NAUBF - National Australia Bank Limited (NABZY) Q3 2022 Earnings Call Transcript

National Australia Bank Limited (NABZY)

Q3 2022 Earnings Conference Call

November 8, 2022, 06:30 PM ET

Company Participants

Sally Mihell - Head of IR

Ross McEwan - Group CEO

Gary Lennon - Group CFO

Andrew Irvine - Group Executive, Business and Private Banking

David Gall - Group Executive, Corporate and Institutional Banking

Rachel Slade - Group Executive, Personal Banking

Conference Call Participants

Jarrod Martin - Credit Suisse

Andrew Lyons - Goldman Sachs

Jonathan Mott - Barrenjoey

Victor German - Macquarie

John Storey - UBS

Ed Henning - CLSA

Andrew Triggs - JPMorgan

Brendan Sproules - Citi

Brian Johnson - Jefferies

Richard Wiles - Morgan Stanley

Azib Khan - E&P

Presentation

Sally Mihell

Good morning, everyone, and thank you for joining us today for NAB's Full-Year 2022 Results. I'm Sally Mihell, Head of Investor Relations. Before we start, I'd like to acknowledge the traditional owners of the land I'm joining from, the Gadigal peoples of the Eora Nation. I'd like to pay respect to the elders past, present and emerging, and to the elders of the traditional lands in which you are also calling in from.

Presenting today will be Ross McEwan, our Group CEO; and Gary Lennon, our Group CFO. We're also joined in the room by members of NAB's executive team. At the end of the presentation, which will take about 40 minutes, we'll open up to Q&A. [Operator Instructions]

I'll now hand to Ross.

Ross McEwan

Thanks very much, Sally, and welcome to NAB's 2022 full-year results.

Actually nice to have some people in the room. I think it's the first time since I've been here in three years that we've been able to have people in the room, so a big warm welcome to all those who have come on in. I am pleased to report that we have again delivered strong financial results with all of our businesses contributing. Disciplined execution of our strategy continues to drive targeted momentum and improved shareholder returns.

The strong balance sheet settings we have maintained over recent years puts us in a good position for a changing environment with increasing cash rates and higher inflation. Our continued focus on cost discipline sees us well-placed to manage the impact of inflation on our businesses.

But we know some households and businesses are being challenged by a higher cost of living and higher interest rates. We are here to help them manage through this period. But overall, we remain confident in the resilience of our customers given the significant increase in savings over the past two years and an expectation that the unemployment rates will remain low in 2023.

NAB is well-positioned for these uncertain times with the right business mix, targeted momentum across our businesses and a strong balance sheet. This means that we can make deliberate choices about where we invest to continue to grow and to maximize returns.

In 2022, revenue grew by 8.9%, benefiting from strong volume growth and higher margins. Costs excluding Citi, were up 3.9%, in line with the guidance we provided with our third quarter trading update. Excluding costs relating to AUSTRAC Enforceable Undertaking and other remediation, our underlying costs were up 1.3%.

Underlying earnings increased by 11.5% and cash earnings rose by 8.3% over the year. The final dividend of $0.78 brings total dividends for the year to $1.51 per share, which represents 68% of cash earnings. These results reflect strong contributions by all of our businesses and Gary will spend some time discussing the key drivers of group performance. We said we would deliver improved returns to shareholders and I'm pleased to say that we have. Cash ROE is 11.7% for the year, comfortably within our target range at double-digit.

However, this remains behind the returns generated off a lower capital base in 2019, and we see further improvements ahead. We have delivered improved returns while maintaining a strong balance sheet.

Our collective provision to credit risk-weighted assets is 1.31%, 35 basis points higher than it was in September 2019. Our funding position has been strengthened by the increase in customer deposits on our balance sheet. Customer deposits now fund 81% of our total loans, up from 70% in 2019.

Our capital position is also strong. Over the year, we've continued to buy back capital to move us closer to our current target CET1 range of 10.7% to 11.25% and deliver long-term ROE benefits to shareholders. APRA's revised capital framework is expected to increase our CET1 ratio by around 40 basis points. Together with the impact of the $600 million remaining buyback, our pro forma CET1 ratio will be approximately 11.8%. This is above our revised target capital range of 11% to 11.5% from the 1st of January.

Turning to our strategic ambition. You have seen this slide before and it hasn't changed. We are now in the third year of our refreshed group strategy, which is focused on delivering better outcomes for our customers and colleagues.

And we'll do this by being relationship-led and easy to do business with while adopting a safe and long-term sustainable approach to managing our business. Customers and colleagues are the twin peaks of our strategy.

We want great bankers for our customers and great leaders, investing in our colleagues is key to delivering a better customer experience and overall performance. Our training programs are focused on building the skills and capabilities we need in areas like climate and in digital. Colleague engagement was stable over the year.

However, it remains below our target of top quartile and this is an ongoing area of focus for us all. You may have seen reporting on discussions regarding our new enterprise agreement.

We do see an opportunity to simplify and modernize this agreement and strike a good balance between rewarding our colleagues while supporting their well-being. This is key to our ability to continue to attract and retain talented professionals into the bank. Relationships are at the core of our service to customers and we continue to have the number one Net Promoter Score of the major banks for consumers in Australia and New Zealand, but there is more to do to achieve the Net Promoter Score results we aspire to.

And business NAB score declined by two points, and we're again ranked number two overall. While it's pleasing to see we're ranked first and second in some of our key business segments, we need to do more to improve our Net Promoter Score in the micro business segment.

In Corporate and Institutional Banking, we ranked number one again in the most recent Peter Lee survey. This is our best result on record, in particular, for relationship strength and transaction banking, NAB recorded the highest score of any bank in the history of the survey. Our transactional banking strength is an important driver of improving returns in this business.

We have delivered good momentum across our businesses in 2022 which reflects the hard work of all of our colleagues. Importantly, this growth has been aligned to our strategy which is focused on growing share in our core SME franchise in Australia and New Zealand, a disciplined approach to growth in C&IB and home lending and growing our share of deposits.

And NAB's largest division, Business and Private Banking, we have maintained our market-leading position. Over 2022, business lending in this division increased by almost $16 billion, representing 13% growth and 1.3x system. Total Australian business lending, which includes both Corporate and Institutional and SME lending grew by 12%, which is slightly below system for the year.

This was a deliberate choice to constrain growth in Corporate and Institutional Banking in the second half to optimize returns across the group. In Australia home lending, we grew by $22 billion this year excluding the $9 billion of home loans acquired with the Citi consumer business.

This represents 1.1x system over the 12 months, balancing volume and returns in an increasingly challenging housing market is important, and I'll talk a little bit more about this shortly. Our business deposits across Business and Private Banking and Corporate and Institutional grew by 17% in 2022, which is 1.8x system.

We also grew our household deposits in Australia by 11% this year, which was slightly above system. BNZ has performed well in a slowing market with lending growth tilted towards business lending. Our home lending grew just below system as we took deliberate steps to reduce our share of higher leverage lending in the New Zealand marketplace.

New Zealand deposit growth this year was 5.4%. I want to spend some time on our leading Business and Private Banking division, which has had another very good year. Our core franchise is based on a relationship-led business model, which has been built over many, many years. We have 3,000 bankers supporting around 1.4 million customers. These relationships between customers and bankers are increasingly being complemented by digital, data and analytics capability that are rating greater value.

As our business customers took the opportunity to invest and grow this year, we invested in our own franchise, including the additional - addition of more than 300 new customer-facing roles. The strong growth in business lending in the first half was sustained and the second half to achieve 13.4% growth across the year.

Across the franchise, there was a broad-based growth demonstrating our longstanding commitment to supporting the business community. Merchant payments is an integral part of our customer relationship, particularly in small and micro business where we see opportunities for good growth.

Our small business customers are benefiting from the launch of simple, easy payment solutions, including NAB Easy Tap, which turns a merchant's Android phone into an EFTPOS reader for contactless card payments and the NAB Hive merchant portal which lets customers manage business and payments needed via a flexible digital portal.

We are continuing to invest here. During the past two years, we've been working on the build and rollout of a Simple Home Loan platform across our distribution channels. About 90% of applications via our retail channel are now submitted via the front end of our Simple Home Loan platform, delivering faster and better experience for customers and bankers.

The next stage for our retail channel will be focusing on automating and digitizing the end-to-end process right through to settlements. We've also started the rollout of Simple Home Loans to our broker network and through our Business Banking and Private Banking network.

We'll gradually extend this to more loans and borrowers. Over the past 18 months, the actions we've taken to improve the customer broker experience have enabled us to grow ahead of system in home lending while maintaining price discipline. However, the market dynamics in home lending are changing as volumes slow, interest rates increase and a substantial volume of fixed rate loans approach their expiry.

In this changing market dynamic, we have the products and processes in place to continue to grow our business and maximize customer retention. However, we will make choices to strike the right balance between volume and price for maintaining risk discipline.

This may result in us being below system for a period as you see on the slide in the fourth quarter of 2022. Our strategy in Personal Banking is based on a simple and digital strategy, improving digital engagement with our customers and providing enhanced self-service capability is delivering an improved customer experience across our channels.

Our online banking NPS has now rated equal first and our mobile app NPS has rated or ranked second of the major banks. The work Angie Mentis and Patrick Wright are doing with their businesses are leading to us getting a better digital offerings with more to come. The acquisition of Citi consumer business completed on the 1st of June.

We remain confident that the additional scale and expertise will support our ambition to deliver a market-leading capability in unsecured lending. The financial performance of the Citi consumer business for the four months to September reflects current market conditions, including lower margins in home lending and increased funding costs.

While the current run rate costs are a bit higher than historical levels, we continue to target a sustainable cost base of less than $300 million following the expiry of their transitional service agreement. We are continuing to invest to grow our business in a safe and sustainable way. Our investment spend in 2023 will be approximately $1.5 billion, which is about $100 million higher than year 2022.

This increase is largely driven by additional investment in financial crime detection and prevention and cyber security capability. Cybercrime is one of the greatest threats of our time and we must be ever vigilant to keep our customers bank safe from criminal activity.

We'll also maintain our investment in our core strategic projects which support long-term growth and drive sustainable cost efficiencies. Higher inflation is impacting our business, primarily through higher wages and vendor costs. Costs associated with AUSTRAC Enforceable Undertaking are expected to be $80 million to $120 million in both 2023 and 2024, which is consistent with our previous disclosures.

Progressing our productivity agenda remains a key to helping offset cost inflation and creating capacity to invest to deliver long-term value for shareholders. In 2022, we delivered $465 million of productivity savings and we are targeting around $400 million-plus of productivity benefits in 2023.

Forecasting cost growth is difficult in this environment but we expect the cost-to-income ratio to continue to trend downwards in 2023. Responding to climate change is one of the key priorities and the long-term pillar of our group strategy. We are taking actions to support our customers and the economy, transition to net zero by 2050.

But the transition is complex. Every business and every household would need to make changes. There's $20 trillion will need to be spent differently in Australia over the next 30 years. NAB is supporting our customers to make the investment necessary to decarbonize and build resilience. And today, we have released our first climate report, which shows the progress we've made and where we see opportunities to grow.

The strength of customer relationships and our corporate and institutional bank is a key advantage. But the next decade is critical. We have set 2030 decarbonization targets for four of our most emissions intensive sectors. We support an orderly transition on the energy system while reducing our exposure to fossil fuels.

We remain the number one Australian bank for global renewable transactions, and we have exceeded our target of $70 billion of environmental financing by 2025. We're being guided by the science. This is what our customers, our colleagues and our shareholders rightly expect.

And with that, I'll pass over to Gary, who will take you through the results in more detail.

Gary Lennon

Fabulous. Thank you, Ross.

Let's start with our usual high-level overview of the financials. This is a strong set of results across all key measures of profit on both the year-on-year and half-on-half basis. Once again, you will see there are no large notable items.

Underlying profit rose 12% over the year and 6% over the half with strong revenue growth outpacing cost growth ex-Citi in both periods. The increase in cash earnings of 8% over the year and 4% over the half is a bit less than the underlying profit growth, reflecting CICs, which, while remaining at low levels have increased from a write-back in full-year '21 and a small charge in first half '22.

While not on this slide, it's worth noting that the statutory profit declined 6% over the half. This reflects volatility in some of our economic hedges, increased acquisition and integration costs, primarily relating to 86 400, LanternPay and the Citi consumer business, partly offset by a gain on sale of BNZ Life. All of our divisions contributed to the Group's strong underlying profit performance over both the year and the half.

Private - Business and Private, Corporate and Institutional and New Zealand all delivered very pleasing growth in underlying profit driven by revenue growth, including the benefit of the rising rate environment in the second half '22 along with good volume momentum. Growth in PB over the half was limited by home lending margin pressure and CIB had a slower second half impacted by lower market income and disciplined portfolio management.

Turning to revenue growth, which has been the key driver of our strong earnings performance this period. My focus will be mostly on the half-on-half. Our second half '22 earnings included a 4-month contribution from the Citi consumer business acquired on 1 June 2020, which I'll also exclude just for the sake of comparability.

Total revenue rose 7.2% over the half, excluding the acquisition of Citi and $132 million drag from Markets & Treasury, which I'll discuss in more detail shortly, underlying revenue growth was 6.7%. Strong volumes contributed $263 million and higher margins ex Markets & Treasury added $406 million.

Fees and commissions was a drag of $60 million. This reflects a $29 million impact from higher customer remediation charges, as well as lower merchant acquiring income relating to increased scheme fees. Partly offsetting these impacts was higher business-related and JBWere fees.

Markets & Treasury income reduced a $131 million over the period off the back of a stronger first half. The key driver was trading income which has been impacted by the ongoing excess liquidity in the system combined with a challenging trading environment in second half '22. Customer-related revenues held up reasonably well in the half.

Turning now to margins. Net interest margin increased four basis points over the half year, Markets & Treasury was a drag of four basis points, two basis points comes from higher holdings of liquids and the balance relates to economically hedge positions and is mostly offset in other operating income.

Excluding Markets & Treasury, underlying NIM increased eight basis points. The key driver of this increase has been the rising rate - rising interest rate environment. The impact is reflected in both higher returns on our unhedged low-rate deposits exposed to cash rate changes in Australia and New Zealand and offshore, combined with higher returns from our deposit and capital replicating portfolios exposed to the three to five year swap rates.

Deposits grew 18 basis points, including 10 basis points relating to the impact of the Australian unhedged deposit balances, which is broadly consistent with the sensitivities we provided at the first half. Deposit mix had minimal impact in second half '22.

The overall impact across deposits and capital from higher - from the higher Australian replicating portfolio returns has been approximately five basis points over the half, including the benefit from $8 billion increase - from a $8 billion increase in the size of our deposit hedge up to $80 billion. Offsetting these positive impacts, the lending margin is down seven basis points, mostly reflecting competitive pressures in home lending.

Funding costs has also been a drag of five basis points in the half, mostly relating to the increase in short-term funding costs. Looking forward, we expect further upside from the higher interest rates in FY '23. On our unhedged low-rate deposits, we expect the benefit to NIM from cash rate increases to peak in first half '23 with more modest upside thereafter.

The benefit of higher returns from our deposits and capital replicating portfolios will move around a bit with swap rates but based on 30th of September rates, the upside for FY '23 is approximately 10 basis points. Against these headwinds, we see a number of - against these tailwinds, we see a number of headwinds to margins.

We're starting to see deposit mix shifting and expect this to become more of a headwind in FY '23 along with higher funding costs. Home lending competition is also expected to accelerate as growth slows and refinancing activity picks up. We don't expect liquids to be a NIM drag going forward as further growth in liquids should be in line with the overall growth in the balance sheet.

Turning now to costs which was 3.9% over the ex-Citi, consistent with the guidance in our 3Q trading update. This includes $208 million of costs relating to the first year of our Enforceable Undertaking and additional provisions required for existing payroll and customer-related remediation programs. The EU costs were $103 million and this is expected to continue at around about $80 million to $120 million range for the next two years.

In respect of payroll and customer remediation, out of our 20 large legacy programs, 16 are either complete or expected to be practically complete by the end of this calendar year with four continuing into next year. Excluding this above $208 million, the underlying cost increase, as Ross noted, was 1.3% year-on-year.

Salary costs increased $135 million. We've also continued to invest in growth across our business which has added $233 million to costs. This includes new bankers and resources to support growth, particularly in Business and Private Banking. It also includes costs relating to the first time inclusion of LanternPay and the full period impact of 86 400. Technology costs are $140 million higher.

This includes additional volume growth-related costs for such things such as cloud, infrastructure and licensing, vendor inflation and the cost of running new technology investments made in FY '21. While investment spend is higher over the year at $1.4 million, the OpEx component is actually relatively flat. Other costs decreased $43 million this period, with the key driver being lower performance-based pay.

Offsetting these headwinds has been productivity savings of $465 million, largely generated through simplification, restructuring, third-party savings and lower occupancy costs. Now looking ahead to FY '23, we see a number of cost headwinds.

The inflationary environment is expected to impact salaries and vendor costs. As Ross mentioned, we're also expecting to lift the investment spend to approximately $1 billion - $1.5 billion and the OpEx rate is likely to remain fairly constant at around 50%. Higher D&A is expected in FY '23 of approximately $140 million, reflecting the increase in investment spend over recent years on growth initiatives such as Simple Home Loans, data and merchant capability, which are being deployed currently along with EU-related items, BS11 impacts out of New Zealand and some property-related depreciation.

Productivity is key to helping us offset these headwinds and we continue to expect savings of circa $400 million in FY '23. As Ross has mentioned, forecasting cost in this inflationary environment is difficult, but we are confident of achieving a lower overall cost-to-income ratio in FY '23.

Now turning to CICs and asset quality. The CIC charge for second half '22 is $123 million and remains at very low levels. This includes underlying charges of $196 million, which reflects continued low-specific charges, improved asset quality and volume growth. The largest driver of the increase in underlying charges over the half is the non-repeat of collective provision releases for the Australian mortgage portfolio in the prior period. CICs this half also include a $73 million release from forward-looking provisions.

Asset qualities continued to improve and our ratios are at post-GFC lows. The ratio of 90 days past due and gross impaired assets has reduced nine basis points to 66 basis points with continued improvements in the Australian - in Australian mortgage delinquencies, low levels and new impairments and successful work-outs in our business lending portfolios. Watch loans are lower, mainly due to improvements in the aviation portfolio.

While this strong asset quality performance is pleasing, we do know that these headwinds - that we do know there are headwinds in the outlook with higher rates, higher inflation, falling house prices, so let's discuss that, what that might mean in a little more detail. Starting with our home lending book.

Customers face a more challenging outlook. House prices have started falling and expected to decline circa 20% peak to trough. The impact of higher cash rates on home lending and repayments is also accelerating.

In the case of variable rate loans, we are reviewing all these by early January 2023 and adjusting payments accordingly. At a cash rate of 3.6%, approximately 3/4 of our variable rate P&I accounts will see an increase in monthly repayments with an average increase estimated at 34% or additional $549 per month.

Reassuringly, most customers in this period in good shape with our offset balances up 30% since March '20, and the average dynamic LVR and negative equity levels are at very low levels. Importantly, strong employment conditions are expected to continue in FY '23. While this means on average, customers should be able to manage, we know there will be some who face difficulties.

We see the most at-risk customers those we borrowed over the last three years when interest rates were very low and serviceability was tested at less than 6% and this amounts to around about $177 billion of lending. We have considered the impact of a 3.6% cash rate on repayments of these customers and narrowed down the at-risk population to those with repayment buffers of less than 12 months.

Of these balances, between $1 billion to $9.7 billion have a dynamic LVR greater than 80% with no LMI or no first home buyer government guarantee. Representing balances at-risk of potential loss should house prices fall a further 20% from September 2022 levels, which already incorporates a 5% reduction from peak. The highest risk cohort is around $1 billion of balances with less than three months' worth of repayment buffers and a dynamic LVR greater than 90%.

In the scheme of our total Australian mortgage book of $329 billion, while these numbers are still large, this does represent a relatively manageable exposure and we'll be working hard to ensure we support these customers who need help. Now, turning to our SME business lending book totaling $132 billion.

In an environment of slowing economic growth, rising interest rates and higher inflation, it is likely there will be more challenges for SME businesses and an impact to asset quality outcomes - and will impact asset quality outcomes for this book. Managing SME credit risk is a core capability of NAB. We've been in this business a long time and seen many cycles. It starts with strong origination practices. Our exposures are well diversified by industry, and we have a highly secured portfolio even after applying material discounts to market security valuations.

Only 6% of loans are unsecured. All loans were assessed at minimum interest rates, which have recently increased materially. These origination practices have seen the quality of our front book lending improve in line with our back book when looking at exposures with probabilities of default greater than 2%. This is despite the strong lending growth in recent times. Our customers are in good shape and the environment is currently very supportive for SMEs.

Business profitability trends remained strong and most customers are able to pass on the majority of higher input costs. Liquidity remains high with B&PB deposits up more than 25% since September 2020 and gearing is low with loan utilization rates below pre-COVID levels.

But similar time lending, while this means the majority of customers look well placed to manage a more challenging outlook, we do know some will struggle. We see our highest risk SME balances are those with a probability of default greater than 2%, which are not fully secured. This amounts to $8.5 billion in balances with loss potential or $1.5 billion if we just consider those balances that are unsecured.

Again, while large, these amounts are fairly manageable in the context of $132 billion business book. Turning to provisioning, which has been maintained at strong levels given the more challenging outlook.

Collective provision stand at $4.8 billion, up $192 million from March. This includes $1.6 billion of additional forward-looking provisions when compared to September '19 levels. Collective provision coverage to credit risk-weighted assets is also well above pre-COVID levels at 1.31% and stable over the half despite improved asset quality this period.

Provisions for total expected credit losses increased $101 million from March to $5.4 billion. This incorporates more stressed economic assumptions in our base case scenario, including house price declines in FY '23 of 14% on top of the 5% that has already occurred in FY '22. We have also increased the weighting to the downside scenario from 40% to 45% over the half. And this downside scenario has unemployment remaining above 8% over the forecast period and cumulative house price declines of around 30%.

Our stress is eased in some of our COVID-19-related sectors such as airlines, our targeted sector FLA for these exposures has been released, but this has been partially offset by a new construction sector FLA and a new Australian energy FLA to reflect the impact of higher energy prices on manufacturing and transport subsectors, which are heavy energy users, but face challenges passing on these costs through - passing on these higher input costs.

It's also worth highlighting in relation to the more challenging housing outlook, we are currently holding approximately $1.3 billion of provisions across the group for potential losses to this sector.

Now turning to capital. Our CET1 stands at 11.5% at September, down 97 basis points from March. Organic capital generation added three basis points or 19 basis points if you exclude the non-credit-related risk-weighted asset movements, primarily relating to IRRBB, which I'll discuss shortly. Credit risk-weighted asset growth accounted for eight basis points of capital over the period excluding the impact of FX and Citi, with strong volume growth mostly offset by improved credit quality.

Over the half, we bought back $1.9 billion of ordinary shares equating to 44 basis points of capital. M&A had an impact - had a 24 basis impact relating to the Citi acquisition less the BNZ Life sale. And the movement in other of 32 basis points include 14 basis points from FX, as well as drags from deferred tax asset movement, software and a few other miscellaneous items.

From 1 January 2023, our CET1 target range will be 11% to 11.5% to align with APRA's revised capital framework. Adjusting for the remaining $600 million buyback which is about 13 basis point impact and an estimated 40 basis point impact as a result benefit from the new framework, our pro-forma CET1 is estimated at 11.8%.

IRRBB risk-weighted assets have increased a further $6.8 billion this half with most of this due to embedded losses arising from further increases in the 3-year swap rates relative to the regulatory 1-year comparison rate. You can see from the chart included here, we are now holding $6.2 billion of embedded loss risk-weights equivalent to 45 basis points of CET1.

While subject to rate movements, we do expect to see most of this reverse over FY '23 and '24. Repricing and yield curve risk have also increased due to the rate increases but we don't expect this to reverse in the short- to medium-term. Turning finally to funding and liquidity.

Both have remained strong for the period. LCR increased to 137% and excluding the CLF sits at 128%, well above the 100% minimum required. NSFR has declined slightly to 119% over the half. And despite volatility in funding markets and widening credit spreads in FY '22, we issued $39 billion of term wholesale funding over the year with $18 billion in the second half '22, which reflects a return to more normal levels of issuance for NAB. We do expect to continue to access wholesale funding markets over FY '23 to support growth and refinancing requirements, as well as to position us well or position the balance sheet well for the phasing out of the CLF and for TFF maturities.

And with that, I will now hand back to you, Ross.

Ross McEwan

Thank you, Gary.

As we enter a period of greater economic uncertainty, we are well positioned. For three years now, we've been executing a clear and consistent strategy with discipline and with focus. This is a bank that has sustained momentum, that is delivering better outcomes for customers and colleagues, which is translating into better returns for our shareholders. The strength of our relationship with our business customers, large and small, is a key differentiator.

Our priorities as well are well established and supported by mature governance and control frameworks. At the same time, we have maintained strong capital and provisioning levels. This provides capacity to support our customers through this period of uncertainty. The strength, stability and consistency is enabling us to make deliberate choices about where we want to invest, where we want to grow and where we want to pull back a little because the returns are not as attractive. In closing, customers and colleagues will continue to be a key focus in 2023.

So too is a disciplined approach to managing our costs with a focus on productivity. We will get right the work we have agreed with AUSTRAC to keep our bank and customers safe. And finally, we will progress the integration of previous acquisitions included the Citibank consumer business and the 86 400 and UBank to ensure we deliver the benefits of these transactions. I am confident in the outlook for NAB and for Australia and New Zealand. We are better placed than any other countries globally to navigate the challenges ahead.

Thanks again for the time and physically seeing you. And I'll hand back to Sal for some Q&A.

Question-and-Answer Session

A - Sally Mihell

Thank you, Ross. We'll start by taking some questions in the room. And I know I don't need to remind you, but please limit to two questions. Jarrod?

Jarrod Martin

Jarrod Martin from Credit Suisse. Gary, you know the question that's coming.

Ross McEwan

Which of two is it?

Jarrod Martin

So, other banks have disclosed. Are you willing to actually disclose what your exit margin is for FY '22?

Ross McEwan

Look, Gary, maybe they haven't picked up on the quarterly exit margin that you gave last quarter and this quarter. So maybe you're there because I think that's pretty well the right thing to disclose as opposed to the minute, at the end of the day, NIM that Jarrod is after.

Gary Lennon

And to answer the question seriously and with respect, the - I've been on record for a long time with my nervousness and concerns around final month exit NIMs because the reality is, they can be distorting. There's a whole bunch of things can go through in the final months, particularly the year, which means any guidance you give directly off that is fraught with danger. It can be volatile and I've seen that over many years, so that's why we avoid doing it.

But as a - but I understand the need that you want to get a decent understanding of what momentum looks like as we're exiting the year, that's why we do, in all seriousness, I think the disclosures we've given on the quarterly, gives you a really good sense of what the trajectory is. We said in our Q3 update, there was very little benefit from any - from rising interest rates in that Q3 update and that it would start to come through in Q4.

And you can see from our disclosures, that's exactly what's happened. So we were down to 1.62% in Q3 and that's gone up 10 basis points to 1.72% in Q4 and that 10 basis point is a fair reflection of the underlying run rate is impetus that we're exiting the year with. So I think it's a better than asking for any spot monthly NIM.

Jarrod Martin

I think sensitivity was, what, two basis points per 25. So that implies 125 basis points. We've had double that. So there's a further 10 basis points to come from that - a further 10 basis points to come from the swap rates, et cetera. So you're looking in terms of the tailwinds going into FY '23, potentially being 20-plus basis points on what the second half margin is. Do you sort of agree with that from a tailwind perspective? We can all...

Gary Lennon

I think you can all put your own numbers on this. There's a couple of important points to call out. So on the replicating portfolio, the 10 basis points that we called out for next year, as long as swap rates sort of behave there and thereabouts, so that's going to be a pretty solid number. On the - on what we've achieved this year on the unhedged portfolio, if you sort of did the midpoint mass on our guidance comes out at about 9.5 basis points. We delivered on about 10%.

So it's slightly better. But it's also we thought that there would be less pass-through in the more - in the earlier rate rises. So it's not unexpected that it was a bit better in guidance for this period that's just gone past. What we're seeing in more recent times is the pass-through is coming off a bit. So the two basis points is probably less than two basis points and starting to decline.

And that's just a consequence of as rates continue to increase, the sensitivities do change. So that would be the best guidance. And definitely, there will be some full half effects of what's already happened in the second half, plus new rate rises, plus the 10 basis points, it does give you a pretty positive outlook for the first half '23 and then it will start to moderate. I don't think they will collapse, but it won't continue at that rate of pace. But I think there will be continued increases after that, just at a more moderate level.

Sally Mihell

Andrew?

Andrew Lyons

Thanks. Andrew Lyons from Goldman Sachs. Just staying on NIM, you provided a variety of qualitative comment on your NIM outlook for '23 including deposit mix being a headwind. But just looking at your deposit growth in the half, it was up $26 billion, with term deposits actually rising by $39 billion in the half. I'm just wondering about how you sort of thinking about the ability of the deposit franchise to the extent you continue to see good growth in SMA to, I guess, continue to sort of fund economically because we probably haven't seen that degree of, I guess, mix shift already from your peers. So just keen to understand how are you sort of thinking about the mix?

Gary Lennon

In terms of the shift in the TDs.

Andrew Lyons

The shift in the TDs, we haven't seen as much from peers. And I'm just keen to understand to the extent we continue to see growth, what sort of an impact do you think that will have? And then I've got a second question.

Gary Lennon

Yes. And a large portion of that mix in the TDs is coming out of David's business, so it's more of a top end institutional, corporate shift, which you'd expect that, that shift should be first. How we think about where this is likely to play out? If you go back to this time into '21, I think TDs was around about 19% of the book. They've now moved up to, from memory, about 25%.

And I think if you go back pre-COVID, that was 35%. So it gives you - and I think that's a fair reflection on where we are in that journey. But we were way back to '19 we have moved ahead a bit with the higher end deposits moving across.

Ultimately, you would think it may move closer to that 35% of the total book in time, but I think that will be progressive but we are starting to see more of that migration starting into - in the SME and even starting in the consumer sector as well. So it is starting but it's still pretty slow, and I would have thought peers would be experiencing relatively the same thing, yes.

Andrew Lyons

Just a second one just on capital. You provided great disclosures around your ECL modeling and particularly the downside scenario which does look pretty conservative. Just be keen to understand perhaps what your capital impact would look like in that sort of scenario, if it was to play out? What - how would your risk-weighted assets respond in a scenario like the one that you've given us for your ECL downside?

Gary Lennon

Yes. Obviously, the more - are you talking about the more severe one?

Andrew Lyons

Yes.

Gary Lennon

Yes. And we do have modeling - I won't quote numbers, but just to give a sense of what's happened to date, and this might be useful to size up that downside. So through COVID period where we have seen increases in risk-weighted assets or decreases in risk-weighted assets because of credit quality improvements, the true - there's a bit of noise around that, but the true improvement level through that period has been about 30 basis points of capital that is - we've got a benefit from through that period.

So how I've always thought about it if we entered into a relatively severe - maybe not as that full downside scenario, but that's not a bad starting point just to consider the impact of that 30 basis points you would think may reverse and it just gives you a bit of a sense. So the numbers aren't massive.

And a lot of these are through the cycle PDs and other things that - but there will be - the biggest driver of capital impulse is when you do start to get re-ratings of customers rather than the underlying PDs and LGDs tend to be relatively stable, yes.

Sally Mihell

Jon?

Jonathan Mott

Jon Mott from Barrenjoey. Two questions if I could. The first one on the NIM. If you go through the divisions, you did mentioned this in the C&IB, the Corporate and Institutional Bank. The - what you saw is only a three basis point expansion excluding the Markets.

You did mention that there was a shift into TDs to some extent. But I would have expected a bit more leverage coming through in the Institutional Bank pretty quickly. Why haven't we seen that? Is that an area that should be coming in future? What's going on there? And I got a second question.

Gary Lennon

There is a little bit of noise in there but the main reason is that, if there is an area that's higher pass-through, it's in that area and we have been seeing, particularly in more recent times, far more intense competition in CIB than any other area. And so, you'll see overall growth in deposits and growth in TDs, a lot has been coming out of that area which is why more competitive and we're seeing different levels of competition for those deposits now, probably in the last three months. It's quite as intensified.

Jonathan Mott

A second question, if I could. Everyone is quite excited about business credit growth, it's 14.7% I think nationally, highest level it's be been almost excluding the GFC in 30 years. There was an interesting comment actually came out of the New Zealand regulator, they're saying while asset quality is currently strong, greater utilization of credit limits and demand for working capital in recent months are potential signs of cash flow pressure in the business sector. Are you starting to see any signs yet that we're starting to see companies drawdown capital? Why is the regulator starting to get a bit concerned about this but none of the banks are?

Gary Lennon

Yes. It's something we're watching closely for exactly the reasons, John, that you've called out, but we're not seeing anything.

Ross McEwan

Andrew may like to comment on it, but we're not seeing it in the book at the moment, but you've got Andrew sitting there looking after the book.

Andrew Irvine

Yes, we're not seeing yet utilizations below pre-COVID levels, and it's pretty constant. If anything, I'm surprised it hasn't ticked up a little bit as clients have had to invest in extended working capital cycle. So we'll watch it really tightly, but we haven't seen it.

Jonathan Mott

Would it be fair to say, Andrew, that what we are seeing, that we are seeing a slight pause at the moment. But with all the supply chain challenges, a lot of your businesses are really ramping up to how to mitigate that, how to eliminate - build their own factories, build out mitigants. So there's quite a strong credit pipeline. But given all the narrative that's going on, there's a bit of just pausing and waiting.

Andrew Irvine

That's exactly right. The pipeline is still strong, but I think clients are - want to see and have confidence that, making the investment decisions that they want to make are the right calls. And I would say that, post the election, we probably had three or four months of increased uncertainty, as clients wanted to understand the impact of rate rises. And I actually feel like, the confidence has increased a bit, Australia has been able to navigate those rate rises and it feels more like a soft landing. And so, we're starting to see that pipeline transition to activity a little bit now. So hopefully, that continues.

Sally Mihell

Victor?

Victor German

Victor German from Macquarie. Maybe a follow-up question on business. We've now heard pretty much every one of your competitors highlighting that, that's the area that they want to focus on and you're delivering fantastic set of numbers. How are you finding competitive pressures on the lending side? And one of the things that you provided for a retail bank, is a proportion of volume coming through broker channel? It will be interesting to get an update in terms of what's happening in the business channel as well? And second question on - would you want to answer this one first?

Andrew Irvine

So on - in terms of mix of volumes, I would say our back book is kind of in the teens in terms of mix of broker to prop. And if you look at front book, it's more like 25%, 75%. - in terms of mix. So we are seeing a skew to broker. Broker margins in the business lending are a little different than in consumer. So we actually have similar NIMs in broker as we were in proprietary. ROEs are lower because we have a little bit less cross-sell, a little bit less deposit in that channel. But the actual NIMs that we get in broker are pretty good. So that is pleasing. What was the first?

Yes. On competition, look, everyone wants to be in this business because it's a good business. This is a relationship business. So it's not that easy to kind of go in. It's a bit less price sensitive and relationships are built over time through cycles.

And this is - we're really, really good at it. I would say bankers are always in high demand, because you want good business bankers. And so we're working really hard to improve our processes and be a destination bank for any business banker who'd want to grow their careers. And what we're really happy with, is our attrition rates of bankers is really, really strong and a lot better than it would have been a couple of years ago. So we're keeping our people and when you do that, you typically keep your customers.

Ross McEwan

Look, this is an area of absolute focus for us to make and we're delighted with the results coming out of it. We've got really strong bankers. We've grown the number of bankers. We've grown the support for our bankers. With Andrew's team, have put a lot of support into the processes that our bankers work with, lots to do.

But our timeliness in the business banking side is some of the best in the market today. We couldn't have said that three years ago. We were losing bankers. We're not losing bankers as much as we were, we have actually probably best in market. We like this business, and we're bloody good at it. And we're going to stay good at it and bring them on.

Gary Lennon

Victor, and just to round out for three, I'd say. It is a very good question, Victor. So the dynamics in business and private is so different from consumer, if you see what's going on. You would have seen our second half NIM of 3%. It's gone up to 3% and the compression on the lending NIM is pretty modest.

It goes to all the points that Andrew said, that this is not a commoditized business. It goes down to a huge amount around relationships. Most of our SME business will say, that whilst interest rates are going up, in the overall scheme of things, it's not that high. And that just goes to show, that it is a really powerful franchise, but difficult to attack in the short term. So how many halves have we been - that question has come up.

How many halves has that question come up, that's probably when the announcement got put out that year, John, is how many halves this question comes up? And it's an - if we do our business well, it's incredibly difficult to attack because it has to be customer by customer, relationship by relationship. And that's why you're not seeing the same sort of margin compression on the lending side that you do see in the consumer businesses.

Ross McEwan

But we are investing well in this business. We've got a long - a lot of things that we want to do. I'd put up there, it's in the small micro market around merchant payments. We've got a lot of work to do in the micro market. We're doing very well in the small, medium market now.

Our metro business is really strong today. three years ago, it was a bit weaker. It's very strong. Our Agri business has gone well on the back end of the market going well, but we've grown market share in a growing market. So this is a business that's hard to land for NAV, and it's our turn. And we're not going to let this go. Please pass that on to others.

Victor German

Maybe just touching on margins as well. And I appreciate that perhaps the delivery in this half was consistent with your expectations back in the first half that you've provided. But if we look at what others delivered, it was probably slightly better, and we haven't seen as much shift perhaps in earlier rate rises, as perhaps was expected earlier on. I guess as you reflected, do you think it's a timing difference, or do you think once we kind of get through this rate cycle, the leverage to higher rates for NAV are going to be lower than peers?

Ross McEwan

I don't think there's any sense that we're at a disadvantaged position versus peers. And you would know we find that actually dissecting everyone's NIM waterfall and getting the real comparative, it's not a straightforward exercise. And there's some things - so can you actually get it lined up. For example, some of the - our increased funding costs that we've called out just normally in the waterfall, there is certainly a portion of that, that relates to liquids. So I know others put that in a different part of the waterfall, and then our increase would look higher, off the back of that reclassification.

So I think there's lots of moving parts. On the outcome for the first - for the second half based on the first half guidance, it didn't come - we came in at 15%, and our guidance at 13.5%. So we did do better than what we thought we were going to do. And to date, it's held up in a reasonably stable way. Or actually, the other important point for us peers, is there's some timing issues with peers.

We've heard the quality problem of growing. So when you have a franchise that is growing across the board, we've had to go out there and you've got TFF coming, and you've got CLF coming off. We had a lot of funding task to do, and we've been doing prefunding to prepare ourselves for TFF as well. Whereas if you don't have growth, you don't have to do that. And that's where - but that will end, as they are starting to return to some level of growth, but that will be a timing difference.

Sally Mihell

John?

John Storey

John Storey from UBS. Ross, just a question for you on some of the APRA trends that we saw from September. It looked like NAV slowed down in some key product categories there. Maybe if you could just comment on that? And then the second question I had was just around the positive jaws guidance that you provided for '23 and just wanted to get a better sense of what the market's performance potentially could look like, as markets - RWAs have obviously gone down and the slide that we provided today, obviously, you're run rating well below where you have historically. So just to get a sense of how important that piece is, with regards to the positive jaws guidance?

Ross McEwan

Yes, thanks. No, look, we - the second half was a little bit different than the first. We kept a very strong position in our SME franchise. We did make some adjustments in our settings and our mortgage business, and we experienced some - there's a lot of competition in that marketplace. And as Gary said, if you've got options as to where you put the money, you put it to where the best return is.

We're looking after our mortgage franchise, and we want to continue to grow. But I do not see on the pricing that's in that marketplace, that would be wanting to grow it as we did last year. We want to look after existing customers and make sure that we're funding them well. But do I want to grow in that market at those sort of margins? No.

I'd rather put it into other parts of the business. So that's the great thing about this franchise. I've now got options. So we're playing those options. And we had a quite a time in corporate institutional, the return is starting to come through there.

They'll probably get a bit more of our funding going forward. While others may not. So we will play it by a six monthly basis. We've got the capability in our mortgage business being built over the last two years. We've got another probably two years of really building a machine in there, there's just one mortgage factory.

We've given you an update on that. I'm delighted with the performance coming through there. So it's not as though it's a service issue that we get volume and we choke on it. That is not the case for this bank. It's about where do you make the money, and where do put your efforts.

So that's why the APRA stats are a little bit different, and I think you'll see them swing around. The other side that we haven't shared very much, that's really important to this franchise is deposits and transaction accounts. This has been one of the weaknesses of this franchise for decades.

And it is now becoming a - it's becoming less of a weakness and actually becoming a strength of the organization, that that's where we're focusing both on our Personal Bank, our Business Bank and our Corporate Bank and in New Zealand, so to get that weakness. And as you've seen, the ratios have changed quite dramatically even since 2019.

So I think you need to also see what we're doing on balancing this portfolio very well. It's also why we wanted to buy the Citi personal unsecured book - business, otherwise, you end up being a mortgage factory, and that's not what we want for our personal bank. So that move alone has helped us become the number two player in the unsecured market. It means that we can invest in it and get put new systems and technology in place. So there's some pretty strategic moves being made quietly behind the scenes here, that is starting to come through.

But, some very deliberate decisions being made by myself and my executive team, as to where we quietly move our funding. On the other one, I might throw to David just on his view on what's happening in the corporate and institutional bank, if I may, Gary?

Gary Lennon

It wasn't part of the question.

Ross McEwan

It was part of the question, wasn't it, the second part?

David Gall

I think the second part of the question was specifically around markets performance. What do we expect there? What we certainly saw both through half one, but then into half two, is pretty solid risk management performance from markets off the back of our customer franchise. So that continued. What we've seen and what I think we'll continue to see is, periods where we go risk off, depending on the amount of volatility that we're seeing out there.

So the trading revenues will still continue to be up and down half-on-half. I think your question was, do you see a reversion over time to, where we may have been a few years ago? And you can't anticipate that, but it was acquired in the second half after actually quite a strong first half in trading. I think year-on-year, it's a pretty good result from the markets team, but you will have halves that are up and halves that are down.

Gary Lennon

I would add to that, David, that there is a broadening out of the treasury as well. So for pre-COVID levels, we were running about $1.8 billion, currently run rate $1.4 million. Lot of factors, lot of changes in the environment, huge amount of liquidity, spreads are arriving sometimes negative. As liquidity gets withdrawn from the market, it's quite reasonable to expect, particularly on treasury, but I don't think as well that some of those margins will widen and some of those arbitrage opportunities will come back. But I'd see that sort of playing out over the next three years, as liquidity gets withdrawn.

So we'll just watch - and the nature of markets and treasury, difficult on the timing exactly, but over that sort of 3-year period, you should sort of - trending back to that 1.6%, 1.8% level ultimately. And the good news is, it's all about the trading. The customer flows have been holding up pretty well, despite margin compression that we're getting continued flow uplift there, which you would expect in a volatile environment.

Sally Mihell

Ed?

Ed Henning

Ed Henning from CLSA. Just following on mortgages. Today, you've again talked about improvement in technology on a mortgage process and how that's all going. But obviously, you've dropped the 0.6x system. Are you saying here that, even though you're improving your process and mortgage systems, it's really just all about price, and that's what's driving the customer decision? Can you just run through that in a little bit more detail on how we should think about that going forward with you spending money on your process and then getting extra share or - at least towards system?

Ross McEwan

It's not all about price. It is an important factor. You just have to be competitive in the marketplace. There is a price for performance on service, and I'll get Rachel to talk on that, because I think we're doing a very, very good job in this space at the moment. But there are players that want this more than we do, at a price that we think is probably worth - not worth being in the market to the volumes we were getting last year is where we're at, and we'd still want to be in this market, and we are.

But will be put in the same level at 1.1x, 1.2x system on these pricings, probably not is what I'm signaling to you. But there is a price for service, and we've been extracting that, but there is a price that you say that's all very interesting. We'll leave it to somebody else. We just think we have other options for where we put the funding that's all. So Rachel...

Gary Lennon

I'll just jump in, and this is important and Rachel will add to this, I'm sure, that there's an important dynamic and change that's going on in the housing market at the moment. That I think all of us probably is expecting, but we're really seeing it and has a direct relevance to your question. As growth slows, then this market is changing to - more from a market that was more about new sales, where the criticality of speed to market was high.

And when you're good at speed to market, you could charge a greater premium for that service, but we're rapidly entering into an environment, where slow growth, big refi market and refis are moving up each and every month. And because of the nature of that, the whole speed-to-market, because you already got a property, you just want to refinance, is not as important a factor.

So the premium you can get for that service premium, is coming in. So it's increasingly becoming for a period anyway, more about price, and a lot of our competitors were keen to grow, and they did what they had to do to grow. But it does mean that returns are challenged.

Ross McEwan

Rachel, any comments from you? With Gary done a beautiful job...

Rachel Slade

He has pretty much pinched all my thunder. But I think I'd just add to what Ross said, I mean our focus in that market at the moment is really focused on our existing customers and focused on the retention there. Particularly, we've still got another $85 billion of fixed rates to roll over the next couple of years. So how we approach that and the capability we've got to put offers to customers. And we're pleased with how we're going there, but we're only a little bit of the way through that.

I think the other thing with September was, and you guys know this - and you see it in the investor performance in particular, some changes that we had to make on our leverage lending around DTI. We've got that under control now. So you'll see that start to look a bit different into the new year as well.

Ed Henning

And can I just ask a second question just on costs. You've again called out productivity benefits coming through, but they are slightly below the last couple of years, and maybe that's a rounding year or not, but the cost base has been increasing. Can you just touch on the ability to continue to get productivity savings - are they getting harder? Do you need to invest more money to get more out, just in thinking about the future cost growth beyond 2023 would be helpful?

Ross McEwan

Yes. I think the - where we find the cost is different - not whether it's hard or not, it has always been difficult and taking cost out of the business is always difficult and you've got to keep - add it all the time, and Gary runs a Fortnightly Friday afternoon session with the executive on...

Gary Lennon

They love it.

Ross McEwan

It's one you sell tickets, too, so popular. But it's around discipline. And I talked in my piece, it's just about the cadence and the discipline you have to have in running these and keeping our eye on them and keeping them focused, and that's what it's about, but it's different. So we're doing a lot of work around our technology and therefore, an end-to-end process. So then you've got to go after the pieces that are no longer required and are stripped out through, because of the automation that's going in.

We're doing a lot of work around that. And I think we've still got lots of opportunities in this bank to continue to improve, but it's quite different to what it was for the last two years. We've got the...

Gary Lennon

There's still plenty of opportunities there. And you're right, the first phase is - tends to be - have a more of a tactical element to it. But now we've got our investment program set up in a very different way with a continuous cadence to that, where you're building multiyear capability.

So it's pivoted to that more strategic long-term investments, where you can start planning and you can see when the productivity is coming out over the next years, through a lens of - we're heading towards this target state, where there's a lot more digitization, a lot less manual process, a lot bit less folks in the back office. We've been doing parts of that all the way through, but it's been pockets. It's now really got that multiyear cadence to it now. But it's - but we still think there's - that $400 million range.

Ed Henning

And with that, do you see confidence in being able to run below inflation over the medium term on costs?

Gary Lennon

Define medium term?

Ross McEwan

Yes, define inflation over the medium term, then we're going to give you guidance, which I'm not going to do. But we've got real discipline on this, and we'll keep it disciplined in our cost position. And as I say, we are focused on it very strongly, given the pressures on every business in Australia. It's not just us, every business has got exactly the same pressures, and we got to deal with them. And I think we're in pretty good shape to do that.

But it does take relentless focus every fortnight. People don't like it. Everybody tells me how wonderful they are, until you then get in and have a jolly good look and they go, oops, sorry, I didn't see that, and they go around and around again. But most businesses don't have that relentless focus, we're building that cadence.

Sally Mihell

Andrew?

Ross McEwan

It's never finished.

Andrew Triggs

Andrew Triggs from JPMorgan. Just a question firstly on deposits, a good slide at the back - - Slide 78, shows the segmentation deposits. And really, it looks like - while it's been talked about, deposit mix changes, the growth in term deposits really looks like it's just funded the growth in the book. And there's also good disclosure there with $92 million of Australian deposits earning below one basis point on the interest rate. So just a couple of questions there, how we should think about that term deposit growth as effectively an alternative to wholesale funding, given it sits in the higher end of the CIB market?

And secondly, that $92 billion, when Gary do you think that starts to decline, if you do get a sort of genuine deposit mix shift away from really low-cost deposits to more flat rate-sensitive deposits?

Gary Lennon

Yes. And that's - in terms of the first part, there's some truth in that, but still the TD rates you're paying for is still well inside the whole site at the moment. So there is definite benefits to acquiring these deposits. And we maintain a very disciplined approach to these deposit pricing. You don't want to go too soft.

You don't want to go too hard. You have to get the nuance right and the balance. So it's not - and there's broader implications to pin your ears back and grow as much TDs and CLB as you can, just because it's got a lower rate than wholesale. You'll end up paying for that. So it's something that the teams work very closely together to get that balance right about where is the best place for the next dollar.

And as we mentioned previously - as Ross mentioned previously that we want to continue to grow our deposit franchise. So we're looking at that. TDs is part of it. More importantly is our transaction - our transactional capability, Rachel, Andrew and David are all enormously focused on that. We've had some pretty good success to date.

We see plenty of upside because we're probably underweight in that space, and issuing more product, more focus, more bankers are targeting those areas. We feel pretty good in the next couple of years, we can continue to grow what are the highest quality deposits.

Ross McEwan

It's also why the merchant space is quite important to us, particularly in the SME, it's the bundling, and why we're putting the effort into our merchant piece, because you put together a merchant capability with a transaction account, it's good business. And we've been - I think we haven't focused well enough on that over the last probably decade, now we're well and truly into it. And it starts with the micro end of it, right the way through.

So yes, growth across the board doesn't matter whether it's UBank, we've basically doubled the number of transactions accounts coming through there. Rachel's now got automatic capability of online through the work that Angie and Patrick have been doing on digitization.

We're getting that in the business bank as well, the small end. So it's all starting to come together, but a much better focus. And Andrew has been driving that very hard that. There's two sides of a balance sheet we look after as a banker, not just one side.

Gary Lennon

Just on the $92 billion, which is the one on the top left here on that slide, isn't that zero - the less than 0.1%. There is a how long will stay? There is an element of who knows. But there is also a pretty reasonable theory that, a lot of those customers - if you haven't moved yet, you're probably not moving. That might be for the whole balance, but I think there is a real possibility that could be quite sticky now.

We've had enough rate increases, and we have seen customers migrate. But there are a number that just aren't rate sensitive. And with each increase, we potentially expect to see less than the percentage sense of that cohort move.

Andrew Triggs

And quick second question. The 40 basis point uplift expected from the APRA capital changes, 1 Jan next year. surprised it's not a little bit bigger, especially given the institutional book had some commercial property exposures, I think, that were captured under supervisory slotting approach. Can you just generally comment on, what the changes have been there and whether - what's happening to the mortgage RWAs under that new capital framework?

Ross McEwan

We are getting benefits. So it's around about what we thought it would be, the upside. And publicly, we were - there was a few rule changes moving around, that could have had a quite a sizable impact. So there was time we said that benefit would be modest. I think last half, I talked about it being a modest upside.

So 40 basis points, maybe it was a bit better than modest. The - yes, we are getting benefit in David's business, absolutely with credit lines and CRE slotting exposure is getting a much better treatment, and that will help institutional business. And I think that's the - maybe the misunderstanding, but it's really institutional and that gets the biggest benefit from these changes. On mortgages, overall, we think it's going to be pretty neutral for us in terms of our risk-weighted asset density on mortgages. And a bit of that is we do have more complex - more of the more complex mortgages in Andrew's business. So that sort of worked against some of these other benefits that we might see.

Sally Mihell

We'll go to questions on the phone line.

Operator

[Operator Instructions] Your first phone question comes from Brendan Sproules with Citi. Please go ahead.

Brendan Sproules

Good morning. Just I've got a question on NIMs, particularly the drag on funding costs, which were down five basis points for the half, which is quite different to peers. When I look at your issuance that you've done during the period, which you show on Slide 31, the quantum doesn't actually look that different to peers. In fact, in this period, not surprisingly, you've had more secured as a percentage. Could you maybe help us understand where the drag is coming from, particularly relative to the peer group? And then I have a second question.

Ross McEwan

Sure. So of those five basis points, and I talked a little bit about the drivers earlier about where peers are somewhat different to ourselves. So we have had a year of pretty high growth. That, together with the CLF coming off and preparing ourselves for the TFF has meant - we've had a pretty active year of funding. So the - of the five basis points decrease, about three basis points of that is short-term funding.

A bit of that's rates, with bills as coming back up, which is something that wasn't there previously, which peers would have that dynamic. The second is - and some of it goes back to the point where it's disclosed. I suspect one of the peers has this issue, but it's disclosed somewhere else in the waterfall. But we have been using short-term wholesale funding to increase our liquids book, in preparation for the CLF coming off. So that has been a major driver of the short-term wholesale funding, which if you didn't have a large CLF, you wouldn't have that problem.

But one of the peers does, and I think they just disclosed it in the markets and treasury area. And I said, the other half would be rate driven. Of the two basis points, I think there's essentially a basis point, which relates to New Zealand and pretty similar dynamics, and really only one basis point relating to term issuance. And whilst the - that's a volume-driven impact and really linked to preparing ourselves for TFF. So the actual quantum of debt - term debt rolling off this period, the price of that term debt and what we had to issue with that, was reasonably benign.

It was just the fact we had to go hard in the market this year, as we position ourselves well for the TFF maturities next year. So we have been carrying a bit of extra volume, and then that goes - that excess and that flows through into NIM.

Brendan Sproules

And just a follow-up question, when I look forward and you obviously have to now move your attention away from the CLS to the TFF. Given the pricing difference between what long-term debt costs you - particularly in offshore markets versus what you have to pay on the term funding facility. Is that really going to hit in FY '24 that - just given the timing of when that first tranche is due and then again in FY '25, and that's where we'll see an acceleration of this component of NIM?

Ross McEwan

Yes, that's essentially right. But it's - there's quite a delayed impact of this roll off that for '23, it will be pretty minimal. That will start to escalate a bit more in '24. And I think probably by 25%, you get the full run rate of that impact. And in my head, I view it - that's over that 3-year period, we're talking about a four to five basis point headwind. So we're not talking about super massive headwinds, and it is broken down that - more of that is back ended than front loaded.

Brendan Sproules

Thank you.

Operator

Thank you. Your next question comes from Brian Johnson with Jefferies. Please go ahead.

Brian Johnson

Thank you very much for the opportunity to ask some questions. And congratulations on some really great disclosure, which obviously scared the market. Just a few questions, if I may. If we go to Slide 25, what we can see is that you've realized $465 million of productivity gains. And I've noticed - I think this has been happening for a long time. If it wasn't for those productivity gains, it implies that the cost base would have been up some 7%. How long can we see this bank continue to basically extend that much money? And then on that, with the salary increases being $135 million, which itself is a 1.7% increase in the cost base year-on-year, have you actually accrued anything for the pay rises that you're about to put through, under what you've actually offered the staff?

Ross McEwan

Well, first off, Brian, on the $465 million, I think any business has to go through and work through how does it improve its business and its productivity on an ongoing basis. And that's what we've got in the rhythm of doing, of taking costs out as we've invested in the business. And I think we've done a reasonably good job on that for quite some years, even before my time, and we've continued on with that. And we've got - as we've signaled today, we've got to keep doing that. And we see some pretty good opportunities across the business to get better productivity out of using our digital capability and efficiencies that we're investing in the business.

So I think that is practical. We can't keep doing that. Salaries, yes, we have - we're right in the middle of going out to our own colleagues on a pay deal on an enterprise agreement. There are some things in that agreement, that we were hoping to achieve, which I think will be beneficial both to colleagues and to the organization over the long term, because that agreement is, as I described it, the FSU is about 30 years old, and it still has some arrangements, that are way back to, when we even had bankers in an airport, which we no longer have. And few other items like that, including things like leave loadings, which I thought went out some time ago.

So we're looking to actually tidy it up and actually put a better structured agreement for our colleagues and for ourselves. Now there is a cost in that. But we're having to bring on people at higher rates now. So there's no reason why we shouldn't be passing it through to our own existing staff. But you know you got to go after productivity every cost.

We're examining very clearly in this bank and looking for ways of changing the shape of the bank. But yes, we haven't accrued anything going forward. It is just a cost of doing business going forward, the increases we put through.

Brian Johnson

So Ross, the way we should interpret that slide. We've got whatever the opening accrual is for long service, annual leave everything. And then just looking at the other side of it, you said there's a $140 million increase in depreciation and amortization year-on-year. Your capitalized Asian threshold on your software is actually quite low relative to your peers. And we keep on seeing the balance rising quite high to your peers. Does this basically - absent some kind of restatement at some point in time, does this just embed a higher starting point of operating cost growth, that would otherwise be the case?

Ross McEwan

Yes, it does, it does. And Brian, the only numbers I look at are the real cost of running the business, because everybody puts on all these other strange-looking numbers that they justify why their costs were lower than they actually were. So I just gave to the - what was the real cost of running the business. And we've - we all know that there's a greater cost coming through this year than there was last year that we're going to have to work our way through. And we - but I think look at the true number at the end number of true costs, including remediation, including EU, that's the number the shareholder pays for, no matter which way you put it.

Gary Lennon

Brian, the core premise of your question is true. And all the banks said, we're in an interesting period, where we are having to invest more. You've got to - it would be, I think, a pretty high risk strategy to not be investing in digitization, simplifying, investing in data.

So that's something I think we're just going through a phase, that there's a higher level of investment on that, and that's for the health of the bank and the health of the franchise and the whole industry going forward. On top of that, for us, we've been fortunate that we've seen some pretty solid growth opportunities that we've been - or we have made the decision to back in those growth opportunities and invested in more bankers in Andrew's business.

And then on top of that - so that's sort of already in-built that you've got some multiyear momentum on costs. Then we've got the EU with AUSTRAC and now inflation coming through, which is the pay increases. So there's just a series of fronts, all for slightly different reasons, but adds up to the current situation. And as Ross said, it just means that it's got to be absolutely imperative to go hard on productivity, to see how much of these headwinds you can offset. But when you're not doing pay increases and then having higher attrition is false economy.

As we all know. So there's with - long and hard fought and not spending money to get out of the EU, that would be a very short-term decision. So we feel like we're making all the right decisions. So that just does mean there's a lot of moving parts in terms of our cost headwind for FY '23.

Brian Johnson

Gary, say, if I were to sit in your seat, mate, I've been looking at that software capitalization threshold up and rising. But going on to the next one, Gary, absolutely fantastic disclosures, which is awesome, sharp contrast with some of your peers, it seems to be everything will be all right. But if we have a look at all your analysis that's done on a cash rate peaking at 3.6%. And then when I have a look at the forecast right at the very back, interest rates go back down. The problem is that, when I have a look at what financial markets are telling me, they're still telling me the peak interest rate is around 4%.

Would 4% materially make everything worse, because if you think about it, that would be a higher proportion of the home loan book that faced dramatically higher repayments? And as things get worse, history tells us that everything actually becomes more correlated. Can you share some insights as to what 4% would mean as opposed to $3.6 million?

Gary Lennon

Yes. And we used the $3.6 million just to line up with our economists' view of the terminal rate, and that's where the 3.6% comes from. I totally can see that - who knows where that terminal rate is going to land between 3.5% and 4%. And so we've been very aware of this fact and in fact, this question. So we have rerun these numbers at 4% for exactly the reasons that you've highlighted, Brian, and it doesn't make much of a difference.

So there's a bit of a modest uptick in at-risk customers, but I'd say there's no massive cliffs that they're getting for - this falls over or no exponential increase in the at-risk customer cohort. So the 3.6% threshold was a pretty reasonable one to report, I think, to zero in on the key at-risk areas.

Brian Johnson

Gary, that observation, as everything becomes more correlated than anyone ever expects?

Gary Lennon

Actually it will, but not over the - I don't think 4% is a trigger point.

Brian Johnson

Okay. Thank you very much.

Operator

Thank you. Your next question comes from Richard Wiles with Morgan Stanley. Please go ahead.

Richard Wiles

Good morning. Just a question on margins. You've said that in the mortgage market, you're not competing as aggressively. There are players who want this more than you do. You've also said that in business lending, where you're overweight, you're not seeing the same lending margin pressures in the consumer book. So given those two sort of favorable factors, can you explain why your margin expansion in the last quarter is pretty similar to Westpac and less than ANZ? Shouldn't you actually be getting better margin outcomes, given your stance in mortgages and your position in business banking?

Ross McEwan

Well, probably some of that will be a little bit of timing, because it has only been the last two or three months that the mortgage market we've been off being onetime systems. So that has very little impact on the book. You're probably talking less than $1 billion out of $300 billion and something, probably one point would be the major one there. So I wouldn't have seen much difference coming through and the timing of that, Richard, would be the only one I'd think about. And we've probably been doing more funding than they have...

Gary Lennon

That's key. Part of this Ross, is the...

Ross McEwan

Haven't been in the market as much.

Gary Lennon

Our premise would be, Richard, this is somewhat of a timing difference. And could - your observations are true. We are trying to be disciplined and less focus at system growth at all costs in housing, which is incredibly intense in the competition and spreads are challenged and really looking to grow in SME and maybe a bit more in CIB. What's happened this period, it goes to my earlier comments, if you take one of our peers that's overweight New Zealand, that's been quite a good place to be given where interest rates are in New Zealand. So there's additional tailwinds for that.

There could be additional problems down the track in New Zealand, so it might be timing on that front. But that's one reason. They also had more foreign currency deposits than we had and also they weren't in the funding markets. As we've had, they didn't get that headwind, but they will have to going forward. And Westpac a little bit the same, where we've been far more active in funding markets.

They do have a decent deposit franchise and a larger deposit franchise than ours. So they will probably get some of the benefits earlier, but I expect this to be somewhat timing, as our business mix, together with the discipline does bode well for our margin performance over time.

Richard Wiles

Okay. That's helpful. Thank you. And just one further question. Can you tell - I know it's sort of early days, but can you tell us what proportion of your maturing fixed rate customers in the mortgage market that you've retained over the last half?

Gary Lennon

Yes. It's - so it is small. I think it's like 15%, $16 billion over 100 and something is sort of what's matured. And our current run rate - and we hope to get better from this actually, but our current run rate is around about 85% retention.

Richard Wiles

Thank you.

Operator

Thank you. Your next question comes from Azib Khan with E&P. Please go ahead.

Azib Khan

Thank you very much. First question on margins. Just going back to the very first question from Jarrod. Gary, it sounds like you're suggesting that the NIM increase from the third quarter to the fourth quarter is a better guide to the NIM trajectory into first half '23, compared with the exit margin. But you've also said on Slide 24 that the estimated benefit of cash rate increases from October '22 is expected to be lower. So is the quarterly - is that quarterly NIM expansion from the third quarter to fourth quarter, is that a good guide going into first half '23? And is the reason why you expect a lower benefit from October '22, because of greater pass-through, through to rate-sensitive deposits and a shift in deposit mix?

Gary Lennon

Yes, there's a little bit in that question. So I would put forward that a quarterly NIM is the best exit NIM, not that it's not an exit NIM because of how is it defined over that time period, but I'll leave that for a moment. Yes, the 10 basis point uplift, I do think it's the best guide and then as we head into '23, there will be a whole bunch of things occurring in tandem. So yes, for future rate rises, the incremental benefit from future rate rises are starting to come down from that sensitivity of 2%. But what is also heading in the positive direction, is why we only got the 10 basis points from unhedged in the first half.

It's just timing around when those rate rises occurred, and we get a full half benefit for that, as we go through the full half, first half of next year. So that's an additional tailwind plus the additional 10 basis points on the replicating portfolio. That's why I think we - when you add all that up, we're exiting the year with strong upward trajectory on NIM, and with some other benefits to play out.

Another reason why I think it's not unreasonable to think that the first half will be the best half of the sector, is a lot of the negativity takes and a lot of the headwinds will take a little while to click in and may well be second half or even FY '24 issues, whether that be some of the earlier questions on really aggressive deposit pricing coming through, further migration of deposit pricing, continued cumulative impact of home lending margin decline. All that will take a little while.

There'll be some of that in the first half, it takes a little while. And so I think that will be a much bigger factor in the back end of '23, when the tailwind from higher interest rates is moderating, and these other factors are starting to increase. That would be my sort of hypothesis, on how it could play out.

Azib Khan

Thanks Gary. Just another question on margins. So the NIM waterfall shows a seven basis points drag from lending margins. Can you please tell us how much of that 7 bps is due to rate lag and how much is due to front to back book?

Gary Lennon

Well, there is a little bit in there on rate lag. It's sort of just a bit of reality of - there's always going to be some in these declines. So I don't tend to over-index calling them out. It's probably in the order of three basis points relates to rate lag.

Azib Khan

And the remainder will be Australian mortgage front to back book?

Gary Lennon

Yes. And New Zealand as well. So Australia and New Zealand flowing through that as well.

Azib Khan

So I think previously, Australian mortgage front and back book was running at about 3 bps per half, at least in the first half. So that's been largely unchanged headwind?

Gary Lennon

The data I see is definitely increasing. But you're somewhat right. It ends up being a cumulative, but it's definitely increasing in the last half.

Azib Khan

Okay. Thank you.

Operator

Thank you. There are no further questions at this time. I'll now hand back to Mr. McEwan for closing remarks.

Ross McEwan

Thanks very much for joining. It's nice to have people in the physical here today, so long that may continue. Yes, thanks for joining, Gary and I, good solid result here today and a nice clean one as well, which we're aiming to continue to give to you. The business is performing well, and as - we're making decisions about where we put our funding to maximize returns, but also look after our customers. Costs are an issue for every business in Australia and we are very focused on making sure that we get the productivity out of this business, as we invest very well in it.

But again, thanks very much for joining us. And as said, nice to see you physically today. Thank you, Sally, for organizing.

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National Australia Bank Limited (NABZY) Q3 2022 Earnings Call Transcript