Commonwealth Bank of Australia

ASX:CBA

Earnings Call Analysis

Earnings Call Transcript 2023-Q2

[Melanie Kirk, Head, Investor Relations]

Hello and welcome to the Commonwealth Bank of Australia’s Results Presentation for the Half Year ended 31 December 2022. I’m Melanie Kirk, and I’m Head of Investor Relations. Thank you for joining us for this virtual results briefing.

For this briefing, we will have a presentation from our CEO, Matt Comyn, with an overview of the business and an update of the results, our CFO, Alan Docherty will provide details of the financial results and then Matt will provide an outlook and summary. The presentations will be followed by the opportunity for analysts and investors to ask questions.

I will now hand over to Matt. Thank you, Matt.

[Matt Comyn, Chief Executive Officer]

Thanks, Mel and good morning, everyone. It’s great to be with you today to present the bank’s half year results. Before I get into the detail of the result, I want to spend a few moments on the disconnect that we’ve observed in the past 6 months between our headline measures today and some of the underlying conditions. The cost of living pain for many customers is very real, and yet the impact is not yet evident in our first half financial performance. We are very conscious that many of our customers are feeling significant strain from rising interest rates, alongside the rising cost of electricity, groceries and other household items. This is becoming increasingly challenging for many households and an increasing source of worry given that the cash rate is likely to rise further in the coming months.

If we assume that there are two further cash rate increases, Australian homeowners have to date only experienced about half of the likely impact on monthly cash flows. We are proactively contacting every customer who is coming off a fixed rate mortgage this year so we can discuss what kind of support and options we can offer them. We can see some customers drawing down on savings and reducing spending to compensate, and yet we have not seen this translate into customers falling behind on repayments. While this has resulted in higher earnings in the period, it is driven by timing rather than the economic reality of higher rates.

While there has been an improvement in margins as the cash rate increase from emergency levels, margins have not returned to pre-COVID levels. We saw margins peak in October on a month-on-month spot basis. Funding costs have increased significantly, which is also coincided with escalating price-based offers across the home loan market in Australia and New Zealand. We believe home loan pricing across the industry is below the cost of capital. On the other hand, this has served to dampen the impact of rising rates on home loan customers.

Against this backdrop, we have been focused on serving our customers well and disciplined execution in this highly competitive environment. This half, we finished the period with peer leading net promoter scores and have delivered a strong financial result. Our continued balance sheet, strength in capital position means we are well placed to support our customers and the broader Australian economy. We are announcing today a dividend of $2.10 fully franked and neutralized dividend reinvestment plan and an expansion of our on-market share buyback program by up to $1 billion.

Turning to our results. Our statutory net profit was $5.2 billion. Cash net profit was also $5.2 billion, up 9%, driven by strong net interest income, partly offset by higher operating costs and increased loan impairment expense. Our operating performance was $7.8 billion, up 18%. Our operating performance and strong capital position has allowed the Board to declare a first half dividend of $2.10, an increase of $0.35 on the prior corresponding period. Our operating income was up 12% for the half, driven by volume growth and a recovery in margins. Operating expenses were up 5%, driven by wage and supplier inflation and higher IT costs. Pre-provision profit was up 18%, reflecting the strong underlying performance. Loan impairment expenses normalizing post large write-backs in the last financial year, while credit quality remains sound. The combination of 18% growth in operating performance and higher loan impairment expenses resulted in cash profit up 9% on the same period last year.

Our balance sheet remains strong heading into a lower growth environment, and we hold substantially higher capital levels. The balance sheet is 75% deposit-funded. Weighted average maturity of our long-term funding is 5.8 years, and liquid assets are $193 billion. Our common equity Tier 1 capital ratio is 11.4. We have implemented APRA’s changes to the Prudential Capital Framework, which were effective from the first of January 2023 and have a pro forma capital ratio of 12.1%.

The overall credit environment remained very benign in the period. However, we are watching closely for early signs of stress, particularly among high-risk cohorts. Troublesome and impaired assets decreased modestly to $6.3 billion from $6.4 billion in the half. Home loan arrears are at near record lows at 43 basis points, although leading indicators suggest that arrears will start to trend upwards from here. Given the uncertain outlook, we remain well provisioned and capitalized for a range of economic scenarios. We hold total provisions of $5.5 billion, which is approximately $2 billion above our central economic scenario.

Our core business continues to perform well through disciplined execution. The strength of the franchise starts with our strong customer relationships. We are fortunate to serve 9 million customers and over 1 million businesses and to have the leading proprietary physical and digital distribution channels. Through our CommBank app, we have nearly 9 million touch points with customers each day. And by delivering a superior customer experience through our digital channels, we are able to develop deeper relationships to better understand and serve our customers’ needs.

We continue to invest in our customer engagement engine, which is now making 53 million decisions in real time each day to deliver superior customer experiences. We’ve also built a number of proprietary assets over time to better manage and assess risk using transactional data, representing approximately 40% of payment flows in Australia. These assets allow us to deliver superior customer experiences at scale, driving customer advocacy and NPS, which are increasingly important in a digital era.

We finished the half with peer-leading net promoter scores in all of our key segments: consumer, business banking and institutional. We led the market on net promoter scores for 11 of the last 12 months in our business bank. But despite being number one, we still have a lot of work to do to improve our absolute scores, and this will continue to be a significant focus for us in the years ahead.

Our NPS is critical to building customer relationships. 35% of Australians consider the Commonwealth Bank to be their main financial institution, which is more than double our nearest peer. In business, 1 in 4 businesses consider the Commonwealth Bank their main financial institution, an increase of 1.5 percentage points in the last 12 months and 21% more than our nearest peer. Transaction account relationships have again grown strongly in this period. We opened 716,000 new retail transaction accounts in the half and an increase of 50% and now have nearly 1.1 million business transaction accounts, which is up 9% year-on-year. Having a transaction banking relationship allows us to better understand customer needs and risk and underpins continued growth in both home and business lending. More than 95% of our home loan customers and approximately 90% of business lending customers hold a transaction account with us.

As you know, we made a strategic choice to increase our investment in business banking. Cumulatively, over the past 3 years, we have directed an incremental $600 million of investment into our business bank, resulting in strong customer and earnings growth. Since December 2018, we’ve delivered market-leading MFI share growth of 170 basis points. And over that same period, deposit market share has grown 270 basis points to 22.4%. We hold $68 billion more business banking deposit balances than we did in June 2020, which is a 43% increase. This growth in primary customer relationships has meant transaction banking now contributes 47% of the business bank’s revenue, up from 34% 2 years ago. And the business bank has moved from a net asset position of $38 billion in June 2019 to being fully deposit-funded today.

We have continued to grow volumes above system in the past 12 months, with deposit balances growing $8 billion at 1.5x system and lending balances growing $16 billion at 1.3x system. This deepening of primary customer relationships and prudent lending has resulted in strong earnings performance. Return on target equity has increased by one-third over the past 3 years, and the business bank now contributes 38% of group profit after tax. Our business bank now leads the market on MPS, MFI share and MFI growth, deposit share and deposits growth and merchant market share.

Despite higher growth, we remain second in market on business lending. We’ve remained cautious given the economic uncertainty and continue to focus on opportunities to further grow our business by leveraging our transaction banking advantage. A big focus for our investment in business banking has been payments and merchant acquiring, which underpin the relationship we have with our business customers. We have launched a range of new smart terminals and have more than 50,000 devices now in market, 30% of those to new merchant customers. These new devices allow us to build differentiated propositions by industry verticals, and we’ve been particularly focused on health care and hospitality. In health care, we enable digital claiming of rebates via full integrations into Medicare, the NDIS and various health insurers and access to digital receipts. This has helped us to win new health care clients, including the NDIS and has supported strong lending growth of 21% in the healthcare sector.

For businesses accepting online payments, late last year, we launched a new e-commerce proposition called PowerBoard, which helps businesses get online and with a few clicks offers a broad range of payment services to their customers without the need for costly technical integrations. The home lending market is undergoing a period of extreme change and intense competition. There are a number of contributing factors, including aggressive volume growth, the cyclical slowing in new lending growth the pending surge in fixed rate maturities and high levels of refinancing. This has occurred at a time where wholesale funding costs have increased substantially. Cash backs are growing in size and prevalence, and we estimate the banks have deferred costs related to cash backs of over $1 billion. This figure has increased almost 50% in the past 2 years and, combined with a substantial increase in commissions over the same period, creates a margin headwind that will flow unevenly across the market.

The operational performance of our Home buying business remains strong, and we are regularly reviewing how we compete given the atypical market conditions. We have a number of unique assets, including the largest home lending frontline team, a direct-to-consumer digital proposition online and a distinct proposition through Bankwest. We also now account for approximately 37% of all proprietary originated loans in Australia. We decisioned more than 4 and 5 home loan applications within a day, and 64% of proprietary applications are auto-decisioned in less than 10 minutes. We are very focused on proactively engaging with our customers as the surge of fixed rate rollovers occurs across the industry over the coming 12 months.

Online, the digital direct home loan we launched mid last year is becoming an increasingly important channel and has already funded over $1.5 billion of loans. We are able to pass on the lower servicing and distribution costs from a direct-to-consumer model through a competitive rate that rewards customer loyalty and doesn’t rely on cash backs, honeymoon rates or fees. And through home in, our digital e-conveyancing service, we have now settled over $3 billion in home loans with 98% of these customers taking up a CBA home loan. To navigate the current economic and competitive environment, we will continue our focus on strong disciplined operational execution across all channels, proprietary digital and broker.

Digital remains central to our strategy. We continue to grow digital engagement and now have over 8.3 million digitally active customers, nearly 1 million more than 2 years ago. The Net Promoter Score for our mobile banking app sits at a peer-leading 28.5%, and our digital Net Promoter Score in our business segment also sits at a peer-leading 11.4%. Through digital, we see increasing returns to scale in terms of building deeper, more trusted customer relationships, better understanding customer needs and risk and delivering a superior customer experience.

Strong digital assets and engagement allows us to help customers in a range of ways. One area we’ve been extremely focused on is fraud and scams given the growing prevalence in the market. Customer losses to scams were estimated by the ACCC at over $2 billion in 2021, and our data suggests they have been more than doubling each year since. We have a range of services and security features in place to help protect our customers. We have been investing in technology to keep our customers safe, including real-time monitoring, fraud prevention technology and secure banking. We’re also doing all we can to raise awareness and educate customers about the actions they can take to stay safe online. We’ve contacted more than 9 million customers about uplifting their banking security.

The security checkup in the CommBank app also walks customers through key steps to keep accounts and card secure from activating location-based security and setting up alerts. And we also recently introduced two unique features, CallerCheck and NameCheck. CallerCheck is a new app feature that allows customers to verify whether a call or claiming to be from the Commonwealth Bank is actually legitimate. NameCheck helps customers ensure that the account they are paying to belongs to the person they are trying to pay. We have dedicated teams working around the clock to look out for unusual activity across our customers’ accounts and we are reaching out promptly if we just detect anything suspicious.

We also know that many of our customers are concerned about the cost of living pressures and rising interest rates. We have increased deposit rates 9x in the past 9 months and helping customers better manage their finances through budgeting and spending tools in our CommBank app. Customers have now accessed more than $1 billion in benefits and entitlements through our Benefits Finder feature, which will help with the rising cost of living. We are here to help our customers and encourage anyone who has questions or concerns about their financial situation to get in touch with us.

And with that, I’ll hand over to Alan to talk to the results in more detail.

[Alan Docherty, Chief Financial Officer]

Thank you, Matt, and good morning to everyone who has dialed in. I’ll unpack the financial results to 31 December in a little more detail, and I’ll also cover the changes to our regulatory capital, which arose from APRA’s prudential framework revisions, which became effective on the 1st of January this year. In summary, these financial results were driven by a combination of macroeconomic variables, management actions and franchise strengths, and we are well positioned to support our customers and the broader economy as financial conditions continue to tighten during the 2023 calendar year.

Looking firstly at the macro context, interest rates have increased very quickly to their highest level in more than a decade, while unemployment is at a 50-year low. The full effects of the rapid tightening of interest rates are still to emerge, but we fully expect to see a moderation in discretionary consumer spending in the months ahead. Those macro factors have manifested in a rapid recovery in our net interest margins, continued historical lows and arrears rates due to full employment but also increased loan loss provision as we take a forward-looking view of that coming slowdown in consumer spending.

Turning now to the results of management actions, our continued focus on customer outcomes is manifesting in our leading customer advocacy scores. Our focus on consistent, high-quality operational execution has contributed to the significant growth in pre-provision profits. And as a management team, we are responding to the tighter financial conditions with a deliberate conservatism in our funding risk settings, together with careful calibration of credit risk settings.

Finally, looking at how the structure of our franchise is evolving. We’ve seen another period of improvement in both retail and business main financial institution share as well as continued growth in customer deposit balances. This has driven strong organic capital generation in the period, which enables us to continue to support our customers’ lending needs as well as continue to reduce our share count and sustainably increase the dividends paid to our shareholders.

Now on to the detail. Statutory profits from continuing operations were $5.2 billion. Non-cash items within continuing operations were relatively small, with continuing cash profits also rounding to $5.2 billion. That cash profit represents 8.6% growth on the same period last year. That was the result of operating income growth of 12%, operating expense growth of 5%, pre-provision profits increasing 18% and loan impairment expense returning somewhat closer to long-run averages during the half.

Looking firstly at operating income. Net interest income increased by $1.9 billion on the prior comparative half, a combination of strong volume growth in all businesses and on both sides of the balance sheet and also the recovery in net interest margins. Other operating income decreased by $400 million over the same period. This was largely due to the revenue foregone from divested businesses and lower associate earnings. Excluding those items, we continue to see strong underlying volume-driven growth in deposit, foreign exchange and business lending fee revenues.

Turning now to net interest margins. Over the most recent 6-month period, margins increased by 23 basis points with the benefit of rising rates on deposits, the replicating portfolio and equity hedges, partly offset by lower lending margins. Taking a slightly longer view of margins in the box at the bottom right, margins have recovered back to around the same level we had seen in 2020 before the full impact was felt of the historical lows in interest rates during the COVID response. Margins do however remain lower than they were 4 or 5 years ago despite the overnight cash rate setting at a decade high. And you can see that monthly spot margins peaked around October before stabilizing in the December quarter. This was due to the increased intensity of home loan and deposit price competition, offsetting the benefit of rising rates.

As we look ahead to the second half, the same factors that I’ve called out previously will continue to be important considerations. Headwinds include the competitive pricing dynamics in home lending and deposits, the rate of customer deposit switching and increasing wholesale funding costs. Against that, the trajectory of domestic interest rates will determine the strength of the remaining margin tailwind from deposits, the replicating portfolio and our equity hedge.

Turning now to operating expenses. They increased by 5.2% on the prior comparative period. Excluding the slight increase in remediation costs, underlying costs were up 4.4% due to inflationary increases in wages and supplier input costs. Growth in other costs were offset by our ongoing business simplification initiatives. And our cost-to-income ratio improved by 3 percentage points to 42.5%.

Turning to our balance sheet settings and looking firstly at credit risk, loan impairment expenses were $511 million in the half as we see loss rates begin to increase off an extremely low base. Leading indicators of credit risk remained benign, with the 90-day arrears rates within our consumer portfolios below where they were a year ago and corporate troublesome balances remaining at historic lows.

As you would appreciate, we are looking closely at very early stage arrears of even 1 day or more across both our consumer and corporate portfolios. These have increased in the last few months, though off a very low base, and they remain well below long-run averages. We are watching those measures closely and do expect arrears to increase in the coming months.

Given the expected tightening of conditions in the year ahead, we’ve decided to top up both our consumer and corporate credit provisions. Total provisions were increased by $200 million to $5.5 billion. This provides us with a $2 billion buffer to our central scenario of a relatively soft landing for the Australian economy and gives us approximately 80% coverage of the potential $6.9 billion loss modeled under our stagflationary downside scenario.

Our balance sheet settings remain peer-leading with our deposit funding ratio increasing again, now at 75%. Long-term funding settings also remain conservative. Given we are forecasting much tighter financial conditions over the next couple of years, we have again reduced short-term wholesale funding to a historical low proportion of total funding of 7%. This form of funding used to represent 26% of our liability stack. This conservatism costs money. We could increase our net interest margins by shortening our funding mix closer to industry peers, but we feel keeping extra capacity in this part of the funding stack remains the prudent course given the current macro environment.

On capital, we have delivered a common equity Tier 1 ratio at 31 December at 11.4%. This is 10 basis points lower over the half, largely due to the progress we made on the on-market share buyback in the last 6 months. Our pro forma CET1 capital from 1 January 2023 under the new APRA capital framework was 12.1%, an increase of 70 basis points and well above the new prudential minimum of 10.25%. Today, we also announced a $1 billion upsize to our on-market share buyback, and the completion of that buyback in the period to 30 June would see an expected change in capital of 25 basis points.

I thought it would be helpful to provide some more detail on how the new prudential requirements manifested in our new capital ratio of 12.1%. As we had previously indicated the aggregate effect of the prudential changes are to increase the reported capital ratio as a result of a lowering of risk-weighted assets. As you can see on the bottom right of this chart, when you take into account our higher capital target of 11%, the overall capital requirement remains broadly the same. Asset classes that seen a reduction in their risk weighting included owner-occupied home loans and commercial property exposures. Importantly, we can now take account of greater risk discrimination in these portfolios and more fully recognize the benefit of high-quality collateral held against these exposures.

On the other hand, risk weightings increased for investor home loans as these exposures are generally more highly geared. New Zealand risk weightings increased in alignment with the new RBNZ requirements. And operational risk capital increased under a simplified and standardized calculation, which is now proportional to the level of banking income. All other risk-weighted assets remained largely unchanged. The first half dividend of $2.10 represents a 20% increase on the prior comparative peak dividend and a normalized interim dividend payout ratio of around 70%, in line with our long-standing dividend policy. Given our very strong capital position, the Board have also decided to again, neutralize the DRP in respect of the interim dividend.

I will now hand back to Matt, who will take you through the economic outlook and a closing summary. Thank you.

[Matt Comyn, Chief Executive Officer]

Thanks, Alan. The Australian economy continues to respond to the higher cash rate, which has increased 325 basis points over the past 9 months to levels we haven’t seen since late 2012. The starting point for the Australian economy is strong as the impact of these changes continued to flow through. Unemployment remains near 50-year lows, underemployment is low, and the participation rate is near record highs. Energy and commodity prices have supported strong export volumes in terms of trade, non-mining investment remains strong, and migration has recovered. However, there is a disconnect between headline measures and the challenging conditions for many households and businesses.

In the past year, gas prices are up 17%, fuel prices are up 13%, and grocery prices are up 11%. And these impacts are even more acutely felt by mortgage holders given increases in the cash rate. We’ve seen the household savings ratio fall to 7% from a COVID peak of over 23%, and house prices have fallen 9% from their peak in April last year. We can see savings buffers being drawn down, particularly for customers at higher risk from rising cash rates. And there is more impact to come given the changes in the cash rate take time to work through the economy, and the market expects at least 2 further rate rises.

A customer with a $500,000 loan 30 years – for 30 years on a variable rate has already seen repayments increase by $700 with another $400 likely to come in the next 6 months. Given this and the fact that 40% of home loan customers were on fixed rates, roughly half of the total expected impact has been felt by homeowners so far, rising to 75% by July. In 2023, we expect GDP growth to slow driven by a pullback in consumer spending. A significant slowdown is expected in many key global economies this year, and the outlook appears particularly challenging in the UK and European Union. Australia is well positioned, but the effects of a slower growth environment will be unevenly felt. However, we will be ready to support our customers feeling the strain. It is a challenging situation for policymakers and many of our customers, but we remain optimistic that a soft landing for the Australian economy can be achieved, and we remain of the firm view that the medium-term outlook remains positive.

In summary, we have delivered a strong result with customer relationships and engagement translating through to volume growth. This has been underpinned by consistent multiyear disciplined execution. Our balance sheet and capital position remains strong. And looking ahead, we will continue to invest in the bank’s core retail business and institutional banking franchises to further differentiate our proposition and extend our digital leadership.

While we are facing a period of economic uncertainty, we are optimistic about the medium to long-term opportunities for Australia. The strength of our balance sheet means we remain well positioned to continue supporting our customers and the broader Australian economy while delivering consistent and sustainable returns to our shareholders.

I will now hand back to Mel to go through the questions.

[Melanie Kirk, Head, Investor Relations]

Thank you, Matt. [Operator Instructions] We will now start with the first question from Andrew Lyons.

[Andrew Lyons, Goldman Sachs]

Thanks, Mel. Good morning. Andrew Lyons from Goldman Sachs. Matt, just a question, you noted that your view that industry-wide mortgages are being written well below cost of capital. And yet despite this, I note that you still grew mortgages in Australia about in line with system over the half. So just in light of this, could you just provide some more detail as to the extent to which your strength in proprietary lending improves the relative return metrics and how your mortgage strategy might evolve if current pricing does remain? I have then got a second question.

[Matt Comyn, Chief Executive Officer]

Yes, sure and good morning, Andrew. Look, I think you are right, we are slightly above system in the 6 months, but down over a 12-month basis. I guess as I said out in the comments, we are finding it certainly an atypical environment and one that we are managing very closely. I think in particular, as we have seen rising funding costs and clearly, there is a range of factors contributing to this, we have been surprised that we haven’t seen some changes in terms of the pricing and offers that are available on the market. I think there is probably some downside risk to margins there as well. We have typically seen a higher level of basis risk or bills, overnight cash spread. And so I think it’s for us a period where we will be continuing to manage all of our settings very closely on both sides of the balance sheet. And I think that’s incredibly important and necessary. Of course, we are going to continue to try and play to our strengths. We certainly feel like we have relative advantages not just in our customer franchise, but of course, in our technology and the relationship that we have with customers. The broker channel is, of course, a very important channel, but we have the strongest proprietary channel and mix. We’ve seen that grow from so probably third of proprietary mortgage originations a couple of years ago to now be 37%. We’re seeing strong growth in unloaned. But look, we’re participating in that market. And clearly, we’re also seeing the impacts of that flow through. And no doubt, you and others will have some questions around margins and where they stabilized in October and the outlook. And of course, there is uncertainty around that, but something that we’re very focused on.

[Andrew Lyons, Goldman Sachs]

Thanks. Appreciate it. And then just a second question. You did note that the first half ‘23 reported results did not particularly reflect the environment we’re in, and there was some timing there. That said, your 42.5% cost-to-income ratio is the lowest you’ve delivered in a number of halves. Just given – I just guess, given the various moving parts around inflation and expenses and rates and margins, I’d be just keen to get your views or your comments on the extent to which you think CBA can sustainably deliver a low to mid-40s cost-to-income ratio.

[Matt Comyn, Chief Executive Officer]

Yes. No, thanks, Andrew. And of course, our churns indicate that – I mean net interest margins, as you know, very well across the industry, been under real pressure for many years and particularly during the sort of emergency cash rate settings. You see a recovery in those margins, particularly in that 6-month period. There are, as we’ve just discussed, a range of different factors. Of course, that’s the predominance of what’s driving the relative change in the cost-to-income ratio, which is a metric that we look at but certainly not the only metric. I think as we’ve said in the past, we will continue to look very closely, clearly at any operating and investments that we’re making. As you would have seen, we’ve been prepared to increase our investments, both in areas like business banking and technology more broadly. Of course, we want to be and need to be satisfied that we’re earning an appropriate return on those investments. Certainly, in the context, as we talked about earlier, in business banking, that’s been a very beneficial strategic investment, but we’re going to continue to sort of manage that – our cost base very carefully. And something, of course, as we look forward into multi years of what we think the income environment will be and potentially some of the structural changes in the competitive landscape, we also want to make sure that we’ve got the right flexibility in our cost base, and we’re making investments to make some structural reductions to that cost base predominantly through improving processes.

[Andrew Lyons, Goldman Sachs]

Thank you so much.

[Melanie Kirk, Head, Investor Relations]

Thank you, Andrew. The next question comes from John Storey.

[John Storey, UBS]

Thanks very much. It’s John Storey from UBS. Matt, I just wanted to ask you about net interest margins. I think Slide 23 that you put up was pretty interesting. Looks like margins have peaked, as you mentioned, in October. One of the things that certainly surprised me the rate at which your funding costs have increased and doesn’t burn that well, I guess, for other banks that are more wholesale funded in the market. You’ve had a 100-basis-point increase in your cost of interest-bearing deposits in the 6-month period. So I just wanted to get a sense around the delta and whether or not you actually see a slowdown. You mentioned some timing differences. I think you’ve got an interesting slide just showing what’s happened with term deposit funding mixes. So the question is, do you see a slowdown in the rate of increase in terms of funding costs? That’s my first question.

[Matt Comyn, Chief Executive Officer]

Yes. No problem, John. Look, let me start. And I’ll throw it to Alan, no doubt he can add some more specifics. I mean we’ve touched on and clearly an increase in wholesale funding costs. On a relative basis, as you indicated, we’ve got more capacity and resilience, which is really important from our perspective, not just from a capital provisioning, but also in our funding stack. And so we feel that we’re better able to absorb those, the relative change certainly versus peers. And Alan and I are very focused on managing for sort of flexibility and resilience, which enables us to so probably time in the market. In some cases, we certainly had a strong last 6 months of issuance. We’ve had a strong start to the year in issuance, including the largest ever domestic bond issuance. And in terms of our weighted average cost, I think it looks very favorable versus peers.

[Alan Docherty, Chief Financial Officer]

Yes. On wholesale funding, as you know, John, I mean there is a very – the banks, not just domestically, but all around the world are now increasingly tap in wholesale funding markets. So I think you’ve seen a big rebound in wholesale funding costs, and that’s likely to be sustained. Basis risk hasn’t normalized back to levels that we’ve seen over the long-term. You got to expect that that’s a matter of time before you see a normalization in basis risk. So you’re not seeing that feeding through yet. And on the deposit part of the liability stack, you’ve seen increased deposit competition, and we’ve engaged very markedly in that regard. You’ve seen it’s a very attractive deposit – term deposit and savings rate offers made particularly in that back quarter, and that manifested through in terms of that net interest margin on a spot basis in the back calendar quarter of December. And again, that switching and deposit competition is going to be an ongoing feature in calendar 2023.

[John Storey, UBS]

That’s great. And then just the second question is around the business bank. I mean obviously, a phenomenal result that was delivered there as you mentioned, 40% of group earnings now coming from the Business Banking division. Just the question on this is more around asset quality. I mean you are seeing early signs of stress in the book around unsecured in retail, but then you also saw a significant increase in the charge in business banking. So I just wanted to get a sense, the 23 basis points in business banking, what’s happening with business banking clients? Do you see further stresses emerging here? The charge looks like it’s a lot higher than through the cycle level already. And is this where you expect higher impairment charges to manifest themselves?

[Matt Comyn, Chief Executive Officer]

Yes. I mean look, firstly, the credit environment remains very benign across sort of retail and businesses and both in terms of what we can see and directly in the book and also anecdotally talking with customers across a range of different industries, very strong trading conditions in the 6 months to December. Of course, there is – there will always be some smaller individual names within those sub-sectors, and we’re thinking much more about sort of the future period. We’ve been very focused on making sure that we’re, from a credit origination perspective, pricing of forward curves, adding more contingency in and around sort of costs in areas like commercial property, making sure we’re thinking through sort of contingency and delays, which have sort of come in. At this point, we’re not per se concerned around the credit quality of the broader outlook. We’re probably on the balance of our total provisions. We think there’ll be more stress in the non-retail, I think just the impact on household consumption over the over the course of the year will inevitably flow through into the non-retail book, particularly in some of those discretionary retail sectors. But if you look at origination, both from a probability to fall, also just security positions where LVRs have been for some time, I think we feel very comfortable in terms of total provisioning.

[Alan Docherty, Chief Financial Officer]

Yes. I mean the – what you’re seeing in terms of the loan loss rate for corporate is 13 basis points overall for the half. But the loan loss expense in the half is very much – has taken a forward-looking view and bringing those factors back in through some of the downside scenarios that we can model out. We’re seeing very little in terms of the flow in the business bank in terms of the clients and bad debt. We keep a very close eye on very early-stage arrears. There is a little increase in corporate early-stage arrears, but they have all cured since the end of the year. So, we are not seeing that flow through yet but we do expect things to tighten and those arrears rates to increase both in consumer and corporate in the year ahead, but yes, abundance of caution on the top-up to the provisioning on the business bank in this period.

[John Storey, UBS]

Great. Thanks very much, Matt. Thanks, Alan.

[Melanie Kirk, Head, Investor Relations]

Thank you, John. Our next question comes from Jonathan Mott.

[Jonathan Mott, Barrenjoey]

Hi, John Mott from Barrenjoey. I’ve got a question that kind of follows on from Andrew Lyons’ earlier question where you’ve seen on that slide 23, the competition is very intense, and it drove the fall in the NIM in the last couple of months of the year. And you also said, Matt, in you’ve reiterated the statement that mortgages are being written below the cost of capital. If we take a step back and we also look at the APRA stats, what it shows is that you’ve reengaged in the housing market over the last couple of months – in the last couple of months have actually been winning share, growing above system in November, December period, which would suggest that you’re the one that’s driving a lot of this competition. Is that a fair assessment? And why don’t you just step back out of the market at this stage and only focus on high-quality customers, we already have a relationship with?

[Matt Comyn, Chief Executive Officer]

Yes. I mean, like John, I’d say, not a fair assessment, but a couple of factors that are certainly worth sort of picking up on. As you’ve seen in the past and as you know, we’ve certainly been prepared to step in and out of the market. We probably – if you go back to sort of midyear, we looked at some of the share loss that we had there. We were trying to stabilize and also we want to engage closely with our customers. It’s predominantly around retention, but there are also, of course, high levels of refinancing activity. We’re very confident we’re not driving. In fact, we feel that substantially in some areas lagging others, particularly in areas like cash back. It is a market that’s hard to get the precision around the settings about exactly where we’d like. I mean we’re sort of – when we’re above system, we’re talking of a couple of basis points. And then I think on both sides of the balance sheet as we’ve looked at both what’s happened in liabilities, how that market is evolving, some of the benefits that we had through the COVID period, we’re just trying to get those overall settings right. I think, obviously, we will be very conscious about not turning my mind to future actions that we might be taking, but it’s fair to say that we’re watching the dynamics very carefully and certainly prepared to make the necessary adjustments. But confident that we’re not driving the pricing at all, but we’re participating in a market which is atypical to the one that we’ve seen over just about every period I can think of in the last 20 years.

[Jonathan Mott, Barrenjoey]

Okay. And just following a follow-on question. Another question to put on Slide 63, which just shows a change in the mix of deposits coming through and it shows quite over a period of time from basically pre-pandemic today, a material change in the deposit mix. And it looks like the worms turned if you want to call it that, especially in retail and some extent, business banking as well. Do you expect that to normalize all the way back to where it was back in December 2019? How much of a headwind is this mix of deposits like the be on your margin – in your funding cost over the next 2 or 3 years?

[Matt Comyn, Chief Executive Officer]

I mean, look, hard to say exactly how much. It’s certainly something that Alan would be happy to talk to. We’ve watched that very closely and still very confident about the earlier guidance that we’ve given about sort of rate increases. I’d say it’s been relatively modest compositional shift in retail. As you said, there is been a big growth in transaction balances. That also makes sense. We would put it down to – we probably gained about 80 points of share during the 2 years of COVID, just given the customer base and the government payments that went through. Some of that starts to unwind to get into a higher spend environment, we’ve got a high proportion across debit and credit. So there is some smaller factors that play through, but I mean you’re quite right. We’re looking at sort of the liability stack across the different products and thinking through different scenarios both in retail and in business. And I mean broadly, we’d certainly expect you’ll see the composition shift the most into TDs, but hasn’t been too significant, certainly not beyond our expectations in retail. And business is a little lumpy, which are a bit more in Q1, which is we think is mostly seasonal, about almost 70% of the shift in that sort of in Q1 versus the second quarter. So I mean, it’s certainly something that we’re watching lastly.

[Alan Docherty, Chief Financial Officer]

Yes. The other thing that was anything unexpected about those trends given the sort of the macro backdrop and the very attractive yields on offer, I’d say going back to Deck 19, I think there is a couple of things you’d have to adjust relative to that time period. One is just the broad increase in broad money supply over that period. And so in absolute sense, there is obviously more dollars in money supply in the system and money supplies unlike in other parts of the world is continuing to grow in Australia. And so that will provide some support around all of deposit categories. And also, we’ve had a big change in terms of the franchise build in both the retail and business bank over that time period. We’ve been growing MFI share in both Retail and Business Bank. And so again, I think that provides support to some of those transaction deposit categories in particular. So it hasn’t been unexpected what we’ve seen today, but obviously, we will keep a close eye on it, and we’ve called that out as one of the considerations around second half margin.

[Melanie Kirk, Head, Investor Relations]

Thank you, John. The next question comes from Richard Wiles.

[Richard Wiles, Morgan Stanley]

Good morning, everyone. Alan, I’ve got a couple of questions for you. The first one relates to deposits and also to Slide 63. It shows you’ve got $250 billion of at coal interest-bearing deposits. Given the focus from the treasurer on deposit rates at the moment, I thought it was interesting to ask about the difference between Goal Saver and Netbank Saver. Goal Saver are now offering 4%. NetBank Saver, it’s more like 1.6%, the standard rate. So what proportion of those $250 billion of at coal deposits are in each of those two products. How much are in net Bank and how much we’re in Goal Saver?

[Alan Docherty, Chief Financial Officer]

Well, we haven’t provided that level of granularity in the disclosures, Richard. So we’ve got significant balances in both those products, and we’ve got very strong rate also available on NetBank Saver at the moment. So yes, we don’t, as you know, provide product-by-product level, balance statistics across either side of the balance sheet.

[Matt Comyn, Chief Executive Officer]

Yes. I guess what I’d add, Richard, is across a range of different products. I mean, NetBank Saver, there is an introductory rate of 4%. Goal Save, which is a very popular product, but that won’t just put out with the balance composition, that’s running at 4 awards savers. We have been running a 12-month TD. So there is some very competitive rates in market as you’d expect. I think the other things that you – on that sort of category of questioning often we get asked about sort of the relative speed we’re putting up rates versus end products. I mean we’ve been very careful to make sure that we’re broadly within sort of the 10 and 15-day range we’re putting up both our rates on both sides of the balance sheet, and that’s broadly in line with what we were doing as rates were coming down.

[Richard Wiles, Morgan Stanley]

Okay. And if I could ask a second question, a year ago, Alan, you included a slide that set a 25 basis point rate hike would boost margins by around 4 basis points over time. Given that rates have moved a lot higher, I imagine that sensitivity has changed. So could you provide us an update on your sensitivity to higher rates? And can you also talk about how you expect the replicating portfolio to support margins in the period ahead?

[Alan Docherty, Chief Financial Officer]

Yes. Thanks, Richard. So yes, the sensitivity, that was particular to low rate deposits net of replicating portfolio and was an overtime sensitivity. So as you know, we need to replicate and we will – the yield on the replication will change on a tractor over that 5-year period. So we haven’t changed that sensitivity or provide any updated guidance on that. That sensitivity still holds over the longer term, and we will see in the tune with the time whether it’s borne out. You would expect, obviously, the rate of switching to change over that period, and so you’re going to see a different sensitivity early in the rate cycle versus the middle and the end of the rate cycle and over the next couple of years. So we keep an eye on that. We haven’t updated that outlook. I think that the sensitivity, I would say, still holds over the longer term.

On the replicating portfolio and on the duration of equity, we provided our usual disclosures and updated them around the average tractor rates there. And so obviously, you’re seeing that in the margins in the first half, and you’ll continue to see that come through in the second half margin considerations that we’re putting on new replicate in tractors at the 5-year marginal swap rate, the new equity tractors at the marginal 3-year swap rate, and they are higher than the average tractor rate that you’ve seen. So you’ll see continued support for margins through the operation of those hedge balances, so you’ll see that. That will be a continuing theme for the year ahead.

[Melanie Kirk, Head, Investor Relations]

Thank you, Richard. The next question comes from Brian.

[Brian Johnson, Jefferies]

Good morning, everyone. And it’s nice to hear a bank talk about balance sheet strength. That said, if we have a look at Page 87 of the profit release, and I was calling this out, I think, at the last result as well, is when you have a look at your central scenario, we’ve got the cash rate kind of finishing the year at 3.6%, house prices falling further 10%. Given that we started this cycle with a cash rate at 75, it’s already 3.35. That terminal rate looks very low relative to what the market is saying and the house price decline. Can we just get a feeling on the veracity of that central case provisioning? So it’s Page 87 of the result.

[Alan Docherty, Chief Financial Officer]

Yes. Thanks, Brian. That terminal rate was effectively the consensus rate when we struck the result during the early days in January. So that was, obviously, the consensus. Terminal rates moved significantly since then given the hawkish comments coming out of the RBA’s recent meeting. And so that terminal rate has moved a little higher in terms of the overall impact, though, on the Central ECL. As you know, the Central ECL, we’ve got a relatively moderate weighting on that Central ECL. We’ve got a very high weighting on the downside scenario, which is a much higher terminal rate than current expectations. We moved some other assumptions around on that Central ECL, including further house price reductions relative to the reductions that we’ve already seen at the December spot, and the unemployment rate has also changed since the previous central sales. So, there is a few moving parts in there. Changing that terminal rate to current consensus terminal rate wouldn’t have a material impact on the $3.5 billion ECL that we calculate, particularly as the – we’ve got such strong collateral coverage on many parts of the portfolio, both consumer and corporate. That terminal rate assumption is a little dated given the events of the last couple of weeks.

[Brian Johnson, Jefferies]

Okay. Just a second one, if I may, for Matt. Matt, you’ve been asked a lot about housing. I wouldn’t make the observation that given ANZ at this close, they have got $1.3 billion of capitalized upfront commissions. Perhaps those numbers, the $1 billion, that looks a little bit light. But that said, when we have a look at CommBank’s household deposit market share, and I just want to read through sequential month, so in August 22, it declined 12%. The next month, it declined 9%. The next month, it declined the next month, it declined 9%. And in December, it declined another 11%. When we have a look at the market at the moment, you can see that CommBank used to have outsized profitability on housing lending, clearly, the incremental loans at the moment are being written. You’re saying below the cost of capital, which is really a function of the fact that you’re stepping back into the market set. But if we have a look at this household deposit market share that you’ve lost, when do you have to come in and really step into the market to basically defend the franchise and the household deposit share?

[Matt Comyn, Chief Executive Officer]

Yes. No. Thanks, BJ. I think the $1.3 billion that you’re referring to in ANZ, I haven’t looked at the number myself, but I guess that probably includes both sort of capitalized broker commissions as well as capitalized expenditure around cash backs. We’ve certainly tried to total the cash back across the industry and looked at their NIM headwind for us and also for peers. But – and then on household deposits, yes, you’re right. I’d say we looked at that period. We’ve been very focused on then trying to stabilize share in the last couple of months. As we’ve looked at some of the underlying reasons, and I touched on it earlier in terms of we got some of the benefits in COVID in terms of government expenditure in the way that sort of unevenly felt across our customer base and the scale, there is a few of those elements that are unwinding, which are providing a headwind. We’ve certainly, for a variety of reasons, including wanting to make sure that we’re supporting our customers, we’ve stepped more into some of the sharper deposit pricing across a range of products more recently.

And so again, as I sort of touched on earlier, it’s very much for us about both sides of the balance sheet. We feel that we’ve got fairly unique competitive strengths on the deposit gathering side and combination of technology and digital offering. But as you know well, there are some very competitive offerings in market. And so perhaps the competitive intensity sort of changes to that side of the balance sheet, it’s been obviously a number of things have changed in the last 6 months, and it’s not uncommon across many industries for perhaps to be sort of different lags and changes in terms of relative competitive intensity in different parts of the market. And so it remains to be seen. But when your broader assumption is quite right in terms of the way we’re looking at it and the relative importance for us.

[Melanie Kirk, Head, Investor Relations]

Great. Thank you, BJ. The next question comes from Brendan.

[Brendan Sproules, Citigroup]

Hi. It’s Brendan Sproules from Citi. Just got a couple of questions on particularly in the in slide around the lending margin but outside housing. So my first question is on the institutional and banking institutional division, where you had falling assets and quite sharp falling NIMs. I was wondering if you could make some comments as to some of the business drivers there. And then my second question is in the Retail division, where you saw your consumer finance NII for something like 15% on flat balances. And maybe you could describe some of the NIM pressures that you’re seeing there.

[Alan Docherty, Chief Financial Officer]

Yes. So yes, in the institutional bank, we’ve seen a decline in margins through the sequential period. Some of that relates to classification differences between net interest income and other banking income. So you’ll see a little bit of a pickup in other banking income driven by the operation of our fixed income and commodities portfolio. So it was a sort of a tougher period for them in net interest income, but we picked up a little more in other banking income. And it’s really just the higher funding costs manifesting through that commodities portfolio. That’s the real driver of the IB&M and the interest margin headwind in this period. On the retail portfolio, on consumer finance in particular, credit card rates don’t change through the cash rate cycle as much as many other products. And so you’re seeing the effect of effectively stable yields on credit cards and personal lending products in a period. Where the cash rate is increasing, obviously, the funding costs are increasing. So there is a little bit of that pressure manifesting through that asset pricing part of the waterfall on consumer finance. Revolve rates also reduced again in the period. So there is a contributing effect from lower revolve rates in the consumer finance portfolio in that 6-month period as well, Brendan.

[Matt Comyn, Chief Executive Officer]

Yes. I mean, revolves as an example, that would be down Brendan, 20 percentage points over the last several years, which is, of course, a bit of a function of the broader economic backdrop as a percentage of people with interest-bearing balances. But it’s the contribution of both that and predominantly, not a pass-through from the changes in the cash rate.

[Melanie Kirk, Head, Investor Relations]

Great. Thank you, Brendan. The next question comes from Andrew Triggs.

[Andrew Triggs, JPMorgan]

Thanks. Good morning, Melanie. First question, please, just around the deposit book. Obviously, reprices reasonably slowly in term deposits in terms of the averaging onto the net interest margin, but quickly in savings deposits, and that does make it somewhat difficult to model. How long do you think it will take, this increased deposit beta that we’re seeing generally to play through the margin? Is it a few quarters that it takes to largely wash its way through? Or is it more protracted than that you think.

[Alan Docherty, Chief Financial Officer]

I mean you’ve already seen a lot of change in the pricing, particularly accelerated, I think, in the – increasingly over the last 6-month period ended in the December quarter and you’re continuing to see, I think, strong competition for both transaction cost savings and term deposit pricing. So we started to see that feed through. That will continue for the next few quarters. I mean we obviously provide disclosures at the – at that level in the average balance sheet as well. So you can start to see how those yield moves are feeding through. We try to give you a view of deposits, domestic retail and business deposits on Slide 63 that’s been referenced earlier. So look, that will – yes, that will continue to flow through, I think over the next few quarters in particular. You’ve seen a lot of it in the margins in the half to date.

[Andrew Triggs, JPMorgan]

Thanks, Alan. Just second question, sorry to harp on about your mortgage growth, but one change that CBA has made recently is improved price transparency in your mortgage offerings, and it does show that CBA pricing for low-risk home loans is only single-digit basis points above the likes of the Macquarie, best offer in the market. I’m just sort of interested in: A, why the move to the better price transparency; and B, what does that say about the, I guess, the commodity-like nature of the product, given – considering the strength of CBA’s brand name, technology, distribution network, etcetera?

[Matt Comyn, Chief Executive Officer]

Yes. No, both important points. I mean, I guess, strategically, of course, it still remains we’re very focused on primary relationship with customers that obviously helps on the – I mean, I think it’s pretty protracted on the liability side, but ultimately, hugely focused on having that main bank relationship in both retail and business, which has helped us in liabilities. We think it gives us an advantage trying to secure the strongest share of proprietary and direct relationships. I think the more recent sort of change, it’s really a function of, I think particularly as we’ve seen a more elevated level of discounting across the market and then some of the pricing constructs, which there is a smaller proportion but still a reasonable portion of loans priced off the SVR, we are just getting feedback from customers. It’s a little harder to tell exactly what sort of end price we were going to get. And so that’s predominantly some of that change. And then look, our pricing across tiers really differs. And depending on the sort of customer base, and of course, there is both existing relationships, which is our core focus, a broader view on customer lifetime value. Alan touched on some of the considerations from our capital on Basel III. We will price more sharply, but certainly not leading and always lagging. And the competitor that you touched on is a very significant originator of mortgages in the market at the moment.

[Melanie Kirk, Head, Investor Relations]

Great. Thank you, Andrew. The next question comes from Victor.

[Victor German, Macquarie]

Thank you. Victor German from Macquarie. I was hoping to actually follow-up on this mortgage discussion as well. Obviously, a lot of questions on that already. But if we look at the number that you disclosed with respect to margin compression, this half, 5 basis points, relating to competition. A little bit elevated relative to history, but it’s not a particularly large number, particularly in the context of the front and back book spreads that we are seeing and a lot of customers moving from fixed into variable. I would be interested in your thought as to where that goes from here, whether you think that number gets bigger as more customers getting better rates. And if you can you give us maybe a sense of what proportion of customers in the half have already been re-priced to newer rates, that would be helpful as well? And then I have a follow-up question on expenses as well. Thank you.

[Alan Docherty, Chief Financial Officer]

I mean look, one of the – obviously, the key dynamics as we look over the next 6 months to 12 months, Victor, as you know, is the amount of refinancing that’s going to come through on our fixed rate mortgage customers. So, we have disclosures of – I think we have got about $96 billion of fixed rate customers that will be rolling over the course of the next 12 months. I mean you have seen obviously a large number across the industry. And so that level of discounting that you have seen in the six-month period, we are likely to see an increased run rate on that from the natural churn of that portfolio, and it’s obviously a very price-sensitive as you can understand, the price-sensitive borrower at the moment given the large increase in rates. So, that’s the key, I think dynamic as we look 6 months to 12 months out in terms of the level of discounting that we have seen in the six months and then how you project that forward over the course of the next 12 months. So, that’s obviously going to be a factor in second half margin.

[Matt Comyn, Chief Executive Officer]

Yes. Maybe, Victor, the – we would say that we think that gap is going to narrow. And maybe another way to think about just in terms of another external source, I can’t remember the page number, but in the statement of monetary policy, the RBA put out last Friday. There is a comment in there about the weighted average standard variable across the market. I think they put it at 35 basis points less than the cash rate increases. That gives you a sense of sort of what the portfolio level is. We think it might be higher than that for – depending on peers across the market. But it sort of gives you a sense that this is going to normalize the front book, back book, obviously, depending on how the dynamic plays out in the market more broadly.

[Victor German, Macquarie]

But in terms of sort of churn, do you think that that’s already kind of happening, or is that more of a second half or first half ‘24 story?

[Alan Docherty, Chief Financial Officer]

No, I mean certainly – I mean that’s been a constant theme, I think of the mortgage market for the last few years, where there has been, I think a lot of pro-activity in terms of more competitive pricing within the back book given a lot of focus around market share across the industry. So, that’s been an ongoing thematic. It was certainly – there was certainly additional churn in the back book through that six-month period. And I think given the refi market and the higher level of absolute rates in the economy, it will continue to be a feature in the period ahead.

[Matt Comyn, Chief Executive Officer]

Yes. I mean I think just given – clearly, there is a lot of interest in that area. Maybe just a very quick comment. In terms of backdrop in context, we have all seen very substantial share shift over the last few years. And clearly, there is a reaction in response to that. We have got falling level of system volume growth that’s available in market. Against that backdrop, net interest margins have been expanding at an industry level. And then in periods – other periods where we have seen pretty rapid changes in funding costs, depends a little bit on transfer pricing mechanisms and how that’s being sort of transmitted through. So, we think there are sort of explanations for what’s potentially been occurring in the last six months. And then of course, we just have – we need to make the right decisions every day in terms of how do we best support customers and also choose to compete.

[Victor German, Macquarie]

Thank you. On expenses, I think in the past, you often chose to invest in the franchise when revenue conditions were supportive. If we are looking at more tough outlook for margins from here and volumes are slowing as well, how are you thinking about managing expenses in this environment? Is there a time when you want to increase the productivity initiatives, or do you feel like there is still a lot of investment that you want to make to continue your leadership position that you talked about throughout the results?

[Alan Docherty, Chief Financial Officer]

Yes. I mean we have had a very consistent approach, I think around business simplification, productivity initiatives. We need – we will continue that regardless of the macro backdrop. We obviously need to be very conscious around what’s the pre-provision profit outlook given tight financial conditions and a slowing top line, which is likely in the – given the conditions that we are looking at in the period ahead. So, I am not sure it’s a very different approach to the one we have had in past periods. You have seen in past periods has managed our cost base relative to the level of revenue performance, ongoing approach to delivering productivity improvements. And one of the things that’s changed in the last couple of years is we are able to allocate more of our investment allocation towards productivity and growth initiatives. That’s been a gradual change in the share of that envelope, which is gradual and appropriate. And so we will continue to invest, I think in both strategic growth and productivity initiatives for the foreseeable future. So, not a very different approach on cost to the one that we have talked about through the historic lows in rates in a pretty anemic top line environment over much of the past 4 years or 5 years.

[Melanie Kirk, Head, Investor Relations]

Great. Thank you, Victor. The next question comes from Ed Henning.

[Ed Henning, CLSA]

Hi. It’s Ed Henning from CLSA. Thank you for taking my questions. Can you just touch on the 3 basis points of higher liquids costs in the margin? Was that from increasing the term or carrying excess liquids? And do you anticipate the liquids creating a further headwind, or was unwind, and if so, when? That’s the first question.

[Alan Docherty, Chief Financial Officer]

Yes. So, most of the 3 basis points was actually an increase in some repo balances that we hold in the Institutional Banking & Markets division. So, there was about 1 basis point of the 3 basis points related to liquids that we hold at the HQLA, that’s the numerator for the liquidity coverage ratio. So, they are both in the category of non-lending interest-earning assets. They both increased over that period. As I look ahead, I mean the repo balances will move around depending on the spreads available in that market. So, that can change over time. In terms of the broad trajectory on liquidity, that’s really going to be a function of money supply growth and then our share of deposit growth. I think with – across all of our franchises, we have been doing a good job over many years of continuing to grow MFI share, continued to grow transaction accounts. You have seen that through the overall growth in customer deposit balances and those deposit balances will attract and need to hold more liquid assets. So, in an environment where if you assume that money supply is going to continue to grow, albeit at a slower rate in Australia, which would be our forecast, then you should assume that deposits will grow commensurately, and liquidity will grow commensurately. And that will be a headwind, if you like, in terms of the nominal net interest margin, albeit, as you know, it doesn’t have much of an earnings impact in net interest income.

[Ed Henning, CLSA]

No, that’s great. Thanks. And historically, you have called out about a 12 basis point headwind when the shift from variable to fixed rate loans. Now, the front book is lower than the back book, and there is lots of competition there. Is there still a tailwind when loans are starting to shift back the variable or not nearly as much as 12 basis points?

[Alan Docherty, Chief Financial Officer]

Yes. It’s not going to be nearly as much as the 12 basis points. So, there was a 1 basis point benefit in the half from the switching from fixed to variable. But as we have talked about given the level of front book margins on the floating rate product, it’s going to be less of a tailwind as we look ahead as things stand.

[Melanie Kirk, Head, Investor Relations]

Thank you, Ed. The next question comes from Matt Dunger.

[Matt Dunger, Bank of America]

Yes. Thank you, gentlemen. If I could ask on the average funding size of new mortgages up strongly, about 7.5% half-on-half, are you able to comment where this is coming from? And what impact LVR limits you have called out on Page 82 might have? And to what extent that this is feeding home loan offsets as well?

[Alan Docherty, Chief Financial Officer]

Sorry. What specifically on 82?

[Matt Dunger, Bank of America]

Slide 82, I was just referencing the LVR limit, what impacts they would have on the strong growth that you have seen in new mortgages funding?

[Alan Docherty, Chief Financial Officer]

This is the tightening of every elements for high-value properties. I mean really, we would see that as just – I have mentioned in the presentation that given the tighter conditions as we look ahead, we are continually recalibrating all of our balance sheet settings. One of the things we are doing on credit risk settings in both the consumer portfolio, home lending, also in our business credit settings, looking at areas where we think there would be increased risk, increased credit risk. And so we adopted some tightening around LVR on very high-value properties, given their exposure, obviously, relatively to falling house prices and falling collateral values against high-value lending. So, that I wouldn’t – that’s not a material part of the flow, however, in volume terms, so that – I wouldn’t expect that to be showing up in terms of overall volume performance in the – given the majority of the book in those very high-value properties.

[Matt Comyn, Chief Executive Officer]

Yes. I think that’s exactly right. It had a very minimal impact. I mean LVR lending or higher LVR learnings come down, same price cycles at the very large loans. There can be some lumpy losses, and hence why we have tightened there. We are trying to obviously be very thoughtful about where we are competing. I think the other probably big changes, higher DTI lending has come down very substantially, which is both from a setting perspective, but also it’s a function of as the buffers are being applied to a much higher cash rate environment. We set that out in one of the slides. It’s a commensurate reduction in borrowing capacities as well. But all things being equal, that’s not a bad thing either.

[Matt Dunger, Bank of America]

Thank you. And if I could just follow-up on capital allocation, how you are thinking about that, given your comments around mortgage returns around APRA’s changes to lowering commercial property risk weightings, how are you thinking about deploying capital versus maximizing the dividend payout ratio?

[Alan Docherty, Chief Financial Officer]

Yes. I mean so we obviously look at risk-adjusted returns across all of our product types. The capital is obviously a big impact on that. On particular changes around risk weighted, I mean in some ways, the way to think about the capital changes are more, I think the – if the changes play to our franchise strengths in the sense that we have got – we have had a very well-collateralized commercial property portfolio. Under the old drills, it was adopted a supervisory slotting approach, where you had to take a very punitive risk weighting on those exposures. We can now bring the full collateral to bear in assessing the capital that we hold against those exposures. We were always happy with our risk appetite in settings in that sector. I am not sure that the – I mean the change in the prudential capital requirements doesn’t change our overall view of risk appetite and where we are willing to grow. So, that individually won’t change our view on that sector and our appetite for growth in that sector. I think what you are really seeing is that the true economic risks related to that portfolio are more – there is more discrimination and more granularity in that assessment as we work out the capital ratio. So, that doesn’t necessarily change our view on that sector. On home loans, we have always had a very strong focus on proprietary business, or owner-occupied home loan mix is very high. Again, the greater risk discrimination and new prudential requirements, I think reflect the economic benefit that was already there in terms of lower losses on that portfolio relative to other forms of home lending. So, again, the greater risk discrimination, I think this gives a better reflection of the underlying economic risks that we have been writing.

[Matt Comyn, Chief Executive Officer]

Yes. And granularity really helps with sharper capital allocation. As we have touched on today, we will manage for the long-term, are very focused on resilience overall at investing in our franchise, in our strengths. Obviously, we are fortunate, we have got a business mix that is able to generate organic capital and no change to things like our capital allocation and dividend payout ratios, etcetera.

[Melanie Kirk, Head, Investor Relations]

Great. Thank you, Matt. We will have to take our final question from Carlos.

[Carlos Cacho, Jarden]

Thanks Melanie. I am Carlos Cacho from Jarden. First up, a question on borrowing capacity shown on that Slide 80, you have chart on the top left shows what looks to be maybe a 30% fall in capacity. Given you have previously disclosed those charts showing that kind of 8% to 10% of borrowers borrow the maximum, presumably, that a lot of those borrowers are not going to be able to refinance or qualify for their current loan. But is there any indication of how – what share of recent borrowers are going to struggle to refinance, leave to a competitor or even extend their loan term with you based on those falls in capacity?

[Matt Comyn, Chief Executive Officer]

Yes. So, maybe firstly, the borrowing capacity, I think it’s not quite there, maybe it’s like 27%, 26% or 27%. And obviously, there are some differences in terms of scenarios. I mean we have – as you would expect, as those buffers are applied, that’s a – it’s a tighter serviceability test. Let’s say it’s a very small impact to-date. I think the other part is we have looked forward as well. I have tried to estimate what proportion of customers against a much higher rate environment. And of course, then – which we think is a very small number, you are relying on a number of different assumptions there as well in terms of, obviously, the year of origination matters, both in the context of how their income may or may not have changed. But if you assume it sort of basically inflated over that period by sort of CPI, sometimes borrowers only provide enough income to actually meet serviceability. I think many borrowers do that. Then you have got to look at sort of expenditure and then what might a reasonable level of expense reduction be. And of course, that depends on your starting position. So, you start basically, and it’s probably not a particularly helpful answer, but you start in sort of lower-single digits and get much lower depending on what sort of assumptions that you push out. And of course, it’s again, circular with where does the terminal cash rate end up.

[Carlos Cacho, Jarden]

So, that would probably be less than that 10% or close to the maximum?

[Matt Comyn, Chief Executive Officer]

Yes, our estimate would be lower than that, yes.

[Carlos Cacho, Jarden]

And then just a second question around the kind of quality of the mortgage book. You noted on slide – or showed on Slide 78 a modest rise in 30-day arrears and how long. You noted you are seeing a bit of an increase in one day arrears, albeit at a low level. Are you seeing any common trends across those customers that have fallen behind repayments in terms of geography reasons for job loss or purchasing at a certain time? Is there any customer characteristics that you are particularly watching as a warning sign now?

[Alan Docherty, Chief Financial Officer]

Yes. I mean we are watching across a number of characteristics. I would say though that the increase in the very early stage arrears that we have seen was more a function. The thematic across most of that was actually operational changes in terms of making sure that you have got enough money in your account as your scheduled repayments increasing. And because we have gone through this very unusual period where there has been – well, there had to be lots of changes to scheduled repayments, you find there is a minority of customers who just need to get the right money in the right account so that they make the right payment. It turns up in something called partial arrears, which means they pay – they might pay the old minimum and they haven’t yet paid the new minimum. And so those – that’s the vast majority of the early stage arrears, and you see a very high cure rate. So, those arrears don’t turn up in the 30-day plus because the customer makes the full repayment after it goes one day in arrears, and so they get back to performing very quickly. So, that’s been – it’s more been an operational change for people to get used to a higher scheduled minimum. That’s been the – that’s the driver of what we have seen in very early-stage arrears. And obviously, we are keeping a close eye on that because we do expect cohort of customers as in some of the cohorts you mentioned to come under more stress as we go into calendar 2023. So, we are keeping a very close eye on it. We haven’t yet seen that manifest in the early stage arrears as yet.

[Melanie Kirk, Head, Investor Relations]

Great. Thank you, Carlos. That brings us to time. Thank you very much for joining us for the briefing. And please let us know if you have any follow-up questions, and we will come back to you. Thank you for joining us.