans are designed and distributed. Our values provide the guide to how we do business and how we interact with our customers, stakeholders and each other. The core competencies of the business, credit, funding, distribution and technology are all supported by 22 years of dialer and through-the-cycle experience that continues to see Pepper Money deliver on strategy and drive profitable growth. Over the first half, we grew our customer base to 327,000, an increase of 13% from calendar year 2021 year-end. We delivered $5.6 billion in originations, 53% growth on prior comparable period. This was driven by mortgage originations growing 48% to $4.1 billion, and asset finance originations of $1.5 billion, a growth of 67% on PCP. We continue to deliver above systems growth. Mortgages in Australia grew 4x systems in the first half of 2022 and asset finance outpaced the market with 21.5x systems growth in the same period. This above systems growth saw lending AUM close June 2022 at $18.3 billion. Mortgages increased 24% versus PCP to $14 billion, and asset finance increased 43% versus first half 2021 to a record $4.3 billion, with total AUM closing at $19.4 billion, a growth of 24% on PCP. Net interest margin of 2.29% was down 30 basis points on PCP. NIM compression experienced over the second half of 2021 carried forward into 2022 with mortgages NIM at 2.06%, 33 [ 34 ] (sic) basis points lower than PCP and asset finance NIM at 3.07%, 30 basis points lower than PCP. NIM has been impacted by rising swap rates and funding costs compounded by continued competition across the market. Therese will cover off in the financials, how we have been responding to front and back book pricing responding to the rising rate environment experienced. Our delivery of strong originations volume saw the business grow total operating income by 12% to $198 million. Our 22 years of experience is demonstrated through our credit quality, our deep capabilities in credit, loan servicing and data analytics together with our prudent approach to pricing for risk is evident through our loan loss performance, which improved by 10 basis points on PCP to 0.18%. The business remains well provided. And at 30 June 2022, we held a total provision for credit losses of $114 million. The recurring investment we make in our platforms and processes continues to support efficient scaled growth. Underlying productivity increased 65%. Our ability to leverage our in-house purpose-built platforms is paying real dividends in terms of scaled efficient growth. In the difficult and volatile markets, the depth and breadth of our investor base and the strength of these relationships truly contemplate. We increased our warehouse capacity to $11 billion, up 11% on December 2021. We successfully executed 4 securitizations over the first half of 2022, raising $2.5 billion in total. We have also closed in July a further nonconforming deal of $500 million, bringing total securitization year-to-date to $3 billion, and we have just mandated a $650 million Prime RMBS deal. Our funding supports our sustainability objectives, including our core pillar of financial inclusion. In the first half of 2022, we completed our second Green Bond at $330 million, and our first Social Bond at $300 million. We were recognized by Canstar winning their inaugural Green Excellence Award for our electric vehicle loan options, supporting our ongoing commitment to environment and sustainability. With our volume growth ahead of system, coupled with business mix, ongoing productivity gains and disciplined cost management, we continue to deliver strong profit growth of pro forma NPAT growing 11% on PCP to $73 million, with the Board declaring an interim dividend of $0.054 per share, an annualized yield of 6.3%. We had a strong focus in the first half of 2022 to deliver volume and AUM growth as we prepared for interest rate increases and a softening market. In Mortgages, we have outpaced the market originating $4 billion. Our asset finance business continues to grow market share, originating $1.5 billion outstripping the market. With our increased focus on customer retention, our prepayments are trending back to long-term averages across all asset classes. Now on to Mortgages. People come to Pepper for a purpose, not price. Over the first half, our digital loan solutions, coupled with the depth of our credit and underwriting capabilities and distribution footprint saw Pepper Money help an additional 7,068 new mortgage customers. Mortgage originations are at $4.1 billion were 48% higher than PCP. Business mix has shifted slightly when compared to calendar year 2021 with 55% of originations coming from Prime customers and 45% from nonconforming, which includes our new customer solution Near Prime Clear. Our diverse mortgage product offering gives us options to shift the mix of our originations to better manage margin versus volume. Our weighted average LVR at 54% is 7 basis points lower than PCP as our customers' equity positions in their homes increased. Pepper Money remains committed to helping those customers underserved by traditional banks, with 30% of originations coming from self-employed, small business. For 5 consecutive years, with year-on-year volume growth, we retained and improved our industry-leading turnaround times. We make the complex simple through our in-house purpose-built technology and the depth of our data analytics. We continue to deliver fully underwritten nonconditional approvals in under 7 hours. Our technology suite of broker and customer solutions, including PPS and Pepper Resolve, which have been in the market since 2017 and 2019, respectively, are providing a seamless path, for years, for customers of all walks of life. Now on to Asset Finance. Our Asset Finance business continues to grow share and expand its product, distribution and customer footprint. The business continued over the first half of 2022 to surpass the existing monthly origination record is set over 2021. Total originations at $1.5 billion in the half grew 67% on PCP and the business now contributes 36% of total operating income. TA originations at $900 million represents 61% of Asset Finance originations and grew 83% on PCP. With closing AUM at $2.5 billion, this customer cohort represents 58% of the underlying asset pool. Moving to funding. We have a strong and long-established track record in debt capital markets. We have a broad and deep investor base of both domestic and global debt investors supporting us. Since 2003 to June 2022, we have raised in excess of $31 billion across 51 transactions via our 3 programs, Pepper Prime, PRS and SPARKZ. It is both the strength and longevity of these relationships, which allows the business to continue to raise funds and grow even in the challenging market conditions. We have raised in excess of $3 billion to the end of July 2022. And in the first half, we completed 4 securitizations totaling $2.5 billion. Pepper Prime 2022-1 of $1 billion, including a $330 million Green Bond. PRS 32 at $500 million, SPARKZ 5 ABS for $700 million and our inaugural Pepper Social Bond of $300 million. We increased our warehouse capacity to $11 billion, up 11% on December 2021, giving us significant scope to fund our aspirations for growth across both mortgages and asset finance. As I have said in the past, we have always taken the prudent approach to funding and maintained a minimum of 6 months of headroom. This is part of our ongoing strategy that allows us to be prepared to manage any cycle, whether it's up or down. On to operations. The investment in our scalable purpose-built platform is both enabling us to operate more efficiently and achieve scale, which supported our record originations and delivered a 65% core productivity uplift. In Asset Finance, SOLANA is delivering 42% auto approval and well on track to reach 60% by Q3. With 91% of mortgage applications processed through SAGE, we have delivered record application flow and uninterrupted market-leading approval turnaround times. And Apollo, our servicing platform, has significantly reduced the effort to serve customers via automation of processes and increasing customer digital accessibility for self-help options. Turning to lending. We entered 2022 prepared for rising rate environment and expected volatile debt markets alongside macroeconomic and geopolitical uncertainty and funding constraints. Against this backdrop, we accelerated opportunities to grow our loan books and delivered record originations of $5.6 billion in the half, up 53% on PCP. Over quarter 1, total applications at $4.3 billion grew 35% on PCP and 53% on quarter 1 2020, with Mortgages growing 24% and 41%, and Asset Finance growing 72% and 94% for Q1 2021 and 2022, respectively. Over quarter 2, as interest rate rises started to hit and inflationary pressures built, total applications have started to slow, with quarter 2 falling 3% on quarter 1 2022; however, total applications in the second quarter still grew 22% on PCP. By asset class, Mortgage applications grew quarter 2 versus PCP by 14%; however, when looking at Q2 versus Q1 2022, applications have declined 5%. Asset Finance applications grew quarter 2 versus PCP by 47%. And looking at Q2 versus Q1 2022, applications are flat. Equifax has reported a 15% decline in mortgage inquiries in July 2022 when compared to June. While we do expect this trend to continue in the short term, we have started to see the rate of decline taper. Now to originations. Quarter 1, 2022, total originations were $2.6 billion. This grew by 18% to $3 billion in the second quarter, delivering $5.6 billion in originations for the half, a growth of 53% on PCP. In terms of assets under management, lending closed in June 2022 at $18.3 billion, up 28% against June 2021, with mortgages up 24% to $14 billion and asset finance at $4.3 billion, a growth of 43% on PCP. This strong AUM position places us well for the balance of the year and into 2023. I will now turn to Therese to run through the financials.

Thank you, Mario, and good morning, everyone. As Mario largely covered off most items on this page, I will just touch on a few points before moving to a deeper dive on NIM, pricing and credit performance. And while today, I will be focusing on our pro forma results, our statutory NPAT at $72.2 million grew 29% on PCP. As noted by Mario, originations at $5.6 billion delivered a growth of 53% on PCP, with lending AUM closing June 2022 at $18.3 billion, an increase of 28% on prior comparable period. Total AUM closed the half at $19.4 billion, a growth of 24% on PCP. As Mario noted, this places us in a strong position as AUM is a key driver of future period income. Volume growth was partially offset by lower net interest margin, NIM, which at 2.29% was down 30 basis points versus PCP. I will address the movement in NIM in detail in the next slide. Total operating income grew by 12% to $198.4 million and pre-provision operating income at $212 million, grew 11% on PCP. Total operating expenses at $93.8 million include a one-off charge of $2.1 million relating to the impairment of an equity investment held in Volt Corporation which was written off following the return of their banking license at the end of June. So excluding this impairment, our expense base at $91.7 million grew only 1% on the second half of 2021 and 11% on PCP. The increase in expenses on PCP relates to FTE growth of our broker administration business, which you can see in the chart below. These costs are fully recovered. After normalizing reported CTI of 44.2% for the impairment in Volt, underlying CTI at 43.2% is flat on prior periods. The 22 years of experience we had at managing through all cycles shows through our ongoing profit growth. We know our key drivers, and we know how to leverage. In an intensely competitive mortgage market with margins compressing, we have known when to grow volumes, delivering growth well ahead of system. Our business mix provides a balanced portfolio with the right blend of short- and long-term lending assets, with Asset Finance now contributing 36% of total operating income. So taking volume growth and portfolio mix together with our disciplined approach to costs and the benefits from scale and efficiency that we continue to drive through our tech stack, we delivered pro forma EBITDA of $119.4 million, up 11% on PCP and pro forma NPAT of $73.1 million, a growth of 11% on PCP. Turning now to NIM. Focusing on the key drivers of the movement in net interest margin. The average NIM for the first half of 2022 at 2.29%, declined 23 basis points on the average NIM for the prior half and 30 basis points on PCP. The largest contributors to NIM deterioration over the first half of this year have been the rising BBSW and spot rates. Focusing on mortgages, which is the graph on the bottom left. The NIM compression were reported over 2021 continue to flow through into this year and has been accelerated given BBSW increases. At 2.06% on average for the first half of 2022 the reduction of Mortgage NIM has been impacted in part by market competition driving lower portfolio rates, as mentioned, in part by the volatility in BBSW and in part by our business mix, with the lower LVRs, resulting in our Prime portfolio growing 27% on PCP to $7.2 billion. It needs to be remembered that with a lower NIM, Prime also comes with lower credit risk and, therefore, lower credit provisioning. I will cover off in the next slide what we've done in terms of pricing to help address this compression. But first, to Asset Finance, which is the graph on the lower right-hand side. The volatility in spot rates is clearly seen in our Asset Finance NIM. Over the second half of 2021, NIM actually benefited 11 basis points from swap rates. This reversed over the first half of 2022 and rising swap rates contributed to Asset Finance NIM reducing 27 basis points on the prior period. On top of this, our customer rates reduced by 28 basis points, driven by the competitive environment and by our business mix with our lower yield commercial and novated lease segments growing as a percent of total. It does need to be noted that novated lease, as it's salary sacrifice, attracts virtually no credit losses. These factors contributed to asset finance NIM reducing from 3.43% second half 2021 to 3.07% first half 2022. So how have we responded in terms of price changes? As our funding cost increased, we have moved both back and front book pricing in mortgage, and front book pricing in asset finance, given it is a fixed rate product. In Mortgages, since the RBA started to increase interest rates in May this year until the end of June, we have moved our back book pricing by 15 basis points over the OCR and front book by 31 basis points over the OCR. As a result, specifically over quarter 2, 2022, average portfolio rates increased 11 basis points on quarter 1, 2022. This increase, however, was partially offset by ongoing increase in BBSW as well as widening margins on new issuances, which drove up the cost of funds. Following the RBA increase in July, we have also increased the back book by 8 basis points and the front book by 35 basis points over the official cash rate. As discussed, our Asset Finance business has seen significant pressure on funding margins as spot rates have widened over the reporting period. This has necessitated a series of front book rate increases to maintain business performance. The December 2021 weighted average swap rate for the front book was 1.22%. As of June 2022, this had moved to 3.38%, so an increase of 216 basis points. On top of this, over the same period, funding note margins increased over 90 basis points on average. We've responded to these adverse market movements by increasing the pricing out of our finance front book by a weighted average of 2.97%. So moving to the second half, while we expect the weighted average front book rates to increase on both portfolios, we will continue to review our position and adjust accordingly given the volatility in margins. Now to focus on the credit quality of our portfolio. We have high-quality residential and Asset Finance lending businesses, and the segments that grew over the first half of 2022, such as our Prime mortgages and novated lease typically attract low losses. We have 22-plus years of experience in credit and underwriting through all cycles. We know how to manage distressed assets and know how to analyze what causes the distress and to take these learnings into our credit policies. And on top of this, we are prudent in our approach on provisioning. At the end of June 2022, we held total provisions of $114 million, a coverage ratio of 0.62% of AUM. As I previously noted, Prime and other low loss products have been the fastest-growing part of the portfolio, which has driven the marginal reduction in the coverage ratio from 0.7% as at December 2021. We have no customers subject to COVID hardships, and we are not seeing any increase to arrears due to customer stress from rising rate environment. While we have adjusted down provisions for COVID, given the current macroeconomic environment, we are holding 24.7 in modular delays, that is management overlays over and above our ECL models, reflecting the current uncertainty in economic drivers. However, a good indicator of potential future loss is 90-plus day arrears, which continued to trend down during the half. Mortgages closed June 2022 at 0.86% of AUM and Asset Finance at 0.18%. The positive portfolio mix and the ongoing strength in credit performance is seen through our loan losses as a percent of AUM, which have improved 10 basis points over PCP to 0.18% as at 30 June 2022. Mortgages have marginally increased by 4 basis points on PCP, which is just reflecting a higher weighting to the down side case in the expected credit loss model inputs given the current macroeconomic trends. Turning to expense management. Our pro forma operating expenses of $93.8 million increased 13% on PCP. As I mentioned, these include a onetime $2.1 million impairment in relation to an equity investment in Volt Bank following the return of their banking license. So excluding impairments, pro forma operating expenses of $91.7 million increased 11% on PCP. The key movement versus PCP are staff expenses, which increased 6% on the first half of 2021. This was driven by increased FTE Manila in support of the broker administration business. As I said, these costs are fully recovered through loan and other income. If we strip out from staff expenses, the impact of increasing our FTEs and the favorable mix we get through growing in Manila, underlying wage inflation is running around 2.5%. Technology cost increase in line with FTEs, it's a cost per seat. Marketing spend increase of $1.2 million on PCP reflects the underlying reinvestment rate of about 2.5% to 3% of total operating income. The scale and efficiency benefit we have been delivering through our technology stack shows when comparing the first half of this year's expenses to the second half of last year. Excluding impairments, pro forma operating expenses of $91.7 million only increased by 1%. So now just to run through some key metrics, we think of our value tree as volume and margin supported by portfolio mix, coupled with productivity will drive performance. Volume growth is shown through the record originations across both mortgages and asset finance, supporting an uplift in lending AUM of 24% on PCP and 14% on December 2021 close. Total operating income has grown 12% on PCP, and Asset Finance now contributes 36%, taking income growth and adding the benefit from the scale and disciplined cost management. Excluding the impairment, CTI remains flat at 43.2%. The depth of our data capabilities, credit underwriting and our risk-based approach has seen continued improvement in the quality of our assets with loan losses as a percent of AUM improving 10 basis points on PCP. This all goes to support a total operating income yield of 2.4%. As such, given the strong performance and capital management of the business, the Board has declared an interim dividend of $0.054 per share and annualized dividend yield of 6.3%. As we have largely covered of all items in the income statement, I will now just turn to our balance sheet on Page 17. Loans and advances as at the 30th of June 2022 of $18.4 billion reflect the 14% net portfolio growth on December 2021. We originated $5.6 billion in new financial assets over the period. The asset growth was financed by the issuance of public term securitizations totaling $2.5 billion, an 11% uplift in warehouse capacity on 2021 year-end and a further $861 million in private term securitization. Net assets as of the 30th of June grew 19% over December, in line with our business origination growth. Cash and cash equivalents at the end of June stood at $1.3 billion. And as usual, we will continue to manage capital, balancing between holding sufficient levels to manage in uncertain markets and knowing when and where to invest the growth. I will now hand back to Mario to close.

Thanks, Therese. I'll provide a quick update on our most recent acquisition of Stratton. We've hit the ground running with our focus on synergies and business integration. Since our completion in July, we have implemented a mortgages referral arrangement, positioning us well for white label integration. We have also found synergies with real estate and supply costs. Our integration has progressed with cyber and security. We have integrated our finance general ledger, accounts payable and management reporting. And we are well progressed with implementing our risk and compliance frameworks, including policies and procedures. Before I open for questions, I would like to give a quick recap. We have delivered record originations, continued our double-digit AUM growth, our loan performance continues to improve with no signs of stress to date. We have continued to deliver market-leading turnaround times whilst increasing productivity by 65%, and we have maintained our minimum 6 months of funding headroom, which will position us for uninterrupted funding through the cycle. While I acknowledge the challenging market conditions in which we operate, Pepper Money will continue to differentiate itself from the market through its portfolio diversity, quality of assets, operational scale and efficiency underpinned by our core competencies of credit, funding, distribution and digitally enabled data. This positions us well to manage through the cycle. Our unrelenting focus is on driving the right performance across the business with our emphasis being centered on margin management through mix of business and front and back book rate management, maintaining a strong capital position to allow for organic and inorganic growth, delivering on our investment objectives with an unwavering focus on ROI. We continue to integrate and create synergies with Stratton, including a successful rollout of our white label product offering, deliver innovative product solutions by creating financial inclusion and product diversification, and finally, continue to create a leading work environment for our staff. Thank you for joining us today. I will now hand over to Gordon to open up for questions.

Thanks very much, Mario. Operator, if we could open the floor to questions now, please?

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

Therese, just a question just on Slide 11, the margin waterfall. Just focusing in on the mortgage changes in the half. You note the BBSW impacted 22 bps. Now I assume that's just the average 1-month BBSW change over the half.

Over the half, correct.

Yes. But just like this business is ultimately the -- profitability of the business is ultimately less about the absolute change in the BBSW but more about the change between the -- spread between the cash rate and the bill rate. And so while you're right in saying that the bill rate is up 22 basis points, the average cash rate over the half, albeit, I can say that it's a bit back-end loaded, the average cash rate was still up 15 basis points over the half. And so I'm just trying to keen to sort of understand why we haven't seen that come through a little bit more, I guess, in the customer range. Is there an element of timing here? And just in light of all those uncertainties, maybe if you can just give us a bit more detail how the NIM has sort of performed over July and August to date?

Andrew, I'll probably touch on that before I pass on to Therese. It's Mario. So with regards to the NIM, the volatility in the BBSW versus the cash rate is a moment in time. So we have to make sure that we factor that in. So when you are factoring an increase, so when the market is actually factoring an increase in cash rate, we are positioned in a period of catch-up and that usually is around that 6-week window to reprice the back book and the front book depending on when that BBSW has been factored in. And so if you take, for instance, the June BBSW, that was circa 114 basis points against cash at around 85. So that arbitrage that impacts their NIM until we pass on that cost of -- that increase of the cost of funds. If you look at today, the BBSW and cash rate is somewhat in line. In fact, it's probably slightly under, and we will gain a benefit from that. So until BBSW continues to be elevated, a fact that -- we have to continue to make sure that we think about that there will be a OCR increased expectations and until that normalizes, so that rate increase cycle normalizes, there will be that point in time volatility, and we will consistently play catch up on that. But it's not set in stone so we just need to make that very clear.

And just to follow on what Mario said as well, subsequent to the half year, we actually have implemented further back and front book rate increases across the Mortgage portfolio and front book increases across the Asset Finance portfolio. So Andrew, you're absolutely right. It's sort of a moment in time, there is a delay between when rates change, et cetera, and when we implement it between 4 and 6 weeks, and it's just flowing its way through.

Great. And so if I just think about maybe the second half of last year as being a relatively normal NIM sort of with timing, I guess just purely thinking about the timing. I think the gap between the cash and the bill rate at that time was a negative 9 basis points. So we think maybe a normal is 15 bps. Are we still saying that, that is going to drive 25 basis points of decline versus that second half margin, which looks like you've already seen quite a big bring forward of that, given the 22 basis point delta in the bill rate that you've highlighted this half. Is that the right way to think about it?

It is, but there's a couple of other elements that come into play. So first and foremost, where the competition is and where the market is, that's going to dictate what front book pricing is going to be at. The other thing is that we have that many don't have is, we have an ability to flex more volume into the less competitive world, which is the nonconforming section of the business and our asset finance and also our CRE lending. So we do have options, and we have already started to exercise those options, in flexing a little bit more volume in nonconforming for mortgages because where we see Prime mortgages right now is an area that we're not really comfortable in originating in just where the margins are. So there are lenders out there that are taking that kind of risk at that kind of rate, but we have always said that we will manage the margin and not just focus on volume. We did come out of the gates very strongly this year on purpose because we knew the headwinds that we were facing. And you can see that in the volumes that we were able to generate in that point in time. But once that NIM starts to deteriorate, we start to focus differently. We look at managing that margin and looking at more so what the impacts of that management is going to have in '23 and '24.

Yes. So but if -- I certainly take the point on the mix and the competitive dynamics. But if I just want to isolate the over-the-cycle impacts of the cash bill spread normalizing, is it fair to say that it would appear, given timing that a lot of it has been brought forward into the first half of the calendar year '22?

Definitely, we saw it in the first half of calendar year 2022. So if you look at the average BBSW up on 2021 was 0.1. Same for the second half, 0.1 and then in the first half of this year, the average was about 0.239, and that actually starts to escalate a little bit towards June as well. We are seeing it starting to normalize now both.

Yes. And it's fair to say as well that we -- so we made a change on a Monday and then on the Tuesday and Wednesday, the swaps widened. So it actually wasn't really taking impact, but we're seeing that's starting to slow down, and we're starting to see that volatility come down. So that will then play to our advantage, and we will be able to catch up and be in front of it rather than being behind it.

Okay. That's very helpful. And then just a final one. Just some of your nonbank peers have started disclosing their stress tests, which I know you haven't in the results. Can you perhaps just give us an idea of what your internal stress test process is and just whether your severe scenarios result in any breaches of your rapid amortization or stop origination triggers?

Yes. No, look, good question. And at least twice per annum, we do a loan by loan stress test across both of the portfolios. For the Mortgage portfolio, again, loan by loan, we look at an immediate stress of about a 30% decline and then a decline of roughly the same amount over a period of time. We've run that exercise recently in the last few months, and we're not seeing any stress occur. One of the things you would notice when Mario was presenting the Mortgage portfolio, the average LVR had actually improved to 54% versus 61% in the first half of last year. So we are seeing customers hold more equity within their home. In terms of the Asset Finance, again, we go through exactly the same process. We go through at least a biannual buy loan stress across multiple scenarios.

Yes. And losses are very heavily predicated on the type of collateral that you take on. We are very conservative in the type of collateral that we take on. If you think about our mortgage business, it's predominantly Red Brick Australia. So you have typical freestanding homes that are in a significant demand in any type of market as opposed to we don't lend to high-rise, high-density. We don't do rural. We don't do lifestyle properties. So we take that volatility away from our collateral.

Given that the majority of our lending and our origination, in excess of 70%, is Red Brick Australia single dwelling, owner occupied. They are very low loss -- very low loss attracting assets.

Your next question comes from John Hynd with Wilsons.

So Slide 25, I just wanted to start with how we should think about the second half. So you're looking at applications that were obviously quite strong and ramped from January to April. When did you start seeing those roll through into the originations? So what was the timing there this cycle? And is that the key driver of the strength that we're seeing now and saw in the results? And then I guess, how do we think about what's happened since March where you started to see applications soften a bit, please?

Yes. So from an applications standpoint, this is not a foreign territory for us. So we've played a very similar playbook with regards to slowing down when we are not confident in the actual market, whether it be housing prices, whether it be funding or market volatility. So for us, it's more of a self-led whilst we're in control of that particular arena. And yes, we did see a 5% drop. But for us, what the importance is making sure that we are looking out on the forecasted back half of this year and 2023 is very, very important for us. So if you think about where the mortgage applications are that will have an impact in originations in the back half of this year, but we are confident that we have started to see a positive rebound and we are flexing more towards a different mix than what we have seen in the last 18 months, and that's purely because we are managing first and foremost, the ethos around pricing for risk and making sure that the margins are contained where we see them. So you might see a slight drop in Prime mix and more towards nonconforming because this is where we -- it's our core DNA, and this is an area that we know when to play, and this is the market to play in.

Yes, right. So that's sort of why we've seen the step-up in Near Prime this half. So we shouldn't see a similar drop off in originations that we're seeing in applications at the moment in the second half.

You'll see it starting to flatten out, and then we'll start to recoup it in the back half of the year. That's how we would naturally play it. If you look at 2020, you can see that from March to April, there is a seasonal drop that naturally happens, and then there's usually a recovery. But for this particular half, we decided to slow down originations because of the market and where it is. It is important to note we have in excess of $4.5 billion of headroom in our warehouses currently, and that's growing month-on-month. So we are preparing for a very strong finish and a very strong start for '23.

I think positively, what we've seen, you've probably seen it reported over the weekend. Clearance rates are now trending back up. It's been a very good August within the market in terms of sort of how sales that have been coming through and we're starting to see a turnaround in that application trend at a market level as well as for the business.

Okay. That's very helpful. Just 1 or 2 more, if I can. On provision coverage, given, I guess, your comments just before about stepping away a little bit from Prime. How do I think about the coverage ex the overlays about 0.49%? What sort of risk profile does this present? And I guess, how can that -- how does that change in this environment? And what would the impact be?

Yes. So just to clarify, when we point out nonconforming, the majority of the volume that we write in nonconforming is the new product that we've just launched called Near Prime Clear and Near Prime. So Near Prime Clear was practically our Prime product I would say, 12 months ago. And what we have done is we've shifted that across, and that's because banks are becoming tighter in their Prime policies. So we become tighter on our Prime and we've opened up a new product segment. So the fact that we are saying it's more nonconforming, the attributes of the customer are virtually the same as Prime. And all we're doing is charging a higher margin on that particular segment. But I will pass over to Therese to just clarify more around the provisioning.

Yes. So obviously, in terms of the divisioning, there's been a little bit of a slight favorable variance because it's the Prime book that we've been writing in the beginning of this year, but the business continues to be well covered. We tend to be a little bit more conservative when it comes to provision coverage versus a number of those within the market running around that 0.62%. What I would actually suggest you have a look at is the 90-day plus of arrears. We always view this is a good indicator as to where we're seeing any stress come in the book because that's where customers actually do start to really think about some sort of -- or you start to see the impact on the customer. Actually, we're seeing our 90-day cost of arrears continuing to trend down across both of the asset classes, Mortgages and Asset Finance. And again, I'll just sort of stress, we have no customers subject to inform COVID hardship and actually, we have no customers currently to subject to any stress as a result of the rising rate environment.

Okay. So directionally, as your, I guess, good customers becomes a little more Near Prime just, what I'm questioning really is the 65 basis points in first half '21 to 49 now, you're comfortable with that? We wouldn't expect an increase given what you're seeing to your book now.

No. And I am going to call out because particularly at the total level, do you remember we're growing our novated lease as a part of the total business. There is zero losses virtually with novated leads because it's a salary-sacrificed business. We've grown Prime over and above the rate of the market, and we've also grown just total TA products mix within Asset Finance. Really importantly, I'll go back to the point Mario made it as well when he was running through mortgages. The LCR of the portfolio is running at 54%. That is down from 61% from the same time last year.

And that is a clear factor because losses do come very much in line with where your LVR positioning is because, obviously, that's the equity that is built into that property. So when we say nonconforming, we can decide to write nonconforming, but at a much lower LVR, which then strips away that particular loss risk.

That's really helpful. Last one for me. On Asset Finance, how should we think about the back book stepping up? But when can we start to see that increase? I mean you're seeing some really strong growth through that channel. I know that they're fixed in nature, but how much longer are we at these levels? And could the step-up be significant or more muted?

So you don't reprice the back book because it is a fixed rate contract. It kind of likes to be on the top at the time of the life of the contract, which is like border to 6 years on average because majority of it is actually cars.

You can see on Slide 12 what...

Yes, I understand, I'm just asking as they roll off...

As it rolls through and you get the time and the mix coming in, you get a very different blend coming through. Really the big swing around about that we've seen though within Asset Finance has been in the BBSW, mainly swap rates. Swap rates have been highly, highly volatile. And we were actually getting benefit from swap rates in 2021. That's just reversed over the first half of 2022.

Yes. And on that because we are pricing off the swap curve, we do believe where we currently situated now that, that volatility has somewhat peaked, and we're starting to see a normalization. So once we receive that normalization, just like in mortgages, then you start to reset what the path is going forward.

Your next question comes from Josh Freiman with Macquarie.

Just checking, you can hear me?

Yes, Josh.

Although I am going to specify the operator, it's, Freiman, for future reference. So 2 questions from me. Look you guys have achieved pretty good volume growth in the half, but that's been broadly offset by pretty aggressive margin compression. I'm conscious to Andy's question, is that timing hit that you guys have had in this half. But I'm conscious that you guys do still have continued rate rises and significant competition, so I just want to check how you plan to manage that volume margin trade-off in the short term?