Westpac Banking Corporation (WBC) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Westpac's 2021 full year results. My name is Andrew Bowden, and I'm head of Westpac's investor relations. I'd like to acknowledge the traditional owners of the custodians of the land on which we meet, the Gadigal people of the Eora nation; and pay my respects to elders past, present and emerging. Presenting today is our CEO, Peter King; and our CFO, Michael Rowland. Without further ado, I will hand over to Peter. Thank you.

Well, good morning and thanks for joining us. 2021 was an important year for Westpac. We are delivering on our refreshed strategy, changing the way we operate; and we've restored momentum in key businesses. It's been a complex year with COVID impacting the economy, our customers and how we work. While operational performance has improved, our financials are not yet where we want them to be. Cash earnings rose strongly, as impairments were better. However, core earnings were lower. Our balance sheet is in good shape, and this allows us to return around $5.7 billion to shareholders through the final dividend and share buyback. This morning, I'll reflect on the full year result and the changes we're making in each division before Michael will cover the financials in more detail. Across our Fix, Simplify and Perform priorities, we're tracking in line with the plans outlined at the start of the year. In the Fix priority, the Customer Outcomes and Risk Excellence program, or CORE as we know it, is largely through its design phase and will soon release a further 2 Promontory reports. The other significant area of delivery was financial crime, [ where we've ] responded to all areas raised in the AUSTRAC case. We've made significant progress simplifying our portfolio of businesses, which I'll touch on shortly. In Perform, the highlight was restoring mortgage growth, and we also grew business lending in the second half. On costs, our $8 billion target is a key focus. And with competition and low interest rates impacting revenue, we must and will reset our costs. Cash earnings improved significantly to $5.4 billion, with ROE just under 8%. And our strong CET1 ratio of 12.3% allows us to return significant capital to shareholders. So turning to the result. Both reported net profit and cash earnings were up significantly. The 2 main drivers were a $3.8 billion turnaround in impairments, as COVID's impact wasn't as big as we feared last year; and a $1 billion fall in notables. Our EPS and ROE were both higher but slightly lagged earnings growth given the capital we raised in 2020. Stripping out notable items gives us a better indicator of underlying performance. And on that basis, cash earnings were still higher, although core earnings were softer from lower margins and higher expenses. The decline in margins reflects both the market and our decision to grow mortgages. Expenses were higher, as we added resources to improve risk management and reshape our business and do it quickly. Last year, we refreshed our purpose and strategy. I use this slide to give our people context behind our priorities. The main change has been adding climate as a Perform priority, which we announced at our ESG update in September. To deliver this strategy, we are fundamentally changing how we operate, and that starts with a simpler business portfolio. The sale of noncore businesses has been active, and you can see the great progress at the top of this slide. These transactions have boosted capital by 26 basis points this year, and as we turn to 2022, our major focus is to progress the exit of super and platforms. The second leg is simplifying our banking operations. The lines-of-business operating model is creating clearer end-to-end accountability and faster decision-making, and the outcomes can be seen in both mortgages and business lending. We're simplifying products and fees. And just as example: We've reduced the number of mortgages on offer from 161 to 68 and halved the associated fees. This is reducing complexity, allowing us to better focus on core banking in Australia and New Zealand. To deliver our transformation, we need to change the way we work, embedding performance and risk cultures and simplifying everything we do. Of course, it starts at the top, and I now have my team in place. And in late 2020, we implemented McKinsey's Organizational Health Index to monitor progress. Over the last 12 months, our score has increased 4 points to 74, placing us close to the global top quartile for this measure. We have seen encouraging improvements in the culture measures of leadership, accountability and direction. Now risk culture is also improving. I can see this in how we manage complaints, the progress in restoring high-rated issues -- or resolving high-rated issues and the confidence people have in speaking up. Process simplification through mapping of end-to-end processes and controls helps us better manage risk and simplify the business. 2022 will see us continue this focus, particularly using digital to automate customer processes. I've been pleased with progress in Consumer this year. Cash earnings rose 14%, with credit quality in good shape, although core earnings were lower as margins reduced and resources increased for Fix projects. Operationally, we improved the franchise, restoring mortgage growth following several halves of contraction. We also lifted customer acquisition with our new app and focus on millennials. While our NPS is not where we need it to be, it started to improve as we enhanced digital capabilities. And digital has been a priority for the team, with our new iOS app launched this year. It's a digital bank in your pocket available 24/7, increasing both the speed and functionality of what customers can do online. One of the features introduced was a new deposit-opening process, and this reduced the time to get a new customer up and running to just a few minutes. This helped lift customer acquisition, which is critical to building the strength of this franchise. The other significant change has been in the management of debit and credit cards. While many of us continue to use plastic, there's now a pathway to fully digital debit and credit cards. With the new app, you control the card. It allows you to download digital cards instantly. We've also made the CVC dynamic, which is a game changer in security, particularly online. And turning around. Mortgage performance was a highlight, and we delivered 10 months of consecutive growth this year. To do well in mortgages, we must be competitive on price, application speed and borrowing capacity; or volumes drop off quickly. Following our focus on speed and competitive pricing, we are now back in the market. And we're seeing over 70% of applications auto decisioned, while customers are also using the app to track the progress of their applications, which is taking pressure off the mortgage team. We've completed the rollout of the digital mortgage origination platform to our network, and with first party done, we're now rolling out the platform to brokers. There has been some discussion on processing times and we have a clear road map for further improvements next year. So having restored momentum and with brokers beginning to use our digital processes, we're well placed for the year ahead. If we turn to Business. While the division lifted cash earnings significantly, it was more challenged at the core earnings line. Lending declined through the year, a function of more modest demand and our frontline fixing issues rather than spending time with customers. We also tightened our credit standards at the onset of COVID, but these have now been reversed and sees us winning customers back. Following changes in the first half, bankers are spending more time with customers; and a new digital onboarding process has also helped. The outcome has been higher lending in the second half and a healthy new lending pipeline. Institutional has undergone significant change over the last 18 months. Having refocused the business and refreshed the leadership team, we're now well placed. [ We've reduced ] offshore exposure, slimmed down correspondent banking and simplified the product set. We also had a tough year in markets income, which was a revenue drag on WIB and the group. The bottom right chart shows the reduction in offshore lending and increased domestic activity, and a rise in M&A activity was a feature of the second half. While WIB is now lower risk, the changes have impacted revenue. However, they're mostly behind us, so we're now shifting our attention to growth, particularly for climate solutions. New Zealand delivered a strong financial result achieving good growth and improved performance of both cash and core earnings. Similar to Australia, New Zealand is working through its program to lift risk management and digitize the bank. That change is being accompanied by the BS11 work to operationally separate from Australia, and these items particularly impacted second half expenses. Growth in New Zealand mortgages were strong, and while we were slightly under market, we grew that book 10% this year. New Zealand deposit growth was also solid with plenty of market liquidity. Margins were a little higher over the year but down half-on-half, and while lower rates contributed to the decline, the New Zealand central bank is now increasing interest rates. On capital, we ended the year at 12.3%, well above APRA's [ unquestionably strong ] 10.5% threshold. Since the benchmark was announced in 2017, we've restructured our mortgage portfolio, reducing the proportion of investor and interest only as well as applying a mortgage RWA floor, so we feel well placed to respond to APRA's final capital rules expected later this year. On a pro forma basis taking into account the buyback and announced asset sales, our CET1 ratio is 11.8%. We'll finalize the management buffers post APRA's announcements, but given the strength in the balance sheet, we decided to return up to $3.5 billion through buyback. And the off-market structure works well for us, as we can buy back shares at a discount, monetize some of our large franking credit surplus and generate a reduction in the share count. And this supports future earnings per share and dividends per share, and that benefits all shareholders. The strength of the balance sheet from a credit and capital perspective enabled us to lift the dividend to $0.60 per share. The principle behind our approach remains the same, and we're targeting a medium-term sustainable payout ratio of around 60% to 75%. This is a little higher than we indicated at the half. In this half, we looked through notables, as many had no impact on capital, and on that basis, the payout ratio was 70%. We will neutralize the DRP by buying shares on market. Well, thanks. And I'll now hand to Michael to take you through the numbers.

Thanks, Peter. And good morning. When I look at the second half result, I'd make 3 points. First, low interest rates and competition hit margins across lending. Trading income was weaker, and costs were up as we focused investment on the things we need to do now and for future performance. Second, the balance sheet is strong. Capital generated from operations and divestments has enabled us to increase the dividend and return capital to shareholders. And finally, we have a clear path to our cost target in 2024. Today, I'll provide more color on the numbers, achieving our cost target and considerations for 2022. Let's turn now to the detail. Notables had a $1.3 billion impact on cash earnings, up $1 billion on the first half. Remediation and litigation costs were $172 million as we increased provisions mainly in advice and in New Zealand and for litigation matters, including resolving outstanding investigations. Asset write-downs, including goodwill and capitalized software, were $965 million. As previously disclosed, we wrote-down mainly intangible assets in WIB following the annual impairment test. This concluded that we could no longer support the carrying value of these assets, with exited businesses and lower interest rates impacting revenue. Asset sales and revaluations were a $192 million (sic) [ $182 million ] drag as we progressed the sale of businesses. The charge was for additional separation costs and write-offs related to the sale of life insurance. This was partly offset by the gain on general insurance and earnout payments from Vendor Finance. The sales of our specialist businesses underpin our simplification plans, reducing risk and complexity, but there's also an earnings impact. The bottom of this slide summarized the contributions of the businesses sold. We've previously flagged a $1 billion after-tax charge in 2022 for the estimated loss on completion on the sale of life. This will be treated as a notable item and be recognized in noninterest income. Notables will be less of a feature of our results going forward. This chart summarizes second half cash earnings, with net interest income, noninterest income and expenses all contributing to the decline. Excluding notable items, net interest income was down a couple of percentage points, with higher lending offset by lower margins, the opposite of the first half. Noninterest income decreased, primarily from lower trading income. Expenses were up 9%, mainly from workforce increases, the lower utilization of leave balances and higher investment spend on Fix. Asset quality has continued to improve. And we recognized a credit impairment benefit in the second half, albeit lower than the first, as we fully provided for the Forum Finance exposure. Tax was lower, with an effective tax rate of 36% above the Australian corporate tax rate, reflecting the nondeductibility of some notable items. Turning to lending. This was a pleasing aspect of the result and reflects the focus and priority we have brought to the mortgage business. Total lending increased, driven by growth in Australian mortgages where the buoyant property market and the process improvements we have made ensured that we grew in each half this month. Investor lending continued to contract. This reflects our lower borrowing capacity, as we have adopted a more conservative approach to credit assessment than some in the market. Australian institutional lending improved from increased demand in the structured finance and retail segments. Business lending stabilized, as our bank is focused on supporting customers in our core markets, offsetting elevated repayments from ample system liquidity. New Zealand continued to grow with higher housing lending supported by continued growth in its property market. Personal lending declined as customers paid down their unsecured credit and shifted to alternatives. Turning to look at the Australian mortgages in more detail. We're pleased to deliver a turnaround. In the second half, we grew just ahead of major bank system with growth in the owner occupied segment. Our better performance has been due to a strong property market, digital origination, additional lenders, improved productivity and targeted pricing. Looking at the composition of the book, we saw a decline in interest-only and investor loans. Interest only is now just 16% of the book, while investor is down to 34%. 52% of flows have been in fixed-rate lending as customer preferences for this type of loan continue in a low rate environment, but the change in composition has impacted margins, so let's turn to that. The 11 basis point impact from lending spreads was mainly from intense mortgage competition along with a mix shift to fixed-rate lending. Competition also put pressure on business lending spreads, while the reduction in personal lending balances dragged on margins too. Deposits contributed 4 basis points from lower TD rates and the continued shift to at-call deposits. The total benefit was smaller this half, as a significant portion of our core deposit rates had already reached their floor. Funding and liquidity generally added to margins, as wholesale funding costs were lower as we drew down our full allocation of the TFF. Lower earnings on hedged capital balances also reduced margins. Going forward, we expect the tractor to have a reduced impact as we move hedged capital back to the 3-year swap rate. Treasury's contribution fell 2 basis points, reflecting lower volatility in the half. The September exit margin is around 180 basis points, excluding treasury and markets. Excluding notable items, noninterest income was down 6%, mostly from the fall in trading income. Fee income was up 1%, with higher institutional fees offset by a reduction in fees from correspondent banking. Wealth and insurance income was down 8%, mainly from the lower revaluation benefit of life insurance liabilities and as customers migrated on to the lower-margin Panorama platform. This was only partly offset by higher general insurance income from fewer extreme weather claims and better LMI income prior to these businesses being sold. Trading income was down, particularly in fixed income, due to difficult trading conditions for us. Other income also included revaluation gains on investments held by Reinventure. Turning to expenses. As we've called out, notable items continued to have a major impact, adding $1.6 billion to costs in the half. Excluding notables, costs were up 9%. We accelerated work on key fixed projects with higher workforce costs. We expect this workforce to fall away progressively as we embed our risk management uplift. Another significant contributor was the lower utilization of leave balances as we -- as staff took less leave during the latest round of COVID lockdowns. Investment spending excluding the fixed component was in line with our normal uplift over the second half. Spend remains heavily weighted to Fix. Our CORE program is improving risk management and our culture. We've also improved our financial crime capability and systems, invested to meet changing regulatory requirements and delivered a single Australian complaints handling system. The increase in costs was necessary to meet our obligations and set us up to deliver on our cost target, so let's turn to that. At our last results, we committed to a 3-year cost plan with an absolute target of $8 billion by 2024. We remain committed to that target and expenses in 2022 are expected to be lower. As we move to delivery, we are now providing more clarity on our plans. The decrease in cost is expected to come from a reduction in notable items and across 3 broad areas. I've called out the $1.1 billion in expenses on the Fix priority that are one-off in nature. These are mostly related to temporary expansion of our workforce to improve our risk and compliance environment and to respond to historical issues. These costs will phase out over the next 2 years. On portfolio simplification, specialist businesses account for around $800 million of costs. We've made progress on divestments and we expect to see the benefits of lower costs this year. The remaining businesses do account for the majority of costs, and as Peter has said, we are committed to exiting them. Once these divestments are completed, we will be left with $9.1 billion of costs in our core banking business in 2021 terms. We are continuing to simplify the business through streamlining and digitization in line with customer preference. We've already made good progress in 2021. Our digital mortgage platform has made our processes faster and better. All major brands are on the platform, and brokers are beginning to access it. And 75% of customers are accepting contracts online. And our upgraded iOS mobile app has been rolled out, allowing customers to deal with us digitally for their banking needs. There's still more to do, but we're progressing digital first at pace, and I'm confident of the strong customer and cost outcomes this will achieve. Finally, on organizational simplification, we are reducing our property footprint as we exit some CBD buildings. The next phase of simplification is further embedding our line-of-business operating model, including streamlining our head office. At the first half, we provided the key metrics we're using to track the progress towards the 2024 target. We've updated these, and you can see we are implementing our digital-first approach. We've also added our total fixed one-off spend to this tracker, as we see this as an important metric. The path to $8 billion is clear. Every executive and general manager has a 3-year plan and an annual target, and delivery is in their scorecards. As I have said at the half, we are committed to this target. Moving now to credit quality. Almost every credit quality metric has improved. On the left, you can see that stress is reduced with lower watch list and substandard as more corporates were upgraded. Employment is robust. Asset prices have increased; and savings are high, positive trends for credit quality. On the top right, you can see 30-day mortgage delinquencies ticked up given our treatment of the second round of COVID packages. We will re-age these loans at the end of their 3 months deferral period. This should see most of them stay out of the 90-day bucket. There is more information on this in the pack. Unsecured lending delinquencies declined despite the contraction in the portfolio as the underlying performance improved. Our provisioning comprises both modeled outcomes and judgment. Total provisions were 140 basis points of credit risk-weighted assets and remain above pre-COVID levels despite the releases in the half. In aggregate, provisions were down 9% over the half, although the level is still 27% higher than pre COVID. The group has maintained the economic scenario weights, given remaining uncertainties, and applied judgment in the calculation of overlays. Our forecasts show that recent lockdowns will negatively impact GDP for calendar year 2021, but we expect a sharp rebound in 2022, albeit off a lower base. Unemployment is expected to be lower. And we expect the property price increases to moderate to high single digits. The overlay reduced over the half as customers who had taken out deferrals following 2020 COVID outbreaks recommenced payments. However, we retain the bulk of the overlays, as there's still uncertainty how customers will recover from recent lockdowns and when the Australian economy completely opens up. Shifting to the composition of the impairment charge. And the only increase is in new IAPs in the half, reflecting the group's exposure to Forum Finance. Write-backs and recoveries were also better, as a small number of impaired exposures were refinanced. Write-offs direct were down consistent with the decline in lending and lower delinquencies in unsecured consumer and auto portfolios. Model collective provisions reduced further this half in line with improved credit quality and better economic outlook. Capital remains a strength, with the CET1 ratio at a healthy 12.3%. Cash earnings were the biggest contributor, followed by capital released from completed divestments. The payment of the interim dividend consumed 49 basis points of capital. Risk-weighted assets increased on the half and were broadly flat on the prior corresponding period. The 16 basis points decrease from risk-weighted assets in the waterfall mostly related to the application of the mortgage risk weight floor of 25%. On the right of the chart, we show the impact of the share buyback and the benefit from asset sales announced but not yet completed. Pro forma CET1 is expected to be 11.8%. Peter has already touched on the rationale for the off-market share buyback. The features of the buyback are on this slide. I refer you to the details in the buyback booklet and encourage you to read it. I'd make 3 points. First, this approach allows us to buy back shares efficiently and at a discount to the market price. It benefits all shareholders, as reduced share count supports earnings per share, dividends per share and overall return metrics. And the buyback allows us to distribute further franking credits to shareholders. The group's franking balance remains healthy even after allowing for the buyback and payment of the fully franked final dividend. 2022 has a number of dynamics that we see playing out, and we've set them out here for you. We expect to maintain momentum in the mortgage market and grow in line with system. While our focus on business lending is bearing fruit, it will be a longer fix. And we are encouraged by pockets of early growth. Margins remain under pressure, with competition and low interest rates likely to continue. Front book, back book pressure; and fixed-rate lending in mortgages will likely further weigh on margins. The tractor is expected to have less of an impact compared to the last half, as we have moved to a 3-year hedge on capital as interest rates rose. Noninterest income will benefit from higher economic activity. However, divestments will drag. Markets income is difficult to predict given the impacts of QE and volatility. Costs, excluding notables, will be lower in 2022; and I've provided color on this already. Credit metrics are in good shape and the economic outlook is positive. And finally, we expect APRA's final capital rules, while the removal of the CLF will also impact capital. With that, let me hand back to Peter.

Well, thanks, Michael. And let me sum up. 2021 saw us improve our operational performance, lay the foundations for better risk management and make progress on portfolio simplification. In the year ahead, we expect a stronger economy, and that's supportive for banking. In 2022, we are focused on 3 big priorities: firstly, growth in our core businesses, in particular maintaining growth in mortgages and lifting growth in Business and WIB; secondly, resetting our cost base; and finally, ongoing simplification and digitization, including further divestments. So overall I'm confident on the outlook for Westpac. Let me now hand to Andrew for your questions.

Thanks, Peter. Can I take a question from -- [ we'll just ] have one question. [Operator Instructions] I'll take the first one from Andrew Lyons, please.

Just a question on your margins. You've noted that your exit NIM is about 7 basis points below the half average. Can you perhaps just provide a bit of detail around the drivers of the weakness in the exit NIM vis-a-vis the half average? Is it broad-based, or are there some one-off items that might have driven the NIM lower in the -- at the back end of the half?

Michael?

Thanks for the question. So the biggest impact on NIM in the half was the reduction from lending, as we indicated in the slide. So that's a reflection of both the mortgage margin as well as the business lending margin, where we are responding to current market price. And also it reflects the mix shift from fixed rate -- from variable-rate lending to fixed-rate lending both for new lending and also from the back book. So they're the 2 big impacts that impact the exit margin in the second half.

Yes, okay. And just a second one. You appear to have about $30 billion of CLF which over the course of next year will need to be shifted into HQLAs. Can you perhaps just talk about what impact do you think that, that will have on the FY '22 NIM?

So the -- so as we've indicated, the CLF does reduce to 0 over 2022. We do need to add HQLA to the portfolio. We'll do that over time. That will be a function of purchasing additional HQLA through additional funding, but also it'll be a function of our deposit-raising capability. So it will have an impact, but we expect it to be minor at this point.

I'll take question from Jarrod Martin, please.

So no surprise, more questions on margins. Can you give us an indication, what your current spread between your front-book mortgage margins and your back-book mortgage margin, so we can sort of utilize that to try and understand what a trajectory from here will be? And then just more broadly on managing margins: Westpac used to be sort of known as prioritizing margin over volume. That seems to have flipped, that volume is a more important driver going forward, so I just wanted to get some comments on that change in philosophy.

Jarrod, I might take the second part. And then I'll hand to Michael for the front book, back book question. In terms of the volume-margin trade-off, we recognize that we have been ceding share. And in fact, in mortgages the book was contracting, and you're right. That's a good strategy to manage margin, but over time, we need to grow our customers. We need to grow the franchise. And with transactions and deposits, you get [indiscernible] customer relationships, so the way we've thought about it is we want to be back at market. We've got to see these books growing again. We've got to attract customers, and to do that, we've got to be focused on 3 things in our mind. First is the service, speed of turnaround. Second is lending capacity, and the third is competitive pricing. And that's what we've been working on in all our books. You've seen it most in mortgages this half. The other thing I would highlight, which is a bit unique at this point, is fixed variable has been a very big impact, as Michael spoke about, in terms of customer preferences, but for us we've got to grow the franchise, have got to grow revenue over time. It's been -- it's we've turned over about 20% of the mortgage book into the new market pricing, I think it is, this year, but Michael, do you want to talk about...

Yes, certainly. So as Peter said, the way we look at it, we are responding to the -- to market pricing, so we need to remain competitive. And that means, in a low interest rate environment, the front book-back book spread does decrease. That's exacerbated by the mix shift to fixed-rate lending. So we've given you an indication by the exit margin to give you a trajectory on our margin, but what I'd say on the front book, back book, there's lots of factors in there, that you've got a potential -- you've got the actual interest rates and what might happen in the future. You've got all those figures, so I think the best way to look at it is look at the RBA stats. They give you a view of the industry and ourselves. So I think that's the best way to look at it in that context.

Michael, would you suggest that you're -- given historical approach, that you would be worse than the industry average for front book, back book, I mean, having a larger gap?

I can only talk to our numbers. I can't really talk to the industry as a whole.

[ Probably, Jarrod, it ] -- I think what is different about Westpac is the fact that we've reshaped that mortgage book so materially since 2017. So interest only has a higher margin, as does investor. And we've materially reshaped the mortgage book to be much more owner-occupied P&I compared to where it was 2017. It does mean we've given up revenue. If we had that same shape of book, we would have materially higher revenue, but we just thought that was the right thing to do certainly as we set up for the different risk weights coming in later in the year.

I'll take a question from Richard Wiles.

[indiscernible] about the [ outlook on costs ]. You said that costs will be lower in FY '22. They've gone up 7.5% in the last year, so that doesn't give us much comfort. It certainly doesn't give us much guidance as to where the costs might be next year. Last year, they were at 10.2 -- or in 2020, they were at $10.2 billion. The illustrative guidance on Slide 25 suggests they'll be around about that level, so would it be fair to conclude that your guidance for FY '22 is that costs will be back in line with the FY '20 level of $10.2 billion, excluding notable items?

So thanks, Richard, for the question. Look, what we've tried trying to do in the presentation today is given you a view on how we see costs going down over the next 3 years. We remain committed to the $8 billion. We're not going to disclose what we see as the cost base for next year, but you can see that a lot of the reduction is in relation to the removal of the fixed one-off spend. That reflects us getting through a lot of the design phase on our CORE and risk uplift programs. And that will -- as I said, that will come off progressively over the next 2 years. And the underlying cost base, and we've shown you that $9.1 billion in 2021 terms, will reduce as we digitize and streamline the portfolio. So that will come off over time. It's probably more likely to come off in a trajectory sense in '22 and '23, but as we've given you guidance, it'll come down in 2022.

So Michael, Slide 22 -- Slide 25, if you just look at it, says costs will be $10.2 billion in 2020, so including the specialist businesses and the Fix. Should we ignore that [ drawing ]? Is that drawing to scale? Is that illustrative? Or is it guidance?

Richard, it's not -- we don't give guidance on our costs for next year. What we're saying -- that's -- that shows you the trajectory of how we're looking at it. That's the best way to look at it.

We'll take question from Brian Johnson, please.

Just to reiterate Richard's point. If you have a look at Slide 25, it looks like $10.2 billion to me. And I'm really confused as to whether you're saying that's an error in the drawing or whether we should think that's a guidance. I'm going to assume that the drawing is correct, and I think the whole market will, which is why the share price is down 6%, but the question that I actually had was if you have a look at the exit run rate NIM that was down quite a bit. The problem is that, according to the APRA stats, we can see that the owner occupied book is still growing and the investor book is still shrinking. Is -- the run rate NIM in the next months after the exit run rate, is it [ even ] lower again? Because the mix would suggest it's still declining.

So you're right, Brian. We have grown the owner occupied book this half and the year. We -- our intention is to provide solutions to all customers. And we will focus on growing both investor lending and business lending, which as Pete indicated has a higher margin. So we're actually pleased that we've got growth in owner occupied, but we are focusing on growing those other 2 books. So we've given you the exit margin as a view of how we're going into the first half of '22. That's the best guidance we can give you, but rest assured we're focused on growing those other higher-margin segments.

Yes, but Michael, the point is right, isn't it? It's that, given in the last months we saw owner occupied up and we saw investor down, the exit run rate is probably not commensurate with the margin erosion that you'll see in the next months as well. Can I just confirm that's correct?

So that's the trajectory. That's a reasonable conclusion to draw.

Brian, the only other thing to add is, as Michael said, there's changes to the way we hedge capital, which will benefit from the 3-year rate rises which have been pretty steep at the back of the year. And there were some deposit repricing changes recently as well.

I'll take question from Victor German, please.

I was hoping to just follow up on costs as well. I appreciate you don't want to give a guidance for 2022, but you did say that costs are going be lower. Would you be able to at least provide us the base that we should work from? Given that there's a few moving parts, including divested businesses, it'd just be useful to understand down from what number. And then sort of a related question: With specialist businesses, I can see in that -- I appreciate it's illustrative parts, but it looks like you're providing -- or you're suggesting that they will drop out by 2023. Should we assume that, that is the timing of your divestments? Or should we now start thinking about potential stranded costs with these businesses as well?

So just to give you some assistance on that. So the best way to think about the base is to look at the graph excluding notable items. So that's how we think about it. So each of those segments will decrease, so we will have less costs in fixed one-off. We will -- so as the specialist businesses sales complete, those costs will come out of the cost base. And we've given you some numbers in IDP to help you do that. And as I said, we expect a reduction in the BAU costs, and we've given you the base of that at $9.1 billion.

So Michael, just to be clear: You are expecting a reduction in the cost base ex the divestments on an underlying basis.

Yes, that's right.

Okay. And just one thing to confirm also. With this Fix number of $1.1 billion, which is you're expecting to reduce over time, I noticed that in your investment spend you've got -- obviously it increased quite materially this year. It's now around $2 billion, but within that number, that 70% relates to Fix. So as that number reduces, presumably you're not expecting your investment spend to reduce well below $1 billion. Does that mean that there is some capturing of that investment in the BAU line? How should we sort of think about that mix?

Yes, the best way to think about it, as you say, that the investment spend increase this year is predominantly on the Fix spend. As I indicated in the presentation, we've increased our spend on financial crime. So we've upgraded systems and capability. We've upgraded our complaints management system. And we've invested generally across our 3 lines of defense. So that's increased. That will come down over time as we exit the specialist businesses, get our risk management framework in better shape and then have that -- have the remaining investment focused on our core banking business. So we do expect it to go down, but we've got a -- still got a little bit of work to do yet.

I'll take question from Brendan Sproules, please.

I've just got a question on the fixed-rate mortgage market. What are your expectations for the competitiveness in that market just given that swap rates pretty much across sort of 1 to 5 years have really expanded in the last month? And then I have a second question, just on costs. I mean you obviously had to accelerate, as you've mentioned, some of the fixed costs in this year, which sort of I guess surprised us today. What are the uncertainties around your cost base for next year that you're not sort of prepared to offer us a target today?

So...

So Brendan, I might -- obviously we can't talk about any future changes in interest rates. That's a tricky area for us, but in terms of sort of fixed rates in the market, if I think about where they were back in March, the 3-year swap rate was around 35 basis points. You roll forward today. It's about 140, so we've had over 1% move in those rates. It's been pretty quick. It's been through September and October. And you can't -- it's unclear where it's going to go, but there's still a chance it will go up, so you'd probably say that the rates at some point in the previous half were the best in this cycle for customers.

And on the second question, on fixed costs, you're right. So we made a deliberate decision to increase our -- and accelerate our costs on fixed to get ahead of it. What -- as I said before, we have clear plans over the next 3 years to reduce those costs across all the buckets. What could come out that we don't expect? Additional regulatory requirements that we haven't been advised of or don't know about. That's the only thing at this point, but -- so you can't rule it out, but that would be the only uncertainty that I can see.

We'll take question from Jon Mott, please.

Another question on the margin. If you go back over time -- and I think Jarrod asked a question on this. I want to sort of get a bit more detail. If you look over the last couple of years, your margin from 2018 went 2.16, 2.12, 2.13, 2.13. In the last 3 halves, we've seen a down 10, up 6, down 9. Now I know you want to get back in the market and be competitive and stabilize your market share. I can totally understand that, but this is huge amounts of volatility to your business and throws huge amounts of volatility through the earnings profile [indiscernible] amplified risk costs don't move around as quickly as this. Is there anything apart from getting back in the game on price and being more competitive that has led to this huge volatility on an $800 billion balance sheet for your margin to move around so quickly? Is there anything else that we can think about that's throwing these numbers out?

I think, well, just a couple of comments on that. Treasury is obviously one of them, but you've got to look at the margin ex treasury. It can move around a little bit, but that gives you a bit of a sense. And really we're at a point in the interest rate cycle where deposits aren't as -- aren't moving as much as lending. So there's a bit of a floor impact in the result. We've had a shorter capital hedge on in the sense of that, so we're probably a bit further through, but then as Michael highlighted, I think we're well positioned for, hopefully, what is an upswing. And then the other piece that I flagged is we've predominantly been growing mortgages. So we've got a big mix impact there. We need to get other parts of our business growing, business lending. In particular, the unsecured personal piece has a bit -- has been contracting. So I think it's a bit cyclical, a bit competitive. And the other thing is liquidity driving into the markets, keeping RMBS costs down for lots of people. So there's obviously the cycle, the competition and then what we need to do to grow our business all at play.

So do you think this will stabilize as we get through these next 6, 12 months, and then we'll be on to a more stable environment and we're going for a rebase? Or how do you see this? Could we easily see it spike back up like we did in the first half this year?

[ For it ] to spike back up...

Or is this the rebase at a lower level?

No. And for us and thinking about returns and margins in the medium term, I would hope that they're going to rise from here. I'm talking medium term, not next year, but that needs a different interest rate level to what we have in the economy today.

And I'll just add that -- to Peter. We've been in through -- just through an extraordinary interest rate cycle. So we keep forgetting that these are the lowest rates we've seen for many, many, many years. And there is -- and that creates volatility. So there's nothing that's in the margin that we haven't disclosed to you. And going forward, we expect there to be more volatility, as Peter said. So I think it's hard to get a stable view, but it's worth keeping that in mind.

I'll take question from Matthew Wilson, please.

Just thinking about the shape of your franchise. You used to have the best institutional franchise on The Street. You've spent the last 5 years shrinking it and derisking it. And it may have happened at a time when we're actually going to move capital back into institutional banking with rates going higher, with what we need to do in climate change. Obviously a large amount of trillions of dollars of capital needs to be spent there, and yet your institutional franchise doesn't look as though it's now in a position to capture the benefits from it. And then you're pursuing really hard in housing, and we look as though we're at the end of a housing cycle. APRA is clearly going to implement macroprudential, and the RBA at some stage when they wake up or raise rates. You look behind the curve in how you're shaping your franchise...

Well, Matt, I'm probably more positive on the institutional bank than what you sound like you are for -- the biggest move that we've had is we invested heavily in some of the Asian locations over the last 4 to 5 years. And that didn't pay off for us, so we're coming back to Australia. I feel pretty good about the domestic capability of our institutional book. You can see the growth in lending in the second half, and that was because we were there for some big customers with some big deals. So I think we do have a good capability. We financed about 33 sustainable finance transactions this year. We have an electricity portfolio skewed to sustainable sources. So I think it's about [ 3/4 ]. So we don't talk about it a lot, but I actually think we've got a very good capability there and one that we can certainly build on. The challenge for that WIB book has been the reshaping to get us back to a simpler geographic presence, but I'm very confident in the outlook for WIB.

No. That's good. And then just one final question: We get to $8 billion cost base in 2 or 3 years time. What are your plans then for removing the duplication and complexity in your core banking platform?

Well, that's happening over time. So one of the benefits of the one mortgage origination system for mortgages is that we now have 1 back-office process, not 4. So it's policy process, a digital offer policy process; and then the ledger system at the back end. The ledger is not our problem, Matt. The problem is the front end. And we're getting after it now, not waiting to the back end.

We'll take question from Andrew Triggs, please.

I just had a couple of questions really around a slide in the deck, Slide 44, which is the customer franchise metrics, which I think has been -- [ arguably ] that's a more concerning slide for a while now. The MFI share, which is 15.7% for the group combined, is well below both your mortgage and customer deposit market share -- or consumer deposit market share. 2 questions there. I mean, one, what are the focus areas from turning this around? And secondly, you talked a lot about the balanced scorecard for management reflecting the costs reset agenda. What percentage of it relates to costs? And what percentage of the balanced scorecard relates to specific and quantified improvements in the MFI score?

So broadly for the group, it's 30 Fix, 20 Simplify, 50 customer and financials is -- are the broad weightings. And that's across the company. So that gives you a sense on relative focus areas, if you like. We're looking at both MFI, which is an external measure, as well as the customer sets, but we also then go down into product and channels. And we are seeing improvements in our product and channel CSATs and NPSes as well. That's why we are very focused on the capability in each of our businesses for customers. And so we are seeing improvements there as well. If you go back to my slide on millennials, you can see we've started to grow there again. That wasn't the case if you go back a few years. And I think the broader point is we've got the distribution teams focused on the customer. We've got to get the rest of the company lined up behind how we drive value in the franchise and customer outcomes, and that will be at a lower cost for the group. And we've got to reset this cost base because we're uncompetitive at the moment.

Can I follow up on the business bank? So I think the -- most of the market has a good handle on what's happened on the retail side of things but, I think, less sort of well understood what's gone wrong in the business bank. Could you give us your thoughts there on what needs to improve to be consistently performing well in small business banking...

Yes. It was 2 big levers. Firstly, our bankers aren't spending enough time with customers. So they've been involved with some of the Fix agenda. So that has materially changed towards the end of this year, and we're getting them out with bankers. So everything is going towards banker time out with customers. The second piece is credit standards. So we did tighten at the start of COVID. They've been now reset. And the third is we need to apply what we've done in mortgages [indiscernible] digital capability into the business segment is our other big focus.

We'll take question from [ Carlos Cacho ], please.

I just -- again related to the margins. On the replicating portfolio, can you, I guess, run us through the thinking in terms of that change? It does look like it gives you a pretty material uplift in the spot reinvestment rate. Based on today's swap rate, it's about 45 bps by my calculations. Is that -- is there a rationale behind that? Or is it really just to try and take advantage of the higher market pricing?

Yes. So as I indicated in the presentation, we did in the second half move the -- move out to the 3-year swap rate. That reflected obviously a change in the curve at that level, but also you -- the -- as we indicated at the half, the impact on the margin from the replicating portfolio was lessening over the year, anyway. But as we pointed out, we just decided, given the trajectory for rates, we would push out to the 3-year rate.

The thing about behind [ shortening it up in the year ] was Michael recognized there was no pickup for term. That was a pretty flat curve between 1 and 3 years. So there was no pickup, so we shortened the profile. And then it's been lengthened now as rates have gone up.

And just also, I guess, thinking about NIM and funding again. On the deposit side, you had a bit of a benefit in NIM over the half. It looks like there's probably pretty limited impact there. Do you think you'll be able like to squeeze any more out of lower deposit rates, or has most of that come through now given the vast majority [ are under ] 25 bps?

Yes, the 4 basis points improvement in the half came from TDs, so less in TDs. At call is pretty much at the floor, so we don't expect much margin improvement in the first half from deposits.

We're going to take a question from Azib Khan, please.

Peter, you've already responded to a couple of questions on the margin-volume trade-off, but I've got another one for you, if that's okay. So in the second half, you've grown home lending in line with system, with notably lower margins. You're pointing to similar dynamics next year with growth in line with system and lower margins, but what we've seen in the Consumer division in the second half is contraction in net interest income half-on-half and year-on-year. Can we expect that contraction to continue next year? Or do you think you can arrest that decline going into next year? And also, in terms of your system growth outlook, I note that your economics team is forecasting growth of 8.5% for next year. Do you think, if growth does get up to that level, that there will be further [ macroprudes ] tightening?

Why don't I deal with your second one? And Michael can deal with margin. I think we're at a point where the regulators rightly are very much focused on affordability houses and house prices outstripping income growth. And so it's right to tap on the brake to slow it down through the buffers. I think, if it doesn't slow down, then there's probably going to be more response coming. That's affordability metrics that we track through our economics team are stretched. You got to go back sometime to see them as bad as what they are at the moment. So I think it's the right thing, to tap to slow this -- the market down.

Yes. On the margin question, the big driver of the reduction in net interest margin in the half was from lending and from Australian mortgages driving that. We -- and as I indicated, we grew strongly the owner occupied segment, not so much investor and not so much interest only. We would look to grow those sectors in line with market in 2022. So while we're signaling that margin will be down in 2022, there are levers that we can pull and that the team is very focused on to ameliorate any complete adverse impact of the reduction.

So Michael, are you saying you're confident you can grow net interest income for the Consumer division next year?

I think that we do have levers to pull to manage margin in 2022. The trajectory is down, as I indicated. That will flow through. How that plays out in net interest income will be a function obviously of the size of the market. And if growth outstrips our current estimates, then we'll do better, but it's with the team to manage that margin up and focus on those high-margin segments. I am not making a call on what net interest income will be, but we're very clear on what we need to do to arrest the decline in margin. And hopefully, growth in the market will help us there as well.

We'll take question from Ed Henning, please.

Just 2 for me and back on your favorite topic of margins. If we just focus on competition, is it fair to say you needed to pedal harder to get back [ to ] system in mortgages? And now you also have increasing digital mortgage originations, so do you see the headwind just from the competition side slightly easing? Or is the market just super competitive and that headwind is going to continue at the same pace as the first [indiscernible]?

Yes. So look, as I think I said at the half year, I've been in this industry for a long time. Competition in the mortgage market is as intense, if not more intense, than I have seen in the past. We have a lot of new entrants coming into the market who are offering very low rates with no back book and no cost and providing a digital-only offer. So we expect that competition to continue. Our response to that, as Peter indicated, was providing digital origination, making it easier and quicker for customers to deal with us and having a competitive rate. So those things are critical. They are within our control. We will manage that, but on the competition side, I really don't see that changing much in 2022.

So even with the digital mortgage originations, do you think you'll have to be as aggressive as ever on price, [ though you can't even be ] back to the middle of the pack and still [ grow system ]?

Need to be at the market on price in mortgages in 2022. There's no question.

Okay. And then just a second one, on noninterest income. You talked about the benefits coming through from activity, and then you've got the divestments as headwinds. Do you see that as a net positive or a negative for next year on -- in total for noninterest income?

So I think, as we think about it, we are hopeful that, as the economy opens up, we get international travelers. We get more activity in the economy. We will benefit across all our businesses from greater activity. However, we are disposing of businesses that have traditionally generated a lot of noninterest income. And we've got more and more assets on the Panorama platform. So I think we're guiding generally to lower noninterest income, which is consistent with the trend and, I think I said this at the half as well, consistent with the trend over the last 10 years in the industry, not just with Westpac, but we are hopeful that positive momentum from economic recovery will support noninterest income next year.

Okay, but at this stage, unless it's really, really strong, it's you're looking at slightly down.

I'll take a question from Brett Le Mesurier, please.

You grew your loan book by 3% in the last 6 months. Do you have a sense as to how much higher your margin would have been if it had only grown by 2%, being 1% -- assuming 1% reduction across the board?

I haven't done that calculation. Sorry, Brett.

So given that you haven't done that calculation, how do you determine what level of growth you should be chasing?

Well, we're looking at hurdle. So we're very happy with the return from the business that we're writing. And if I look at the return in consumer bank and business bank, not -- WIB needs improvement. It's about the hurdle that we'll get from that business.

And the hurdles are lower than they used to be, I presume.

Yes, they are.

We're going to take some media calls. [Operator Instructions] I'll take one from Clancy Yeates, please.

Peter, you said that more sort of macroprudential policy was likely if the market doesn't slow down. Can I just clarify? You talked about 8% [indiscernible] price growth next year. Does that assume no more change in macroprudential policy?

It's from -- the 8% is from our economics team, Clancy. And I'm fairly sure they will be forecasting based on what's in place at the moment. They wouldn't be trying to predict any future changes to macroprudential.

Okay. And what do you think the regulator's goal is here? Do they want to stabilize house prices? Do they just want to see slow -- growing more slowly? Like what do you think are they trying to achieve?

APRA is about banking stability. That's -- so they're thinking about the state of the banking balance sheets. Now I'm not saying there's a problem with banking balance sheets. Capital is good. The credit outcomes are good. Funding and liquidity is good, but they're just, I think, trying to get a little bit in front of it in terms of what's happened.

James Eyers, please.

Just a follow-up to one of the analysts, I think Matt, asking about institutional banking and the energy transition. We're seeing COP26 on now. There's discussion of this article [ "fix" ], which is about finalizing carbon market rules. This is a really big area for Westpac in the past. And then we saw ANZ last week talking about its institutional bank being really well positioned to lend into this massive energy transition. Like can you just talk a little more about your aspirations for the institutional bank in this transition? Like can you match ANZ's lending without that Asian footprint? And do you support the carbon market developing, Australian companies participating in a global emissions trading scheme?

Well, just on climate solutions, we're already there. So we've already got $10 billion in lending. As I said, 75% of lending to electricity generation is to sustainable sources. We did 33 transactions this year. Our focus will be domestic. Australia and New Zealand will be our focus, and helping customers to transition. In terms of carbon pricing, we've supported a price on carbon. I don't know how that will flow out given the developments globally, but certainly we do support a price on carbon.

And on the footprint of the international -- of the institutional bank without that Asian footprint, do you think you can remain competitive in this sort of energy transition project finance base?

We do. I mean we've got a massive balance sheet in Australia and New Zealand. We've got operations in Singapore, London and New York and soon to be in Germany for Brexit, so our footprint will support our aspirations in climate.

Take a question from [ John Kehoe ], please.

Peter, just wondering. If we do get a rising interest rate environment over the next couple of years -- I know it's still a big if. What do you think that means for sort of the bank net interest margins across the industry? Surely that's going to be positive. And are the banks going to get like positive carry trade, therefore, on the term funding facility given that, that money was fixed at 3 years and through mid-2024?

Well, on the TFF, that's now finished. As Michael said, we've drawn down our allocation, so that's sort of in the numbers, if you like. In terms of sort of look forward and interest rates, that will depend on competition as well as what happens with interest rates, but certainly we see some positives from higher rates already in the way that we invest our capital. That's about mid-$40 billion worth of capital that we need to invest. So a 3-year rate going from 40 basis points, 35 basis points back in March up to 1.4% is good for our margins.

I'll take a question from Peter Ryan, please. We lost -- maybe we lost the sound there, guys. I'll just try...

Can you hear me now?

Yes, we can. Thanks.

A question for Peter. Just on the housing market, we're seeing house prices continuing to surge, rocket increase. How concerned are you about a potentially blooming correction once we -- even if we do get gentle interest rate increases perhaps earlier than expected?

When we -- Peter, when we lend -- and this has been for the last couple of years. We've been using a 5% floor rate for assessing affordability of housing, so -- and most people are borrowing in the low 2s. So we've assessed people at 5%. They're borrowing at 2%, so we feel like there's capacity for people to afford higher rates. Having said that, I think there is a correlation between interest rates and housing prices. We can see that over history. And therefore, housing prices are likely to moderate. And we certainly see our economics team forecasting slower growth, still growth in 2022; and some contraction in 2023.

[Operator Instructions] I'll take one from Joyce Moullakis, please.

Just one of the slides in the presentation mentioned reduced head office roles and a real estate -- a reduced corporate space on the real estate footprint. Could you provide a little bit more color around that? I think you've mentioned a 20% reduction in head office roles. Could you give a bit more color around that and the time frame around it? It -- I understand it excludes the branch footprint. So...

Michael, do you want to...

Joyce, Michael Rowland here. So the way we think about that is, as I indicated, as we simplify our organization, we need less complexity in our head office to support a larger organization, remembering that Westpac was set up as our banking and wealth business. So as the wealth business reduces and we exit those businesses, we need less head office support. That will come down over the time that we sell those businesses. And as we indicated, that will be progressively over the next 2 years.

Okay. And it doesn't include the branch network that...

We're very clear that we continue to invest in the branch network. We are focused on responding to customer preferences, so that's why we're investing heavily in digital. And digital first is a clear focus. This is not about the branch network.

I'll take final question from Kate Weber, please.

I was just looking for an update on your banking as a service platform, just especially since Afterpay got acquired by Square, if that impacts anything; and how much Westpac expects the banking as a service platform to help reduce its digital costs over FY '22.

Yes. So in terms of the banking as a service platform, the last major requirement has been delivered. So that was the ACCC sign-off for open banking. So we're pretty much ready to launch now. It's a consumer offer. Consumer deposits is the offer, and you'll hear more soon. I might leave it there.

Okay, well, thank you all for your time this morning, and good morning.

Thank you.