Westpac Banking Corporation
Q4 2016 Earnings Call Transcript

Published: 8 Nov 2016

[Andrew Bowden:]

Well good morning everyone and welcome to Westpac's full year 2016 result. My name's Andrew Bowden and I'm Head of Investor Relations. I'd like to acknowledge the traditional owners of the land on which we meet today, the Gadigal people of the Eora Nation and pay my respects to elders both past and present. Thanks everyone for coming today, welcome to those on the phone as well as those on the webcast. Presenting today we'll have the normal format with Brian Hartzer, our CEO, and Peter King, our CFO. So without further ado, let me kick it off and welcome Brian to the lectern. Thanks.

[Brian Hartzer:]

Thanks Andrew. Applause? That's recent. It's not bad when you applause from your auditor, just in case you're wondering guys. Well thank you for coming. It's been a big year for the industry and for Westpac. We've absorbed a significant increase in capital, interest rates have fallen and are some of the lowest on record. Global financial markets have been challenging. We face a number of regulatory and political headwinds and competition has been intense. Given that backdrop, I'm pleased we've delivered consistent operating performance while strengthening both our balance sheet and our customer franchise. There are a couple of things I'd like to highlight. The overall cash earnings are flat over the year and were pretty evenly split between the halves. Our consumer and business banking divisions continue to perform well and drive our earnings. WIB and our wealth businesses have maintained leadership in their respective markets but have faced more challenging conditions. That's reflected in their weaker results, which affected the Group results as well. Given the external environment, our priority this year was on building strength and managing the business in a disciplined way. At the start of the year, we took the decision to raise capital and adjust mortgage rates. We wound back on growth where the returns or risks were unacceptable. We've managed expenses tightly. We've stayed conservative on provisioning and we've set ourselves up well for the new liquidity rules. We've also made substantial progress over the last six months on digital transformation. There's more to do, so we'll continue to invest in this area, but we have the flexibility to adjust the pace of our investment as the environment changes. The final point I'd make is that our primary goal is to grow the long-term value of the franchise, while delivering acceptable results along the way. So it's nice to be recognized as the world's most sustainable bank for the third year in a row. The franchise is clearly stronger, thanks to the progress we've made on customer numbers, deposits and service quality, so the strategy is working. Let's turn now to the headline financial results. We delivered cash earnings of AUD7.8 billion and cash earnings per share of AUD2.355. The CET1 ratio of 9.5% is well above our preferred range, and that puts us in good shape to respond to any adjustments to capital requirements next year. However, with shareholders' equity rising by over AUD6 billion, that was an impact on our ROE which declined to 14%. Excluding the more volatile treasury and markets areas, margins were up three basis points over the year. However, the second half was tougher, with the margin declining three basis points as interest rates fell and funding costs rose. Managing costs is critical in this environment and we've done this well. Cost to income ratio finished the year at 42%. On provisions, we said at the last result that we expected our charge in the second half to be lower and that's what happened. Overall, asset quality has continued to perform well. We've done further deep dives in the areas we called out in the last half and this hasn't revealed any major issues. So we continue to be comfortable with the quality of our book and our provisioning. On dividends, we kept the final dividend flat at AUD0.94 per share. So those are the results, which reflect a number of conscious decisions we made during the year. Let me turn now to how we thought about making those decisions. We've spoken in the past about striking the right balance between strength, return, productivity and growth. Our priority this year was unashamedly on strength, particularly as we responded to new regulations. We did a lot of work on the balance sheet this year and we're pleased with how it ended up. You can see this on the top left of this chart where we've comfortably come in ahead of our target on capital, we've exceeded the new liquidity requirements and we've strengthened our deposit base. We've remained conservative in provisioning and our high coverage ratio on impaired assets speaks for itself. Switching to the return quadrant, one of the consequences of the focus on strength has been a lower ROE. We've grown where it made sense and wound back where we couldn't see reasonable long term returns. We started the year by re-pricing mortgages for the change in risk weighted assets and through the year we've worked hard to manage margins. This has also been true in WIB, where we've increased margins over the half, improved productivity and increased ROE and there wouldn't be many institutional banks in the world that can boast a 12% ROE. In the growth quadrant, we've targeted areas where we see value such as mortgages, deposits and SME. We would have liked to see higher wealth and insurance sales. The constant regulatory activity has impacted performance, as it did last year. It's beginning to turn around, but it's fair to say it's a bit slower than we'd like. On productivity, we've had to absorb a considerable increase in regulatory and compliance costs. Nevertheless, I know that there's some of you who'd like to see expense growth lower, so let me talk about that. Our cost to income ratio is already very low by world standards, but we're not easing up and we continue to target our cost to income ratio below 40%. At our strategy update last year we targeted 270 million in productivity savings per annum and we've delivered 263 million this year. Obviously evolved our revenue growth environment, makes driving the ratio down a bit more challenging, so we have to do this sensibly. The next step from a productivity point of view is going to come from helping customers to shift to digital channels, automating and streamlining our processes, taking paper and manual handling out of the system, simplifying our offerings, which reduces cost and risk and moving from two operating systems to one. All of this will give us a more sustainable and profitable business model. To give you a sense of the progress here, we've now passed over one billion logins on our digital channels and in the second half, 22% of our sales were done online. Over the last 12 months we've digitized seven out of the top 10 manual activities in our branches in our call centers. This includes things like activating a new credit card online, blocking and unblocking a card or disputing a transaction. For our business bankers, we rolled out a new system that allows them to complete annual reviews in minutes, rather than what used to take days. All this has taken costs out of our branches and our call centers and freed up more time for our bankers to spend with customers. Another big driver of cost is product complexity. So this year I've asked each of our businesses to review their product set with a view to dramatically reducing complexity over the next few periods. Implementation is now underway which will further reduce costs and risk. The other big driver of our cost is our technology platform and there have been some important milestones this year. We rolled out a new online banking platform for business in St George, Bank SA and Bank of Melbourne. This has already delivered a significant lift in digital usage and an increase in customer NPS. In August, we migrated St George's old Hogan system onto the new version, which is called Celeriti. This will ultimately be the single transaction and deposit back end system for our retail bank, so this is a big milestone. The customer service hub moved from concept to development this year. We've now proven that this system works and will deliver the functionality that we require. Panorama is now live with funds on the platform growing strongly. So while we could have cut investment spending this year and reported lower cost growth, we think the right thing for shareholders in the long run was to maintain it. The new platforms we're building will deliver world-class service for our customers, they'll make our bankers more productive, they'll reduce our risks and they'll lower our costs and that will help sustain returns over time. Let's turn now to the performance of our operating divisions. If we look at the combination of our consumer bank, business bank and New Zealand businesses, they generate about three-quarters of the Group's earnings. They've all performed well; together they generated 6% growth in cash earnings and that's off the back of 8% last year. In New Zealand, customer numbers were up 1% and we grew loans and deposits by 9% and 11% respectively. That's a pretty good result given all the regulatory changes that we've had in that market this year. The other big focus of the New Zealand team has been on a transformation program that we call Fit. This will deliver significant productivity over the next few years. Back in Australia, you'll recall that this was the first full year of the new business structure where we had dedicated business bank and consumer banking divisions covering all of our brands and this has worked really well. In the business bank, we grew deposits by 9% this year and we're now close to having the largest number of business customers nationally. We've continued to roll out our LOLA platform, as well as the video-based Connect model across all our brands. On the lending side, we've had a targeted approach to lending growth, which was 5% overall. Within that, we had 8% growth in SME business lending and 3% growth in property, which was a conscious decision. The consumer bank performance was a standout this year with 14% growth in cash earnings and 13% in core earnings. We've seen this business consistently outperform, delivering growth in share, well managed margins and consistent revenue in earnings growth. Our portfolio brands continue to give us an edge in the competitive market and each brand grew its franchise this year. At the same time, we've materially improved efficiency, closing over 100 branches and in-stores over the last 12 months and taking almost two percentage points off the cost to income ratio in that business. Now let's talk about BT and WIB. BT has had a challenging year with lots of moving parts in the result. If we adjust for the partial sale of BTIM, cash earnings were down 2% in the year. Most of this decline was due to FX movements in Ascalon and higher regulatory costs. The other negative was in the advice business, where ongoing regulatory uncertainty has had an ongoing impact on sales. Despite this, BT still managed to grow funds under management by 5%, funds under administration by 7% and insurance premiums by 9%. BT Private Wealth continues to be the premium private bank in the market and its results were another highlight. Overall, we remain positive on the outlook for this business, especially as demand for investments and insurance grows and as our Panorama platform increasingly gives us a competitive advantage in this market. Institutional banking continues to face challenges and the large fall in WIB earnings was a major drag on the Group result this year. Having said that, the team has done a good job in a tough environment. The main fall was in non-interest income and the move in provisions from a net benefit last year to a net charge this year, largely as a result of some large single names in the first half. The focus on WIB is to manage through the cycle and there are a few things I'd highlight in the result. First, we've taken substantial action on cost. Second, we've managed margin and returns well, deliberately giving up revenue where the risk and return tradeoffs just didn't make sense. Third, we've stayed open for business, continuing to support customers and winning a substantial number of new transactional relationships this year. What we're finding is that customers want to partner with us because they know that we'll be supportive through the cycle. That's a good lead in to how we're thinking about managing ROE overall. This year we've looked hard at the ROE target from a number of perspectives. We believe that having an ROE target is important, both at a portfolio level to signal to our investors how we're running the company and internally, to make sure that our managers are developing strategies that can sustain good long term returns on capital. But as we look at the environment, we saw persistently low interest rates, tighter liquidity and funding rules, higher capital requirements and higher regulatory and compliance costs. So while we might aspire to a higher level of ROE over the longer term, the combination of these factors means that an ROE target of 13% to 14%, is more realistic for the medium term. That takes me to our dividend decision. We decided to leave our dividend unchanged this half at AUD0.94 which represents a payout ratio for the year of 80%. Now that payout ratio is a little higher than we would consider sustainable over the long term, but with our capital ratio comfortably above our target range and with a significant franking surplus, we felt comfortable to maintain our current dividend at that level this half. Now I know the current period dividends are an important part of people's consideration in how we create value for our shareholders, but I did want to highlight longer-term investment pictures as well. We've said that our goal is to create one of the world's great service companies. As well as being good for customers, it's the right strategy for our shareholders as well. The service strategy is about increasing customer numbers and having a service culture that rewards our people for building relationships that last the test of time. It's about growing the value of our brands and attracting customers whose sole motivation isn't price and using technology to give customers reasons to consolidate their business with us while lower cost and reducing risk. This simple model translates into values for shareholders through better margins and efficiency and lower risk and ultimately a better return over the cycle. It also means that we're running the Company in a way that's more sustainable in an environment where we are under intense scrutiny. Now before I hand to Peter to go through some more of the detail, let me wrap up with a few comments on the operating environment. At the half year I talked about how I was positive about the outlook for the Australian economy and six months on, the optimism hasn't changed. If you look at the macro indicators, unemployment is low, interest rates are low, commodity prices have actually increased and we're beginning to see a pickup in investment intentions. The transition to a more service based economy is clearly happening and the drag on GDP from the reduction in investment in the mining sector has largely rolled through, so that will begin to be a benefit for growth. The main threat we see is from global factors, which continue to create fragility in businesses and confidence. For banking, this means we'll probably see a slight moderation in credit and deposit growth through the year as housing activity eases and also through the impact of the system tightening on credit standards earlier in the year. We expect asset quality will remain sound overall, although we'll continue to see some isolated areas of stress particularly in areas where there are strong links to the resources industry. So the outlook really depends on consumers' confidence in their job prospects and businesses' willingness to invest. At the moment this is a bit of a catch 22. In simple terms businesses have capacity and willingness to invest but they're waiting to see if consumers will spend. On the other hand consumers are waiting to spend as they're not sure about the outlook for the economy. One catalyst for change would be for state and federal governments to increase their investments in road and transport infrastructure further. This is because our experience increasingly shows that where infrastructure projects are announced business investment, and particularly small business investment, follows. A longer term roadmap of committed infrastructure investment would give businesses in those areas the confidence to invest in their capacity which would help make projects more affordable. We think that with interest rates at historical lows it makes sense for governments to borrow to fund transport and other infrastructure projects that boost the long term productive capacity of the economy. Let me conclude with the observation that Westpac's strategy of having a strong and prudently managed balance sheet, strict performance disciplines and a strategy of embracing technology to deliver great service and deeper customer relationships remains the right strategy for the times. Given our position, our unique portfolio brands and our high quality management team, I remain positive about the outlook for Westpac and our ability to continue to deliver consistently good performance. Finally, can I just say that these results reflect an enormous amount of hard work by our 40,000 people this year. So to each of them I'd like to say thank you for keeping your eye on the ball, for improving service for our customers and continuing to deliver for our shareholders. With that I'll hand it over to Peter King to take you through the result in more detail. Thanks.

[Peter King:]

Thank you Brian. Good morning everyone. As I reflect on the year I think there's three main highlights. Firstly the strengthening of the balance sheet and particularly the way we've incorporated liquidity and capital changes in the pricing and decision making. The second is the disciplined way we've managed both growth margin and costs. Finally, asset quality, where the trends are sound and our conservatism on provisioning continued. Brian has covered the overall picture including the divisional performance so I'll mostly focus on the second half. Starting on the left with the second-half cash earnings waterfall like the full year this result was unchanged with the rise in interest income and lower impairments offset by decline in trading income and a higher tax rate. I'll cover the major line items in a minute but it's worth just touching on the 101 million increase in tax. The increase in the tax rate to over 30% mostly reflected no prior period tax benefits following the 57 million that we recorded in the first half. It is normal for us to have a tax rate higher than the corporate tax rate. That's because distributions on newer hybrids aren't deductible and the majority of our earnings are in Australia. The table on the right shows infrequent items. That gives a bit of a perspective on earnings quality. You can see that these items weren't a feature this half. One of the group priorities this year was actively managing the growth return trade-off. I'm pleased with the result. In WIB our approach to pricing has seen lower return segments decline, particularly in the Asian trade portfolio. We have also reduced risk-weighted assets by removing unused limits and restructuring the derivatives portfolios. That improved their capital efficiency. In business bank we continued to perform well. Small business lending grew about 5% over the half while commercial property growth was moderated. In customer deposits we grew 6% with the household deposits continuing to track above system. Overall this performance saw deposits fully fund loan growth this year. Bank margins are an area of focus. I'll spend a little bit of time on that story. In May we called out the headwinds in deposit spreads and wholesale funding. These were a little bit stronger than what we expected. That saw the margin in the half decline by 3 basis points to 2.11%. A driver was the increase in competition for the term deposits. Looking at the chart on the bottom left it shows that for most of 2015 these costs eased in part offsetting intense competition for assets. But this year following some very competitive deals and with banks preparing for the NSFR, TD costs have risen. For example, a 12 month term deposit is currently 2.5% which is well above the equivalent swap rate of 1.75%. This dynamic was the major driver of the 2 basis point decline in customer deposits. Interest rates also reduced impacting both deposit spreads and capital returns. At the bottom right we show our tractor which is linked to the 3 year swap rate. The tractor hedges around 80 billion of capital and lower rate deposits and so has a direct impact on margins. The impact of the lower market rate since the GFC has dragged that tractor down. On term wholesale funding costs there's been a few factors at play, new subordinated debt and hybrid issues are generally more expensive than maturities. And the structural changes to U.S. money markets saw the cost of that funding pool increase from about 5 basis points over Libor to 30 basis points currently. In addition we're reshaping the balance sheet for the new NSFR requirements. In particular we increased both the size and duration of term funding. Over the year we issued more 7 and 10 year tranches which helped push the duration of new term funding up to 5.4 years. In responding to these dynamics we did re-price mortgages and business lending. That saw the asset spread increase. But it wasn't enough to offset the cost of funds increases and lower interest rates. And turning now to non-interest income, the 3% decline this half is best explained by division. Starting with the consumer bank the 4% growth reflects higher credit card income following changes in credit card reward programs. In business bank the rise is mostly due to growth. BT had good FUM, FUA and insurance premium flows however these were offset by more life insurance payments. The institutional bank had a large decline in both fees and markets income. Lower fees accounted for about a quarter of the decline. That mostly reflected lower activity in the debt markets. The rest of the decline was due to markets income. To give this a little bit of a longer term context I've added a 3 year view there. It shows that while the second half contribution was lower over the year markets income was actually up. I would however highlight that the derivative adjustments had a big impact year-on-year and if you exclude these markets income is relatively flat. On the costs front, the year played out as we expected with 3% growth over the year and 1.4% growth over the half. Productivity accelerated to AUD147 million in the second half and this saw the annual benefit lift 10% to AUD263 million. These savings are evident across the business including restructuring our network, changes to operating models in WIB and the business bank as well as the benefit of digitalizing processes. For the group productivity saves largely offset operating cost increases and an increase in investment. So a big driver of the rising costs was the AUD41 million left in regulatory and compliance costs. I wanted to call these are specifically because the scope and timing of these are often driven by external factors. For example, following industry issues we've had significant increases in inbound requests. In many cases these are complex reviews, span multiple years, require a quick turnaround and independent verification. So we've therefore needed to supplement internal resourcing. Across divisions the consumer and business banks both held cost flat in the second half which was a very good outcome. BT managed its operating costs well but the higher regulatory costs drove expenses up in BT as they did in the group business units. As Brian indicated our decision to increase investment spend did impact cost so I'll just cover off on some of the financial outcomes. As you can see on the left the investment spending was up about 20% year-on-year. As projects moved into development in the second half that explained most of the pickup in the spend in the second half. In relation to the accounting changes we implemented last year the proportion expensed increased to 42% compared with 37% in 2015. On software amortization the charge was higher over the year at 565 million. We have maintained a lower average amortization period of 2.9 years which is around half the peer average of 6 years. Turning to asset quality and the portfolio is sound. At the half we indicated the best of the asset quality cycle was behind us. While several large exposures moved into impaired we didn't view this as systemic. That's how the half has played out. The left hand chart shows our stressed ratio rising over the year with the increase mostly related to New Zealand dairy and the second order impacts of the mining investment slowdown. The increase in consumer mostly relates to the reporting of mortgage hardships that I referred to at the half. As well as some deterioration in the mining states. When looking through the movements by industry in the chart on the right these factors explain the rises in agriculture, in mining, in trade and construction. The one exception is services which is a company specific issue. While stress in the commercial property portfolio is largely unchanged it's been the source of some questions so I'll just have a look at that portfolio. Commercial property is a segment that receives a lot of attention. We began tightening credit criteria in 2012 and again tightened about 18 months ago. That doesn't mean we stopped lending but we did reduce the risk here. Drilling into the residential development portfolio, we have just over 5 billion in this portfolio with 3.2 billion in areas potentially exposed to oversupply. Our exposures are normally to customers who we've known for some time and have a record of managing through cycles. The bottom left hand chart shows our risks decisions have affected the LVR with the LVR reducing over time. There has also been concern about settlement risk in this portfolio. Of course we're watching that closely. But our experience to date has been good. Settlements have been a bit slower than traditional benchmarks but it's largely been a timing issue. On the mortgage side the controls we've had in place for some time have served us well and the book continues to perform in line with expectations with low dynamic LVRs and low delinquency rates. Moving to the Australian mortgage portfolio delinquencies have tracked consistent with expectations. Mortgage hardships had a big impact here with the overall 21 basis points increase including 13 basis points for the hardship changes. The second major impact was deterioration in the mining regions and particularly WA which you can see on the chart and while these markets are showing more stress we don't believe it will be a major concern for us as we're underweight WA and it comprises about 10% of our mortgage portfolio. On personal lending the unsecured portfolio also performed well with the delinquencies declining in line with seasonal expectations and we're pleased with the management of the auto book. The operational issues we highlighted in the first half have now been resolved and you can see a significant reduction in delinquencies. In New Zealand dairy we started to increase provisions in 2014 and with the milk price moving lower this half we undertook another file by file review assessing over 700 individual exposures. This saw a number of facilities downgraded to the stress category and a 36 million in collected provisions. It really highlighted that New Zealand farmers had reduced costs for the changing conditions and with milk prices recovering recently the outlook for this sector has improved. This sound asset quality lead to an impairment charge of 14 basis points of loans and that's AUD210 million lower over the half. You can see on the left hand side that most of the decline was in the individually assessed provisions and outside the large names downgraded earlier in the year the trend in impaired assets has been positive. In fact, the IDP has a chart that shows new impaired assets were the lowest in 14 halves. Write backs and recoveries were little changed and so had no major impact here and write offs direct followed normal seasonal patterns with a bit of a rise in the half. So in aggregate the trends in asset quality and impairments have brought no surprises. I've been pleased with the capital generation over the half ending the period at 9.5% and comfortably above our preferred range. We absorbed 110 basis points in mortgage risk weighted asset changes although this was largely offset by our entitlement offer. A future of the result was the RWA efficiencies, mostly offset other RWA changes and some of the efficiencies included reducing undrawn and unutilized limits, particularly in the trade portfolio as well as the management of the derivatives portfolio I referred to before. The largest model change was the nine basis points for basis risk in our liquids portfolio and so we end the year at 14.4% on an internationally harmonised basis and that's in the top quartile of banks globally. Now to liquidity and funding and this is a new view that I find useful to explain how we're managing the balance sheet. Our balance sheet planning always start with the funding and this year we improved our funding mix with deposits fully funding loan growth whilst we also grew equity and long term wholesale funding. We held our short term funding largely unchanged but reduced the offshore component by 10%. We also worked hard on the composition of deposits and the 14% ratio at the bottom of the chart is a measure of deposit quality that we use internally. It shows how much deposits needs to be directed to liquid assets rather than funding loan growth. In the assets chart it shows we grew third party liquid assets in part due to lower CLF. This trend continues into 2017 with our CLF falling another AUD10 billion and this will see a mixed change in liquids with mortgages that support the CLF reducing and government securities increasing. So our estimated NSFR is 105% and new regulations see quality deposit growth as the key in determining the loan growth we can support. This slide outlines some of our key financial considerations for the year. We've already mentioned each of these through the presentation so I won't go over them again. As I look at the trends we expect 2017 to be similar to 2016 and as Brian said we'll continue to be disciplined in executing our strategy, we'll look to grow the franchise over time and we're driving the cost to income ratio below 40%. So with that I'll hand to Andrew and Brian and I will be happy to take your questions.

[Andrew Bowden:]

Thanks, Pete.

[Craig Williams:]

Thank you, it's Craig Williams from Citi here. A couple of questions please. Firstly around watch list exposures being up 20% this period, 90 day past due loans are 19% I think. So why did collective provision fall in the period while GRCL and expected loss both moved higher? Is this simply a timing issue with collectives to move higher next year and a second question around the institutional bank, it seems like it's working harder on capital efficiency but balance sheet is contracting, revenue is falling. So is cost growth a suitable outcome or is there a need for more focus on cost management as surely you can't expect write backs to be a continual support for returns in that business?

[Brian Hartzer:]

Do you want to do the first one and I'll take the second one?

[Peter King:]

So Craig, on watch list and substandard the two big drivers were the review of the New Zealand dairy portfolio which did move quite a bit into that watch list bucket. So still performing but watch list as well as mortgages and just one thing on my chart on impairments it doesn't pick up the interest carrying adjustment which goes through revenue. When you take account of that the collective provision is actually pretty flat, so it hasn't reduced in the half. So that's just one thing to bear in mind as you think about that. So overall I think it's those areas that we saw that are driving that list and we feel that provisioning is pretty good for that level.

[Brian Hartzer:]

And Craig, on the website we made a number of deliberate decisions to walk away from growth this year on some of the balancing side where we didn't think the returns made sense and the team managed that really carefully through the year. We did take a significant step on cost, there's probably a bit more to do on costs there, but I think we're being pretty sensible about making sure we stay open for business over the next period and there's also investments going on in technology and maintaining our position on the transactional side and the like. So we feel pretty good about how we're managing the balance set up.

[Andrew Bowden:]

Jarrod.

[Jarrod Martin:]

Jarrod Martin from Credit Suisse. Brian, can we have a chat about the new ROE target. Everyone I suppose understands the previous aspirational target of 15%, what surprises me about the new range of 13% to 14% is that you're currently at 14% so implicitly you're saying that you can't make things any better and this is about as good as it gets for Westpac in terms of returns. That surprises me in terms of that's a new target out there. Can you make some comment on that?

[Brian Hartzer:]

Yes, well Jarrod we're at the top end of that range this year. What we're trying to recognize is that the environment has gotten tougher, particularly on rates and the ongoing increase in regulatory costs and the like; we still have some uncertainty about capital coming out of Basel. We still have uncertainty about what APRA is going to do around unquestionably strong. So we felt that over the medium term it wasn't probably realistic to get back to a 15% level. That isn't to say that we aren't going to continue to manage capital very carefully and to continue to drive earnings growth. I mean, I think it's important to say we're saying this is probably a realistic range given all the things we're dealing with for the medium term but we're not saying that this is guidance about what we're going to come out with this next year.

[Andrew Bowden:]

John.

[John Mott:]

John Mott from UBS. You said at the start that you're focusing on mortgages deposits and SME which makes sense given they're the highest returning products out there but if you look around the market you've got your two Melbourne peers coming back to Australia and they're focusing on mortgages, deposits and SME and your big city peer down the road also focusing on mortgages, deposits and SME. Whenever you see 80% of the market focusing on a few products which are the highest returning's, doesn't this just mean that the margin and the ROE in these products are just going to keep going down as we've been seeing for the last five, 10 years and that NIM pressure and ROE are just going to be ongoing as everyone squeezes into the most profitable products?

[Brian Hartzer:]

Well, John I'd say on the one hand yes, it's certainly a competitive market and we expect that to continue. On the other hand it's not like those other banks went away. Yes, they've been spending a lot of time dealing with overseas issues that they've had but they've remained aggressive and fierce competitors in the domestic market over the last year. So I don't see anything fundamentally changing in that and I guess I would point back to the success that we've had in those businesses over the last year and the advantage we have with the different brands, the progress that we're making on technology, particularly in the business bank, the way we've been able to grow the number of customers to grow share there. So we still feel yes, it's competitive but we're optimistic about our position in those markets.

[Andrew Bowden:]

Victor.

[Victor German:]

Thanks, Andrew. Victor German from Macquarie. Since Andrew didn't given direction in terms of how many questions we can ask, I'll ask a couple.

[Andrew Bowden:]

That would be one.

[Victor German:]

After this one. First, just if I could clarify Jarrod's earlier comment? So in terms of guidance for ROE would it be fair to assume that your guidance of 13% to 14% is predicated on additional capital rather than your views that earnings are likely to go backwards?

[Peter King:]

I might just deal with a technical question there. We're not providing guidance, just so we're really clear. We've indicated we're.

[Victor German:]

Well, you sort of have, 13% to 40% in the medium term.

[Peter King:]

But it's not guidance. Just.

[Victor German:]

Okay. The second question I was hoping to ask was around costs. So cost growth this year was about 3%, you've delivered 263 million of cost benefits which is around 3%, so underlying costs grew by about 6%. There was about 130 million or so of additional costs associated with investment which is about 1.5%, so that takes us to abut underlying cost growth of 4.5% for the year. Just interested in your observation if that's sort of reasonable cost growth, if you think is reasonable in this environment to go into FY17 or how do you likely address additional investments and continue to address and to what extent are you sort of committed to that 2% to 3% guidance on costs given that in the past we have seen sort of you've started off with that guidance but then over the year things have changed? Are you a bit more committed, are you sort of more on top of the costs where we stand today?

[Peter King:]

I think what we've said is we're aiming to be at the bottom end of the range and I think we'll set the business up to do that but you can't predict the future perfectly and I think you can see from the way we're managing the business in a disciplined way we'll make the right choices. So 2% is what we're setting the company up for and all the loan execs are focused on that. In terms of the year on year movement you're right, the investment coming down will be one of the reasons that cost growth does come down. I think we're very clear that in an environment that's low growth we want to be disciplined on costs and that's how we've set the company up.

[Victor German:]

Will you say an increase in investment is about at the right level where we are now?

[Peter King:]

In terms of the cash spend it's about that level.

[Victor German:]

Right, so you're not forecasting additional?

[Peter King:]

No.

[Victor German:]

Thank you.

[Andrew Bowden:]

Brian?

[Brian Johnson:]

Brian Johnson, CLSA. One question, three subsets. The first one, you've got a chart in there which shows TD rates have escalated quite sharply. When I look at the chart the shape of it would indicate that they were increasing towards the end rather than over the period. Can we just confirm that that means right now the NIM is probably run-rate down on where it was over the period? The second one is, in the slides you show basically that the access to the committed liquidity facility goes down by AUD10 billion between '17 and '16, the actual LCR ratio you're running is about 135%. If you take that 10 billion out it's back to about 125%, is the target going forward 125% or 135%? Then the next one is on the ROE target, the ROE aspiration whatever you want to call it, you haven't called out today the fact that capital requirements could go up under Basel IV. Based on the warm day that you enjoyed in Canberra, Brian I'd just be interested, if we were to get a change in the capital, does this mean that ROE target could basically click down a little, or a lot?

[Peter King:]

So I think the first question was exit margin and Brian, you're right, the cost of funds did head up at the back end of the half and therefore the exit margin's slightly below our average for the half. On the CLF, it does go down 10 billion. Part of that will be absorbed by running a lower LCR ratio. So 135% has been built expecting that reduction in CLF, so we've done quite a bit of work this year. So we think 120% around there is probably a good target. And then on Basel, I think my feeling at the moment is it feels like it's less of an issue than it was six months ago, Basel and probably more interested in APRA on unquestionably strong at this point. So I think we'll hear by the end of the year from APRA on unquestionably strong and I still expect to see any rules next year with a transition period. So the key point there is there's time, there's time.

[Richard Wiles:]

Good morning, Richard Wiles, Morgan Stanley. If you've lowered the ROE target for the medium term, how come you haven't reviewed your target payout ratio? I would have thought the two go hand in hand.

[Peter King:]

I think when we thought about the dividend this period, we were staring into it with capital above the top end of the range a pretty healthy franking surplus and don't know where we're going on capital. And when we look at that, we thought actually we'll hold it flat, we'll use the DRP as we said we would to bring that effective payout ratio down into a range that's affordable and that's how we've thought about the dividend decision this time. When we roll into next year, I think we'll have clarity on regulation. We'll also, I think, have another look at growth return and we'll make another decision at that point on the dividend.

[Brett Le Mesurier:]

Brett Le Mesurier from Velocity Trade, a question on your deposit funding. You commented that all your assets, your loan assets, were funded by deposits, but within the consumer bank, only half of the consumer bank loan growth was funded by growth in consumer deposits, the other half appears to have been funded by growth in the institutional deposit base. Is it your expectation that that's the way you're going to be going forward or are you hoping that your consumer bank deposit growth is going to equal your loan growth? And I also notice the growth in your consumer deposits was all in TDs and there wasn't any growth in transaction deposits. So are you also expecting that with the investment you're making in your consumer bank, that you'll be able to grow transaction deposits?

[Peter King:]

So I think you're right in summarizing the balance sheet. The way we think about the balance sheet is we run a portfolio, so we get all the businesses together and think about the options, or the opportunities in every market and this time the institutional bank did a great job with particularly some of the government clients; we've got a pretty strong franchise there. So this period it worked out that way. In future periods, we'll see. As Brian said, we think mortgage growth will probably come off a little bit, we're targeting system or above in deposits in the consumer bank, so we'll continue to manage that balance sheet in a dynamic way, depending on what we see in each of the segments. Just finally, you're right on, most of the growth was in TDs, I think because people took advantage of the fact that TDs are now paying more than online savings accounts.

[Brian Hartzer:]

But a general point is right as well, which is that deposit growth is going to be a really important part of what we're doing and certainly the whole focus of the strategy around service has core transaction deposits as the fundamental basis of growing our business over time and that's why we were quite happy with the growth in customer numbers that we had.

[Andrew Triggs:]

It's Andrew Triggs from Deutsche, just a couple of questions please. Firstly on funding, quite a significant reshaping of the balance sheet during the period with the lower reduction or lower reliance on short term wholesale, particularly offshore, but also as a whole. Do you think the NSFR at 105 that further work needs to be done and also on the long term wholesale funding, whether the sort of the mix of the tenor that you raised this period is similar to what you would expect in future? Just a second question, just the size of the overall trade book at present and whether you think that needs to reduce further or if there are any other opportunities to reduce slow returning assets in the institutional franchise.

[Peter King:]

So NSFR, just one thing to highlight is the denominator and the numerator in the NSFR are five times the LCR, so you don't need to run as big a buffer in the NSFR. So 105 is a good position, it may need to be a little bit higher. We need to go through with APRA the final calibration, so things like we're unclear yet how to treat some of the superannuation funds that come into the Bank and that's one of the bits of feedback we gave APRA, that these deposits have real value for the economy, so they should be recognized in the NSFR. So there's a few things to settle down, but I feel really good where we've ended the year. We did a lot on capital, we did a lot on funding, we've got NSFR in good shape; we're well prepared for the CLF drop, so it was a big year. Just more generally on how we're managing assets rather than focusing on portfolios, we're really looking at each facility comes up, we're looking return, we're building in the new capital requirements, we're building in liquidity requirements, we're thinking about what might come out of Basel in setting up pricing. So it's a real, it's not portfolios, it's customer-by-customer work that each of the business units are going through, both in WIB and the business bank and in New Zealand.

[Andrew Bowden:]

Might take a call on the phones from Andrew Hill please.

[Andrew Hill:]

Hi, good morning guys. I just had a follow-up question on the TD cost chart you have in there on slide 18. I appreciate the exit margin was quite a lot higher through September, but in October it looks like you cut your three and six month TD rates by 20 to 25 basis points. I'm just wondering what sort of impact that had on the exit margin overall.

[Peter King:]

Andrew I think we're dynamic in pricing all our deposit products and you're right, we did reduce some of the term deposit rates. That's not factored into that chart, but certainly see the cost not rising as fast.

[Andrew Hill:]

But still rising.

[Peter King:]

Yes, we haven't got it down to that low point.

[Andrew Hill:]

Okay.

[David Walker:]

Thank you, David Walker from Clime Asset Management. Earlier you mentioned political risk, could we ask you to go into more detail about what you see those are and has your view on what those are changed since your Parliamentary testimony recently?

[Brian Hartzer:]

Well I think there have been a lot of areas that have been looked at across banking as a result of some consumer issues that have come up and some of the ongoing questions about the housing market and the like. We're seeing that come through in the form of lots more inquiries that we have to prepare for, lots more regulatory interventions that, as Peter was talking about, lead to us having to do a lot of research into the past. All those things add to cost and put pressure on regulators about various changes they might make. So we're not calling out anything particular there, just the fact that when you look in aggregate at the amount of money we're spending responding to these things, it's quite significant.

[Andrew Bowden:]

I'll take question from the phone, from Azib please.

[Azib Khan:]

Thanks, hi Brian. So you mentioned earlier that you won a substantial number of transactional customers in WIB this year. Your loan growth has contracted in that business, so are you deliberately staying away from any term loan piece that would be involved with these new relationships? Is your focus just on the transactional business and maybe even markets going forward? Also, what has enabled you to win such a substantial number of transactional customers?

[Brian Hartzer:]

Well, we've had a lead position in transaction banking way before, over a decade and that's the foundation of good long term relationships, being able to manage people's payments and their transactional flows. We have some fabulous technology capabilities and some great people in that part of the business and that's helped us continue to grow. We certainly are not stepping away from term lending to our core relationship clients. We continue to look to support customers across the board. The growth there, what it's really saying is we're having to make choices about where you have a large institutional lend that doesn't have a lot of deeper relationship associated with it, where there's not a big opportunity for providing transactional banking or the other sorts of markets, products that we can provide into there, then we're stepping back. If it's just a matter of renting our balance sheet, that's not what we're interested in. But for our good long term relationship clients, we're absolutely there to support them on the debt side as well.

[Andrew Bowden:]

I'll take a question from Andrew Lyons please, on the phone.

[Andrew Lyons:]

Good morning. Just slide 23 has some interesting disclosures around your resi development portfolio and the LVR at 54%, which I think should keep going down just given the pipeline. Just two questions, can you perhaps just talk about how that's trended over a longer period of time? Secondly, where is the additional equity coming from that's seen your LVR come down?

[Peter King:]

Yes Andrew, I haven't got the longer term chart, but I think the anchor point would be maximum LVR of 65% in that portfolio, is where we've been thinking, so brought it down quite a bit as we look forward on the developments. On MES debt and whatnot, I think it's just come out of different parts of the economy, so I wouldn't pick any particular part to call out today.

[Andrew Bowden:]

I'll take a call from Scott Manning as well, please.

[Scott Manning:]

Morning guys, just some comments please on the margin management in the consumer bank. The margin for the period down three basis points, do you think you could have done a better job at managing that in the face of the pricing that was being put in the market? Do you think you followed price a bit too much? Then comments on how you're managing that book going forward, given the pass through of the August rate cut and also the recent withdrawals from discounts on the front book.

[Peter King:]

I'll say this as CFO and say you can't talk about toward margins.

[Brian Hartzer:]

I think Scott, what I would say is we have had a track record now I think over quite a number of years of managing our margins effectively and managing the tradeoffs between margin and growth. It's a very dynamic market, there are a lot of moving parts and I think the team has managed that very well. There are leads and lags from time to time. We saw a bit of that in the second half with the increase in term deposit rates, the mortgage repricing. We had some changes through the early part of the year with the application of different APRA rules at different times in different banks. That led to some funny things in terms of how different banks were pricing. But on balance, I think we've managed it pretty well and will continue to manage it very closely going forward.

[Andrew Bowden:]

With that, I'm going to call it to a close. So thank you very much for coming and look forward to talking to you over the next few days. Thanks.