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Edited Transcript of CGF.AX earnings conference call or presentation 8-Feb-21 10:30pm GMT

·64 min read

Half Year 2021 Challenger Ltd Earnings Call Sydney Feb 9, 2021 (Thomson StreetEvents) -- Edited Transcript of Challenger Ltd earnings conference call or presentation Monday, February 8, 2021 at 10:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Andrew Tobin Challenger Limited - CFO * Richard J. Howes Challenger Limited - MD, CEO & Director * Stuart Kingham Challenger Limited - Head of IR ================================================================================ Conference Call Participants ================================================================================ * Andrei Stadnik Morgan Stanley, Research Division - VP * Anthony Hoo CLSA Limited, Research Division - Research Analyst * Ashley Dalziell Goldman Sachs Group, Inc., Research Division - Equity Analyst * James Cordukes Crédit Suisse AG, Research Division - Research Analyst * Kieren Chidgey Jarden Limited, Research Division - Analyst * Matthew Dunger BofA Securities, Research Division - Research Analyst * Nigel Pittaway Citigroup Inc., Research Division - MD & Head of Pan-Asia Diversified Financials and Insurance * Shaun Ler Morningstar Inc., Research Division - Equity Analyst * Siddharth Parameswaran JPMorgan Chase & Co, Research Division - Research Analyst * Simon Fitzgerald Evans & Partners Pty. Ltd., Research Division - Executive Director of Diversified Financials ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Welcome, everybody, to the Challenger 2021 First Half Results Presentation. Following the presentation, we will open the call for questions. (Operator Instructions) I'll now hand over to Challenger's Head of Investor Relations to open today's session. -------------------------------------------------------------------------------- Stuart Kingham, Challenger Limited - Head of IR [2] -------------------------------------------------------------------------------- Good morning. I'm Stuart Kingham, Challenger's Head of Investor Relations, and welcome to our 2021 online half year results briefing. In a moment, I'll ask Richard Howes, Challenger's Chief Executive Officer, to open today's session. The presentation will be followed by a question-and-answer session. Could I please remind those, asking a question, just to clearly state your name and the organization you represent when asking that question. I'll now hand over to Richard. -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [3] -------------------------------------------------------------------------------- Thanks very much, Stuart. I'll commence the presentation by providing some highlights of the half year, both financial and strategic. I'll then talk about the success of our growth and diversification strategy, and how the bank acquisition that we announced late last year will see us continue this growth and help us achieve our vision of providing financial security for retirement. I'll then hand over to Chief Financial Officer, Andrew Tobin, for a more detailed look at our financial results before making some final comments on the outlook. I'm pleased with the start we've made to financial year 2021, and I'm optimistic about the opportunities for our company going forward. Our strategy of diversification has delivered strong growth and business momentum. We're on track to achieve our profit guidance for the full financial year. We're strongly capitalized, and we have appropriate portfolio settings in place to take the business forward. We'll continue to prudently deploy our excess cash and liquid investments over the second half. We're excited about our acquisition of a bank, which we announced in December and expect to receive the regulatory approval for as early as March. It will allow us to significantly enhance our offering to retirees in the form of government-guaranteed term deposits. The familiarity of this product will enable us to acquire more customers directly and at earlier stages in their journey to retirement. The bank will be an important driver of growth over the medium term. Our financial performance was in line with expectations. Normalized net profit before tax was down 14% to $196 million compared to the previous half, while statutory net profit after tax was up significantly to $223 million. It included the partial reversal of the negative investment experience from the pandemic related sell-off. Challenger's financial performance in the first half of the 2021 financial year reflects steps taken to move to a more defensive investment portfolio setting in the earlier stages of the COVID-19 pandemic. These resulted in significantly higher levels of cash and liquidity. As we had flagged, we're prudently deploying this excess liquidity position. We're halfway through this process. Reflecting this, pretax normalized ROE was 11.5% for the half. We expect this to increase as we continue to deploy the balance of our excess cash and liquid assets. Group assets under management grew strongly, up 13% during the half to $96.1 billion. Our Funds Management business achieved market-leading growth with net flows of $6.4 billion. There was also good growth in the Life book, particularly in the second quarter. It was driven significantly by index plus net inflows, reflecting new clients and an expanded product offering. The growth in the Life book demonstrates the benefit of the diverse products and distribution channels that we've built. Institutional sales, Japanese sales and retail lifetime annuity sales, primarily through independent financial advisers, all contributed to this growth. Life has $1.5 billion in excess regulatory capital, ensuring we're in a strong position. Our PCA ratio of 1.63x remains above the top end of our target range, being 1.3 to 1.6x the minimum amount set by APRA, and our CET1 ratio is 1.09x. These settings are appropriate given our growing and broadening customer franchise, reflecting the Board's confidence in our business performance and the strength of our capital position, it has declared $0.095 per share dividend fully franked. Overall, the outcomes for the first half demonstrate the Challenger has emerged from the COVID-19 crisis in a strong position, well-placed to take advantage of opportunities to grow our business through our continued focus on providing our customers with financial security for retirement. To achieve that goal, we continue to make good progress implementing our strategy in the first half. At the end of last year, the federal government released its retirement income review, highlighting the need for better solutions in retirement. The growing focus on retirement solutions reinforce the important role that we play in addressing this need for retirees. To help make this a reality for more Australians, we continue to work with super funds as they've develop tailored offerings for their members in retirement. At the same time, we're improving the experience we provide for customers. We've upgraded our investor online portal and simplified and enhanced the rollover processes, which is driving strong reinvestment rates among our direct customers. Our Funds Management business remains the fastest-growing Australian active funds manager and is making great progress in exporting its compelling offer into offshore markets. We continue to explore new boutique opportunities for Fidante Partners and to support the rollout of new CIP asset management products. Our fourth pillar, maintaining leading operational and people practices is critical to our success. I'm proud to say that throughout the COVID-19 crisis, we maintained high employee engagement as measured through regular pulse check surveys. Our risk culture remains strong, and our commitment to gender equality was recognized with our inclusion in the Bloomberg Global Gender Equality index for the second year running. Through this strategy, we've created a compelling product offering for our customers to support our vision to provide financial security for retirement. Our Funds Management business offers customers strong returns through investments in equities, alternatives, real estate and fixed income. The business supports people through their working lives as they accumulate wealth, and when they get into retirement. Our Life business with market-leading annuities alongside institutional retirement solutions, provides guaranteed income for older Australians, converting savings to income throughout retirement. As part of a balanced portfolio, our Life products provide financial security and peace of mind for many Australians. The combination of the Funds Management and Life businesses have helped support customers in their journey -- in their retirement journey. We have market-leading positions in both businesses. Both have continued to grow over the past half year, both have diversified their income streams. Challenger is a company with strong business momentum, operating in a conducive environment. The federal government's retirement income review released late last year, highlighted the importance of finding better solutions for retirement, and that's precisely what we do. As I mentioned earlier, our Funds Management business is the fastest-growing active manager in the country, significantly outpacing all its major rivals, including Fidante where net flow's triple. These market-leading organic flows were driven across retail and institutional. Our performance in retail was particularly noteworthy, with net flows up 32% compared to the previous 6 months. Our leading retail distribution capability was recognized by Zenith Investment Partners in naming Fidante, Distributor of the Year. Zenith highlighted the quality of the boutiques and their ratings across the product suite. They recognize the growing funds under management, excellence in reporting and the quality of adviser support. In our Life business, Challenger remains the #1 provider of annuities in Australia. This chart clearly illustrates the success of our long-standing strategy to diversify our product range and broaden our distribution channels. Over the past 5 years, we've achieved compound annual growth in sales of 11%, and we've done this during a period of major disruption that dramatically impacted our term annuity sales. Our sales composition has changed deliberately and significantly, and we believe we're well-placed to continue to grow from here. We've been successful in building and broadening our activity with institutions, and we've continued to benefit from our partnership with MS Primary in Japan. We've also been successfully building new relationships with independent financial advisers and will now benefit from the stabilization in the adviser market that we're now seeing. We're now further strengthening our offer for customers with the addition of a banking license. As you may recall, we announced the acquisition of MyLife MyFinance a small ADI in December. I'm looking forward to adding term deposits to our customer offering in the near future. The familiarity of government guarantee and term deposits will enable us to acquire more customers directly and at earlier stages in their journey towards retirement. Together with other product development opportunities, this will drive growth over the medium-term and beyond. A bank provides a natural complement to our business, and it will directly support our purpose to provide customers with financial security for retirement. We're still progressing through the regulatory approval for the bank acquisition. It's important that we integrate the business well, including from a risk and compliance perspective. We're working hard to make the integration as seamless as possible for customers, for employees and for all stakeholders. It's a highly strategic acquisition for Challenger and reflects our confidence in the broader role that guaranteed products will play in retirement and the growth that we will enjoy as a result. The bank will provide us with direct access to customers, both in retirement and earlier in their journey toward retirement through the $1 trillion term deposit market. Term deposit sales are less reliant on retail financial advice, and a familiar and trusted products as well as being government guaranteed. Owning a bank also provides us with future product innovation opportunities, and we're confident that we can leverage Challenger's existing leading capability and brand to take full advantage of these over time. This acquisition is a powerful demonstration of our appetite for growth and our willingness to pursue broader opportunities. It shows that we'll make prudent investments for the longer-term with a clear commitment to building on our leading position in providing financial security for retirement. I'll now hand over to Andrew to go through the financial results in more detail. -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [4] -------------------------------------------------------------------------------- Thanks, Richard, and good morning, everyone. As you have already heard today, our first half 2021 financial results reflect the strong business momentum that we have derived from our strategy to diversify our product offering and distribution footprint. The results also reflects Life's prudent investment portfolio settings and capital position that have been maintained over the half. Given the significant changes to Life's investment portfolio following the COVID-19 market-related sell-off in the second half of last financial year, the most meaningful observations in this period's results after the last sequential half being 2H, '20 rather than 1H, '20. The key callouts in the slide pack have therefore been prepared on this basis with the 1H, '20 data also included for completeness. Looking at the group result on this chart, the main headlines are as follows: net income for the period was $325 million, down $50 million or 13% compared to the second half of 2020, driven by Life cash operating earnings, which were down by 17%. Funds Management income was relatively stable over the half with higher management fees, offsetting a fall in performance fees. In response to the revenue outcomes, we remain disciplined with our expense management, with expenses declining by $16 million or 11% compared to 2H, '20. Expense reductions related mainly to non-personnel costs, including occupancy, travel and entertainment, marketing and advertising and professional service fees. Overall, group net profit before tax declined by $32 million or 14% compared to 2H, '20 to finish at $196 million broadly in line with our expectations. The EBIT margin of 61% declined by 90 basis points and normalized pretax ROE was also lower at 11.5%. The ROE outcome reflects lower earnings in the half and higher average levels of capital following the equity that we raised in June last year. Now looking at the group results in some detail. The decrease in normalized profit before tax from $228 million to $196 million was primarily driven by a $33 million lower contribution from normalized capital growth in the Life business. This was due to the change in investment portfolio composition and a lower capital growth factor applied to the alternatives portfolio for the half, which has no overall impact on statutory profit. In addition to the decline in normalized capital growth, Life's cash earnings fell by $17 million, which was broadly offset by expense savings of $16 million across the group. Normalized net profit after tax was $137 million, down $15 million or 10%, reflecting lower pretax earnings and an effective tax rate of 30% compared to 33% in 2H, '20. In terms of statutory profit, which includes valuation movements on Life's assets and liabilities, we posted a positive investment experience profit of $87 million after tax, representing the partial reversal of prior period negative investment experience, and I will provide further details on this shortly. Overall, we posted a statutory net profit after tax of $223 million for the half. Moving on to the key headlines of Life's financial performance. Total sales for the period were $3.4 billion, up 10% on 1H, '20. And pleasingly, we generated solid sales uplifts across all product categories. The annuity book posted a net inflow of $158 million, and other Life sales posted a net book growth of $551 million, translating into overall Life book growth of $709 million or 4.7%. This was a strong reversal of the net outflow that was reported in 2H, '20. Life earnings before tax decreased by $46 million to $193 million, reflecting lower cash operating earnings, as I have already outlined, offset by expense savings of $4 million, and Life's normalized return on equity was 12.5% for the half, below our through the cycle target, reflecting the prudent investment portfolio settings that were in place over the half. Let me talk through Life's key business drivers in a bit more detail. Firstly, focusing on sales. Given the seasonal nature of our sales profile between the 2 halves, the sales charts show a more meaningful comparison to the prior corresponding halves. Total Life sales increased by 10% to $3.4 billion, with annuity sales contributing $2.2 billion and other Life sales, $1.2 billion. Domestic annuity sales were $1.6 billion, representing an 11% increase on the PCP. Domestic term sales were 2% higher at $1.3 billion supported by a more stable advisor market and good reinvestment rates supported by both independent financial advisers and also direct customers. Pleasingly, we saw lifetime sales of $347 million, representing an increase of 64% compared to PCP. Lifetime growth was supported by increased penetration into the IFA segment and reinsurance of a closed lifetime portfolio from an institutional client. MS Primary sales increased by 15% to $543 million and represented 25% of total annuity sales for the half. We expect the Japanese sales volumes to moderate in the second half and glide toward the minimum annual volume agreed with MS Primary, which is JPY 50 billion or approximately $700 million per annum. Other life sales representing Challenger's institutional guaranteed index plus products were $1.2 billion, up 5% on PCP, supported by a number of new clients and expanded product offering. The line on the chart represents the percentage of long-term sales being domestic lifetime and Japanese sales. We had a record period of long term sales, which represented 41% of total sales, up from 35% in the PCP. This next chart shows the composition and context of the Life book growth that has been generated. Total Life book growth was $709 million or 4.7%, and this was largely driven by other Life inflows of $551 million. The total growth compares favorably with prior periods over the last 5 years. The annuity book increased by $158 million or 1.3% of opening liabilities, supported by the 12% annuity sales growth in the half. The maturity rate on the annuity portfolio was 16% in the half, and we are forecasting this to fall to between 11% and 12% in the second half, reflecting the seasonal nature of our past sales profile. The overall positive book growth reflects the product and distribution diversification that has been constructed over the last couple of years, including expanding our relationship with MS Primary in Japan, an increasing focus on institutional sales opportunities and working with a wider range of independent financial advice networks. Challenger is focused on growing its long-term annuity portfolio as it embeds significant value. This chart highlights the component parts of Life's total annuity and other liabilities, which now stands at $15.8 billion, up from $15.6 billion in the PCP. The increased volume of Japanese sales, combined with the lifetime sales meant that the new business sales tab was 9 years in the half. This metric has increased from 6.5 years back in 2016. The continued shift to longer-term annuities has resulted in the combined lifetime and Japanese policy liabilities, now representing 46% of the total Life book. It is now larger than our term annuity portfolio at 35% for the first time, and this proportion has nearly doubled over the past 4 years. The Japan policy liability value has now increased to $2 billion. Pleasingly, the institutional index plus fund liabilities grew by 25% over the half to $3 billion and now represents 19% of the Life book. This is represented by the green section on the bar chart. Turning now to Life's investment portfolio. A key observation is that there has been no material change to relative asset allocation since June 30, and the investment portfolio is in good shape. The investment portfolio increased by $1.3 billion to $19.6 billion at December 31, reflecting net book growth, positive valuation gains and retained earnings. The fixed income portfolio has grown by $800 million to $14.8 billion, representing 76% of Life's total investment assets, which is consistent with the allocation at June 30. Life targets to hold at least 75% of the fixed income portfolio and investment-grade exposures and the actual investment-grade being 86% at December 31. This reflects the defensive portfolio settings, including the elevated levels of cash and liquids in the portfolio. We started the half with $3 billion of cash and liquids and are being gradually deploying this excess holding during the half. This can be seen on the left-hand side of the chart with the cash holding at balance date, falling from 16% at June 30 to 11% at December 31. It is important to note that the average cash balance in 1H, '21 of 13% was higher than the average of 2H, '20 being 11%. This is shown in the far right bar charts and informs the earnings profile in 1H, '21 compared to 2H, '20. The credit performance was resilient in the face of the uncertain COVID-19 market environment as well. In fact, we saw a net reversal of credit defaults in the period, equating to 9 basis points on the portfolio. The property portfolio was unchanged at $3.3 billion, with the asset allocation falling by 1 percentage point due to the growth in the overall investment portfolio. Property valuations were relatively stable in the half and I will highlight this further shortly. The alternatives and equities and infrastructure asset categories, both increased by approximately $200 million in the period, with the relative portfolio allocations being similar to June 30. Alternatives represent 4% of the portfolio and equities and infrastructure represent 3%. There are a number of components to the margin movement in the half. The key takeaway, though, is that the margin reflected the portfolio composition and high levels of cash and liquids that were held at the start of the year. As this is gradually deployed over the second half, we are forecasting the margin to improve from the 1H, '21 position. Now looking at the detail. The 1H, '21 COE margin was 2.55% and decreased by 55 basis points compared to 2H, '20. The attribution of the change can be seen on the chart as follows: the normalized capital growth contribution was the most material change, declining by 35 basis points. This was due to the asset allocation changes made to Life's investment portfolio at the end of last year and a reduction in the normalized growth factor for the alternatives portfolio from 3.5% last year to 0 from July 1, 2020. Lower earnings on shareholder funds impacted the margin by 6 basis points due to lower interest rates, and a lower product cash margin of 14 basis points was generated. As noted on the chart, the key movements in the product margin were as follows: other income fell by 13 basis points due to the 2H, '20 period including a one-off Life Risk revenue of $10 million from an early contract termination and lower investment yield across the portfolio of 39 basis points, following the compositional change to the investment portfolio, and elevated levels of cash and liquids held compared to prior periods. Offsetting this decline in margin were lower interest expense of 27 basis points due to the lower interest rate environment and product mix and a yield uplift of 11 basis points from the partial deployment of the opening cash and liquids balance into high-yielding assets during the half. As I've noted, the continual and gradual deployment of Life's excess cash position in the second half the year is expected to support an increase in the 2H, '21 yield by 20 to 30 basis points, and this is shown on the far right of the chart. I'm also pleased to highlight that our property portfolio is performing better-than-anticipated at the start of the year. We are now forecasting full year rent reductions of $10 million to $12 million from abatement negotiations compared to $22 million that we forecast at the start of the year. This next slide outlines the breakdown of pretax investment experience profit for the period. The $238 million gain in fixed income -- in the fixed income portfolio represents a positive valuation outcome of $200 million from credit spread movements in the half, $25 million of normalized growth and $13 million from the recovery of prior period defaults. The valuation uplift represents the reversal of a significant portion of the unrealized valuation losses recognized in 2020 as a result of the COVID-19 market-related impact portfolio. The $43 million investment experience loss on property mainly reflects a small valuation loss of $10 million compared to our assumed normalized growth assumption of 1% or $33 million for the half. All the direct properties were again independently valued at December 31, consistent with our approach at June 30. This resulted in small valuation downgrades in the retail segment of the portfolio largely offset by minor uplifts in the office portfolio. No properties were sold in the period, and so all of the valuation loss is unrealized. The equity and other infrastructure gain of $34 million reflects a $42 million valuation gain on the portfolio, reflecting higher domestic and global equity markets in the half, offset by a normalized capital growth expectation of $8 million for the half. The alternatives portfolio, consisting of absolute return funds and general and life insurance exposures, posted a neutral investment outcome for the period. Sub asset category valuation movements offset each other, and we assume no normalized capital growth on the alternatives portfolio. And looking at policy liabilities, the total valuation loss here was $104 million, represented by a $172 million loss from the illiquidity premium component of the discount rate used to value policy liabilities, offset by a gain of $64 million on interest rate and inflation hedging outcomes and a $4 million contribution from a net reversal of new business strain on sales. Overall, we reported a pretax investment experience profit of $125 million for the half. Turning now to capital. Challenger Life company's position remains strong with $1.5 billion of excess regulatory capital, broadly consistent with the excess position at June 30. The group also held $137 million of cash in addition to this capital. Challenger Life company's regulatory capital base of $3.9 billion increased by $379 million over the half. This reflects Challenger Life's retained earnings, additional equity injected via the share purchase plan proceeds and the net increase in additional Tier 1 capital following the issue of Challenger Capital Notes 3. The prescribed capital amount increased by $448 million over the half. This was mainly a result of deploying Life's excess cash and liquidity balance at June 30 into high yielding assets, including fixed income, equities and alternatives as well as the increase in investment assets driven by the book growth that was generated in the period. The capital intensity increased from 10.7% at June 30, to 12.2% as a result of the asset allocation changes made. Amidst the uncertain market conditions from the pandemic over the half, it was pleasing that S&P also recognized Challenger Life's capital strength in the period and confirmed CLC's A rating. Looking at CLC's capital ratios on the next slide. Consistent with our planned actions to deploy the excess cash and liquids balance in the period, the PCA and CET ratios both fell over the half. The PCA declined from 1.81x at June 30, to 1.63x at December 31. This is significantly above APRA's minimum requirement of 1x and remains above the upper end of our target, 1.3 to 1.6x range. The common equity ratio declined to 1.09x compared to 1.2x at June 30. As noted in now MyLife MyFinance bank acquisition announcement on December 31, we plan to distribute $100 million from CLC in the March quarter to fund the acquisition and capital requirements to support growth of the bank. This is expected to reduce CLC's PCA ratio by approximately 4 basis points on a pro forma basis. Our plan is to continue to deploy the excess cash and liquids balance into primarily investment-grade fixed income opportunities in the second half. Following these actions, CLC's regulatory capital ratio is expected to remain around the top end of the target PCA range over the course of FY '21. Now turning to funds management. Net inflows for the half were very strong at $6.4 billion with Fidante partners net inflows near tripling compared to PCP to $5.8 billion and CIP asset management recording net inflows of $659 million. Average funds increased by 7% over the half to $85.9 billion, with a 9% increase from Fidante Partners and a 1% increase in CIP asset management. Given the strong total net flows, it is important to highlight the record closing fund balance of $91.2 billion, which is 6% higher than the average fund for the half. Net income was $81 million or 1% higher than 2H, '20, noting that Funds Management generated $8 million or 11% increase in fund related fees, which was offset by a $6 million decline in performance-related fees. Disciplined expense management saw $5 million of savings compared to 2H, '20, and overall Funds Management's pretax profit was $35 million, up $5 million or 18% compared to the 2H, '20. Looking more closely at Fidante Partners. This slide shows the breakdown of retail and institutional flows as well as providing an overview of investment performance. The chart on the left shows the $5.8 billion of net Fidante flows split into retail and institutional net flows. We saw a record $1.9 billion of retail net flows and institutional net inflows were $3.9 billion for the half, mainly weighted to fixed income allocations, and this was supported by an 11% increase in the institutional client base over the half. The charts on the right outlined for data partners investment performance. 54% of funds achieved first or second quartile performance over 1 year and 81% of funds have achieved first or second quartile performance since inception. Another way to look at performance is relative to benchmark. This is also a very strong outcome with 76% of FUM outperforming benchmarks over 1 year and 88% outperforming over 5 years. And finally, turning to dividends, reflecting the confidence in future business performance and strength of our capital position, the Board has declared an interim dividend of $0.095 per share fully franked. The dividend represents a 46.6% payout of normalized EPS and is within the Board's target payout ratio of 45% to 50% of normalized earnings. With the dividend reinvestment plan in place, the net cash dividend payout ratio is expected to reduce by approximately 2%. So in conclusion, our results today are in line with our expectations set at the start of the period. They reflect the compositional changes that were previously made to Life's investment portfolio, prudent deployment of Life's excess cash and liquids investments during the half, very strong growth in Funds Management net flows and FUM, and also disciplined expense control. The business outcomes also demonstrate the momentum that it's building from a more diversified distribution and product offering, which means that Challenger is well placed for future growth. I will now hand back to Richard for his comments on strategy and outlook before rejoining the call for the Q&A session. Thanks, Richard. -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [5] -------------------------------------------------------------------------------- Thanks very much, Andrew. So as Andrew has demonstrated, we've really turned a corner following a period of significant disruption and are now well placed to grow from here with a strong balance sheet and significant sales momentum in both Life and Funds Management. We're focused on building on this momentum across our Funds Management, Life and banking businesses. Looking first on our non-guaranteed businesses. Funds Management forms a very exciting part of Challenger's future. We expect its contribution to earnings to grow. We will achieve that through organic growth from existing boutiques as well as via new boutiques and partners. We're expecting growth to come from North America, Europe and Asia as well as from Australia. I'm confident we can leverage our leading distribution capability to keep growing funds under management at industry-leading levels. During the next 6 months, we'll complete our program to deploy Life's excess cash and liquidity position, and we'll maintain appropriate investment portfolio settings that reflect our growing and broadening customer franchise. The Life business has emerged from the disruption to the industry in good shape. We'll continue to deepen our relationships with independent financial advisers and increasingly deal directly with customers through enhanced digital capabilities. We expect that our strategy of partnering with super funds to develop retirement solutions for members, will create new opportunities. The federal government in its retirement income review late last year emphasized the need for better outcomes for retirees, and Challenger is well placed to contribute to the industry's response. During the next couple of months, we expect to complete the acquisition of We'll then integrate the bank into the broader business. We will expand the bank's current term deposit suite by offering a wider range of tenors that are focused on achieving -- and we'll be focused on achieving breakeven for this business in FY '22. The acquisition signals our willingness to invest in growth opportunities. It's emblematic of the type of investments we will make in the future, and I'm confident that we could accelerate our growth over the medium term. We're on track to achieve a full year result within our FY '21 guidance range of $390 million to $440 million, reflecting our prudent deployment of Life's excess liquidity position, earnings are expected to be weighted towards the second half of this year. Our key through the cycle targets remain unchanged, and we expect normalized pretax return on equity to improve as large liquidity and capital is deployed. As you would expect, we'll not reach our target this year given the gradual deployment that we've already taken. We enter the second half of 2021 in good shape, having withstood industry and COVID-19 related disruption of recent years. Our strong performance in Funds Management, momentum across Life, and new opportunities in our banking operations means that Challenger is well placed for future growth. Thanks very much for your time. Andrew and I will now take your questions. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) The first question comes from Simon Fitzgerald from E&P. -------------------------------------------------------------------------------- Simon Fitzgerald, Evans & Partners Pty. Ltd., Research Division - Executive Director of Diversified Financials [2] -------------------------------------------------------------------------------- The first question I have relates to the rental abatements, the revision from $22 million to $10 million to $12 million. I was just wondering, firstly for you to elaborate how much of that may have been spent in the first half '21, but also with the additional $10 million to $12 million in rental yield, I imagine it's not really a enough to warrant a revision to your guidance, but had you thought about sort of bumping up or at least revising the guidance given the change in the rental abatements? That's the first question. -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [3] -------------------------------------------------------------------------------- Simon, it's Andrew here. I might grab that question. Thanks very much for the question. So we've called out today that an improvement in the rental abatement expect the start of the period, as I mentioned on the call, we expected $22 million, and we revised that guidance to $10 million to $12 million. So overall, you can think of that broadly is about 1/2 of that taken in the first half, 1/2 in the second half. It's quite immaterial in the scheme of the overall results. And the second part of your question in terms of guidance, all of these things feed into our guidance thinking at this stage, we're comfortable with our guidance range and reaffirming that today, noting that there are a number of things that go into determining the outcome across the period. -------------------------------------------------------------------------------- Simon Fitzgerald, Evans & Partners Pty. Ltd., Research Division - Executive Director of Diversified Financials [4] -------------------------------------------------------------------------------- Okay. That's clear. The second question regarding the deployment of cash into higher-yielding fixed income assets. At the moment, I can see that you're targeting $1 billion in the second half of '21 and remembering that the full amount you were going for previously was $3 billion. I was just wondering, so have you spent a little bit more than a gradual deployment for the first half '21? Maybe you could just sort of elaborate terms of how much has been spent so far versus what you've got left to do? -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [5] -------------------------------------------------------------------------------- Thanks for the question, Simon. Yes, look, we're about halfway through that deployment. So we've put about $1.25 billion into fixed income. We've also made some investments into equities and alternatives. We have about 1/2 of that deployment into fixed income to go. So I'm comfortable that the way we're deploying that is consistent with both what we said during the capital raise and then also what we said at the full year results when we last spoke. -------------------------------------------------------------------------------- Simon Fitzgerald, Evans & Partners Pty. Ltd., Research Division - Executive Director of Diversified Financials [6] -------------------------------------------------------------------------------- Okay. And just one final question. Again, it relates to the redeployment. I do recall at the time that you first started talking about this. Credit spreads have probably moved pretty significantly since then. I think the A grades are down 61% since sort of April last year and B grade down around 48%. Can you talk about what this means for your target of 20-plus returns when you first started talking about the redeployment of capital into high-yielding fixed income assets, please? -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [7] -------------------------------------------------------------------------------- Yes, sure, Simon. And totally fair question given the way the extent to which markets are moving around. So we've deployed the capital in the way we said we would, and the returns we're generating are in line with those that we said that we would return. So you're right to remind participants on the call that the guide we've given there was in deploying the capital we've raised and in redeploying the $3 billion of excess cash and liquidity into higher-yielding assets, we would generate at the margin ROEs in excess of 20%, and we're very much on track to do that. No doubt, tighter spreads makes that more challenging at the margin, but I remain comfortable with the lead we gave you guys on that. -------------------------------------------------------------------------------- Operator [8] -------------------------------------------------------------------------------- The next question comes from Matt Dunger from Bank of America. -------------------------------------------------------------------------------- Matthew Dunger, BofA Securities, Research Division - Research Analyst [9] -------------------------------------------------------------------------------- First on costs, Andrew spoke to of $16 million from the expense savings. Can you talk about, Andrew, when these were implemented. Have we seen the full period benefit in the first half? And also, any expected costs and the timing of those on the banking, Life and material cost uplift? -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [10] -------------------------------------------------------------------------------- Yes. Thanks, Matt, for the question. So I called out specifically some categories of expense, if you like, so lower marketing and advertising, travel entertainment, occupancy, et cetera. There's run rates that will still continue to play out in the second half that we'll benefit from. The point to your question around the bank is that we've called out specifically in sort of the guidance statements in the analyst pack, the impact of the bank. That will be about $3 million of sort of profit before tax impacts, assuming that we sort of take ownership of the bank at the end of that March period and have ownership for the first quarter -- sorry, for the June quarter. Therefore, that will have about a $3 million sort of loss impact in the current period of time. So that's probably the way to think about it. -------------------------------------------------------------------------------- Matthew Dunger, BofA Securities, Research Division - Research Analyst [11] -------------------------------------------------------------------------------- Great. And if I could just ask a follow-up question on the Japanese sales. You were talking about expanding the relationship with MS&AD, but how do you expect their incentivized to do more than the $670 million of sales per annum, which you've got locked into the next 5 years? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [12] -------------------------------------------------------------------------------- Matt, thanks for the question. It's Richard. I might grab that one. So the thing we're calling out in this result is that the sales performance through our partnership with MSP has been going very well. In part, that reflects how strong MSP's sales outcomes in the December quarter, for example, have been into their market, and there are benefits both to Challenger and to MSP in the reinsurance arrangements. So both sides of that benefit from the business that is written. That said, we're basing our planning on the minimum contractual requirement of JPY 50 billion, which at average exchange rates over the reporting period, as you point out, corresponds to around AUD 670 million . I mean clearly, we're achieving run rates in excess of that. So it would be unsurprising if we exceeded it ultimately, but our planning is based only on that minimum at this stage. -------------------------------------------------------------------------------- Operator [13] -------------------------------------------------------------------------------- The next question comes from Kieren Chidgey from Jarden. -------------------------------------------------------------------------------- Kieren Chidgey, Jarden Limited, Research Division - Analyst [14] -------------------------------------------------------------------------------- Just a couple of questions, if I could, starting with the ROE target. You're at 11.5% in first half '21. And Andrew, I think you flagged a 20 to 30 basis point uplift as you fully redeploy into higher-returning classes in the second half of '20 in terms of life margins. As on my numbers, that will put you on track for around 13%, so still shy of the 14% group target. So just wondering what else sort of is required across the group to get you back in that target range at group level on ROE. Is it just the full run rate once you've fully deployed that capital? Or are there other things actually required to boost it? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [15] -------------------------------------------------------------------------------- I'll take that, Kieren. Thanks for the question. So I think you're right to call out that the main feature of the likely ROE outcome for this year is just the excess of cash and liquidity and excess of capital and gradual deployment thereof throughout the period. So in other respects, as I look at the ROEs that we're generating on the investments that we're making, those are in line with the 20%-plus ROE guidance that we gave during the capital raise and the results announcements. Taking a step back from that, it's worth bearing in mind that these are through the cycle. This is a through-the-cycle target. And so tighter spreads at the moment, it makes that at the margin more challenging than it might otherwise be. And it's also worth just reflecting on our intention based on the growing and broadening customer franchise to remain around that top end of our target range. And in that sense, it's important to consider the lower-risk characteristics of the -- of our earnings profile in that context when you're thinking about that. -------------------------------------------------------------------------------- Kieren Chidgey, Jarden Limited, Research Division - Analyst [16] -------------------------------------------------------------------------------- Okay. And so the ability to get back to target or above target in '22 at this stage, you're saying it's more reflective of where credit spreads are at this juncture? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [17] -------------------------------------------------------------------------------- So we've not changed that target. That remains our through-the-cycle target. It's a function of where spreads are at the time we deploy and a range of other things. So it's worth thinking about in that broader context, I suppose, Kieren. -------------------------------------------------------------------------------- Kieren Chidgey, Jarden Limited, Research Division - Analyst [18] -------------------------------------------------------------------------------- Okay. And second question, and apologies, I might have missed the comment. But sort of related to Japan, obviously, you've done a fair chunk of your sort of full year minimum agreement with them through first half, probably around 80%. So just interested in comments on sort of full year basis, whether or not, given they are experiencing higher sales based on your commentary more generally, there's scope to drive that $670 million this year. And secondly, given the stronger sales coming out of Japan, where you think the maturity rates on the overall book would hit into '22. I know you flagged 27% to 28% for this year, but just interested in any commentary beyond that. -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [19] -------------------------------------------------------------------------------- Okay. Thanks, Kieren. Yes. So I think given where we are in terms of the run rate, it would be unsurprising if we were to once again exceed that minimum contractual volume of JPY 50 billion, but our planning is based on that -- those minimums at this stage. It's obviously a function both of how strongly MSP's foreign currency annuity business is performing in Japan as well as the quota share dynamic between our 2 organizations. So very happy with and pleased with how that's performing and wouldn't be surprised if it eclipses, but -- as it's done previously, but our planning is based on the JPY 50 billion minimum. Kieren, just remind me what the second part of your question was. -------------------------------------------------------------------------------- Kieren Chidgey, Jarden Limited, Research Division - Analyst [20] -------------------------------------------------------------------------------- Just on maturity... -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [21] -------------------------------------------------------------------------------- On the maturity rate, sorry. -------------------------------------------------------------------------------- Kieren Chidgey, Jarden Limited, Research Division - Analyst [22] -------------------------------------------------------------------------------- Yes, Richard. Yes. -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [23] -------------------------------------------------------------------------------- So yes, I think the thing to bear in mind is that the maturity rate was sort of front-ended in this half. So we have lower maturity rates into the second part of the year. So it will drop to sort of 11% to 12% for the second half. And then I think in some of the modeling I've seen amongst analysts out there, a lower maturity again in FY '22 would be a reasonable thing to expect as well. -------------------------------------------------------------------------------- Operator [24] -------------------------------------------------------------------------------- The next question comes from Anthony Hoo from CSLA (sic) [CLSA]. -------------------------------------------------------------------------------- Anthony Hoo, CLSA Limited, Research Division - Research Analyst [25] -------------------------------------------------------------------------------- Can I just ask a couple of questions? Firstly, just on the bank acquisition, you talked a little bit about it in Slide 10. But can you also talk about what sort of ROE you expect from the business particularly in relation to your group target and also what sort of capital levels you aim to hold there? And then secondly, just following on from the earlier question, just around your maturity profile of your annuities, outside of the strong sales in Japan, just wondering what -- can you give us some insight into what gives you your confidence around FY '22? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [26] -------------------------------------------------------------------------------- Great. Anthony, thanks for the questions. So we will think about the bank in terms of the returns we target for that in the same way that we think about the broader group. So our ROE target of 14% above the RBA cash rate will apply to that business as well. Now obviously, it's a subscale balance sheet at the moment with assets and liabilities materially less than $200 million and lower sort of capital accordingly. And that's why we're flagging FY '22 as being how we're thinking about the timing of breakevens. But the -- in terms of how the ROE and capital intensity works, it's instructive to look at our fixed-term annuity business as kind of an economic analogy to that. We'll be using the same lending franchises and investment capability, if you like, on the fixed income side to build the investment strategy for the asset side of the ADI. And then in terms of capital intensity, it's -- there are differences at the margin. In particular, capital tends to be a lot more stable for the ADI given the book value mechanics of the capital regime. But in terms of the capital charges for asset risks, they're similar. So there's a lot of good comparisons that can be drawn to the fixed-term annuity business in terms of how its -- the profitability signature and capital intensity and so forth will work for the ADI. Anthony, the second question you asked was around maturity rate and what gives us confidence there. The weighted average tenor of the business we wrote over the half was 9 years, and that has remained high for a long period now. It reflects, among other things, record lifetime annuity sales in the period, significant contributions from our MSP partnerships, as you've called out. In many ways, our purpose to provide financial security for retirement revolves importantly around our ability to provide a lifetime of income to Australian retirees. So I'm optimistic about the role we can continue to play in that regard, and that will continue to translate into long-term liability writing. -------------------------------------------------------------------------------- Operator [27] -------------------------------------------------------------------------------- The next question comes from Ashley Dalziell from Goldman Sachs. -------------------------------------------------------------------------------- Ashley Dalziell, Goldman Sachs Group, Inc., Research Division - Equity Analyst [28] -------------------------------------------------------------------------------- Just an initial question on the GIR sales, obviously, another pretty strong result in the December quarter. Recognize some of the commentary today around efforts to really build out that distribution plus some new client relationships seem to be being developed on that product. It's been a volatile sort of sales product or item for you, but just given some of the increased focus and efforts on the distribution for that product, are you able to help shed kind of any light for us on what a sort of normal run rate is likely to be there going forward for sales? And then secondly to that, are you able to help us just with a sort of spot refresh on the margin differential of those sales relative to the domestic lifetime product, please? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [29] -------------------------------------------------------------------------------- Yes. Thanks, Ashley. It's understandable. You sort of focused on index plus/GIR given the success we've been having in recent periods, not just this half but others in recent times. And what that sort of is emblematic of is that the payoffs, if you like, from our strategy to deliberately diversify our distribution efforts. In this case, it is still the case, as you're alluding to, that institutional business like this will tend to be lumpy. So it's difficult to predict exactly what it's going to be period-to-period. But some of the things I reflect on in feeling good about that business and its trajectory is that there's a broader range of institutional customers that we have participating in those products. And the product range itself broadens. So we have different tenors but also different -- and different reference indices and different collateral pools. So recently, one of the innovations that we have brought in is that the collateral pool includes annuities themselves, which means we're able to offer even higher rates of guaranteed alpha against the index over longer tenors. And we're finding that that's attracting a broader range of customers at longer tenors. Now importantly -- so I'm definitely comfortable with the way that side of the business is growing, albeit that it will continue to be lumpy and difficult to predict half period to half period. As to your question on margin, it's -- the interesting thing here is that the margin achievable will be a function of the collateral pool, the tenor, and both of those things will in turn drive the capital intensity of that particular tranche of the product, which then will in turn drive margin because as with all of our business, we didn't -- what we -- the way we run the business is in targeting ROE outcomes and being informed by the ROE that will be driven by our pricing. And so particularly for this type of product and comparing this type of product to, say, our retail annuities, for example, the margins can be quite different, but the ROE is similar. -------------------------------------------------------------------------------- Operator [30] -------------------------------------------------------------------------------- The next question comes from Nigel Pittaway from Citi. -------------------------------------------------------------------------------- Nigel Pittaway, Citigroup Inc., Research Division - MD & Head of Pan-Asia Diversified Financials and Insurance [31] -------------------------------------------------------------------------------- Just a quick question actually on Slide 19 if I could. I mean obviously, there, you are flagging the 20 to 30 basis points improvement from redeploying assets. I mean I'm just checking that, that is gross of any sort of roll-through of sort of a negative impact from lower spreads. And if that's the case, just whether there's any other sort of items other than that sort of 20 to 30 basis point benefit, the roll-through of lower spreads that you think would be meaningful for sort of thinking about margins in the second half. -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [32] -------------------------------------------------------------------------------- Nigel, it's Andrew here. So yes, 20 to 30 basis points is the expectation from the continued deployment of a cash and liquids balance that we've got. So it does reflect our expectations of the margins that we can generate in the second half recognizing the current spread environment. So there's no one-offs -- to your question as well, there's no sort of one-off Life Risk items that may pop up that we've called out specifically in this current period's sort of margin comparison. So it's a complete sort of read-through of the expectations of a normal sort of deployment of that cash and liquids balance. -------------------------------------------------------------------------------- Nigel Pittaway, Citigroup Inc., Research Division - MD & Head of Pan-Asia Diversified Financials and Insurance [33] -------------------------------------------------------------------------------- So just to be clear there, is that just the redeployed cash and the sort of margins available? If you look at the rest of the book, you still got to factor in spread, contraction, roll-through on the rest of the book rather than the cash being redeployed. Am I thinking about that correctly? -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [34] -------------------------------------------------------------------------------- Well, it's the cash deployment or the margins we're generating from that cash being deployed. If you think about the product margin in the period, other than the sort of the lower other income item that we've called out, being the Life Risk change, there really wasn't a contraction in that product cash margin. And so the 20 to 30 basis points, the best way to think about that is the expectation of the excess cash and liquids that we're deploying in the second half. -------------------------------------------------------------------------------- Nigel Pittaway, Citigroup Inc., Research Division - MD & Head of Pan-Asia Diversified Financials and Insurance [35] -------------------------------------------------------------------------------- Yes. Okay. So you're saying everything else neutralizes back because presumably, it's things like less competitive term deposit pricing, that sort of stuff that sort of flows all through that? -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [36] -------------------------------------------------------------------------------- It's -- yes, it's a factor of different things in there, but that's right. There's nothing that we think about that's one-off in nature that will impact the second half. -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [37] -------------------------------------------------------------------------------- I mean, Nigel, the only -- maybe the only slight nuance to call out in terms of the impact of deployment on margins and profit generated is it's kind of easier in the case of fixed income because you're just -- other than what the default rates turn out to be from 1 half to the next, it's predictable. To the extent we've deployed some money into equities and alternatives, you can have timing differences in terms of when and where that -- those returns turn up. So there's a -- in terms of what the impact is in any 6-month period, you've just got to bear that in mind. -------------------------------------------------------------------------------- Operator [38] -------------------------------------------------------------------------------- The next question comes from Siddharth from JPMorgan. -------------------------------------------------------------------------------- Siddharth Parameswaran, JPMorgan Chase & Co, Research Division - Research Analyst [39] -------------------------------------------------------------------------------- Just a couple of questions if I can. Firstly, just on the bank, the chart you showed is quite helpful. It shows that there's about a 40, 50 basis point boost to, I suppose, just the cost of selling term deposits versus actually selling annuities. I was just wondering, I mean, looking forward, are we likely to think that really, you could replace most lines that you're selling today and put them into the banking environment? I mean because that 40 to 50 basis points is probably just a worst-case improvement that you get. Presumably, it's even better for things like the wholesale products you sell. Maybe if you could just comment on how we should think about the future of the life company. Is it likely to be actually that most of this -- most of what you're going to be selling in the future is going to be through the bank? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [40] -------------------------------------------------------------------------------- It's a good question, Sid. And just the one thing to highlight in making those comparisons, we're comparing to average term deposits there, and we will operate the ADI with a view to ROE outcomes. To the extent that we've been in a position where we've been able to offer fixed-term annuity rates above what average term deposit rates are, we see that will translate into an attractive product offering that we can offer retirees and pre-retirees. It's a much bigger market as well, a $1 trillion term deposit market. And so we can see really important growth prospects there. It may be that for some advisers and some customers, they'll prefer to take a term deposit rather than a term annuity. There will be other customers for which term annuities still remain their preference, for example, rolling money from a super fund into a term deposit keeps it within the tax umbrella of the super system. And that can be not impossible, but it can be a little more complicated in the terms of -- in terms of term deposits. So we expect both businesses to continue, but we're definitely open eyes on the fact that term deposits will be a preferred product to term annuities for some customers. And our -- what we're aiming at here is the broader opportunity and that the growth we expect from the ADI and from term deposit growth will far eclipse any drop in term annuity sales. -------------------------------------------------------------------------------- Siddharth Parameswaran, JPMorgan Chase & Co, Research Division - Research Analyst [41] -------------------------------------------------------------------------------- Okay. And if I could just ask a question on your discussions with APRA around running your investment mix through a bank. We don't see this for any bank that I'm aware of anywhere globally that runs kind of investment mix that you're proposing to run through the bank. Just could you just comment on how -- what their thoughts are on this, whether there's any implications for liquidity and also whether you'd propose dropping your normalized approach to investment -- I mean, your normalized approach to reporting profit? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [42] -------------------------------------------------------------------------------- Okay. So yes, that's a smart question. And just to clarify what we meant in terms of using our investment capability within the life business to assist the asset strategy on the ADI side, we're really talking about our lending franchises there and our fixed-income investment capability. And that's very well suited to a bank balance sheet. In many ways, a bank is built to borrow from depositors and lend those out -- lend those deposits out to households and businesses. So we -- you wouldn't expect to see exactly the same balance sheet not by any stretch. So it would be unlikely you'd see commercial properties and equities owned on the ADI balance sheet, for example, but some of the lending activity that we do on the life balance sheet is very relevant and applicable to that environment. -------------------------------------------------------------------------------- Siddharth Parameswaran, JPMorgan Chase & Co, Research Division - Research Analyst [43] -------------------------------------------------------------------------------- Okay. That's quite clear. So basically, there'll be more risk assets in the life company, that's the way we should think about it. -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [44] -------------------------------------------------------------------------------- Well, yes. So the more capital-intensive assets, which equities and property obviously represent and alternatives represent, yes, you would expect that to be -- those not to be a feature on the ADI balance sheet. The life company will still continue to have fixed income within its investment portfolio, but the ADI with generally lending activity. One question you also asked there was normalized earnings. Sid, as you know, the purpose of normalizing our earnings is to remove the period-to-period volatility associated with credit spreads and other investment market risk premiums moving around because the bank reporting regime is essentially a book value regime or a historical cost regime. There's less of a need to normalize those earnings. So you won't expect to see the same reporting framework that we use in life reported across. -------------------------------------------------------------------------------- Siddharth Parameswaran, JPMorgan Chase & Co, Research Division - Research Analyst [45] -------------------------------------------------------------------------------- Okay. And just a final question for me. Just the GIR products where you pay -- after expenses, you pay a margin over reference index rates, I mean how can this economically work? Maybe if you could just explain the logic of that, please. -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [46] -------------------------------------------------------------------------------- Yes, sure. So I mean in the same way that on a fixed annuity, we pay a margin above swap to the customer or a margin above the government bond rate that we talk about, our lifetime annuities, for example, paying customers around 130 basis points over government bond rates. So -- and then the way we economically make money in that case is that we're capturing the spread difference between that 130 basis points above the bond rate and then the total investment return we make across Statutory Fund 2 and Statutory Fund 4. And then it's that spread that drives our profitability. Likewise, you can think about GIR as having a certain cost of funds. So we promised to pay -- let's take an example, the Morgan Stanley Capital Index, net of withholding tax, plus a certain small modest margin. We will then go into the swap markets and hedge out the MSCI risk. And so then we're left with a margin to BBSW in that case as a cost of funds. And then the collateral pool that we back that liability with is a range of credit assets typically, the spread of which is higher than the cost of our hedging costs plus the margin that we're paying to the customer. So it's similar to the annuities business. It's about capturing the spread between what our assets earn and what we're promising to pay, including hedging costs. -------------------------------------------------------------------------------- Operator [47] -------------------------------------------------------------------------------- The next question comes from James Cordukes from Crédit Suisse. -------------------------------------------------------------------------------- James Cordukes, Crédit Suisse AG, Research Division - Research Analyst [48] -------------------------------------------------------------------------------- I just have 2 questions. The first on the guidance, it's quite a large range especially if we consider the implied second half guidance. We can see there's a big step-up in the COE margin in second half. What are some of the other swing factors you're thinking about that could see you hit the top or the bottom of the range? And what's holding you back from narrowing it? -------------------------------------------------------------------------------- Andrew Tobin, Challenger Limited - CFO [49] -------------------------------------------------------------------------------- James, it's Andrew. I might take that question. So there's a number of things that go into sort of thinking about guidance. It's the same range as we've had in the -- in prior periods. So that's one thing to note. We're halfway through the year, so it's -- again, it's probably a bit too premature to sort of narrow and pinpoint the range at the moment. We've also delivered a pretax profit today of $196 million, which is about, I think, 47% or thereabouts at the midpoint of that guidance range as well. So we are calling out the fact -- the expectation is that the earnings will be weighted to the second half. That really represents the gradual deployment and further deployment of that excess cash and liquids position that we've highlighted today. But there's always going to be a number of potential ups and downs that determine the results. Richard mentioned before distributions from the equity and alternative portfolio or property rentals. There's a number of different things that go into our thinking. And as we progress throughout the period, we'll sort of get more comfort around that. But we think today, it's still appropriate to maintain that guidance range. Now the other items that we've called out today and discussed today is the bank. There's an impact that we're expecting of around about $3 million in the second half result, minor in the scheme of things, but this is just another example of things that can move around a little bit. -------------------------------------------------------------------------------- James Cordukes, Crédit Suisse AG, Research Division - Research Analyst [50] -------------------------------------------------------------------------------- Yes, all right. And look, just second question, the retirement income review came out last half. Has that provided a bit more clarity to some of the large funds to start moving forward? And how are your discussions going with those funds around distribution arrangements? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [51] -------------------------------------------------------------------------------- Yes. Thanks, James. So as you would know, we've been in conversation and running workshops with large super funds for really a number of years now. So we've been part of -- I'd like to think part of the process of funds in the industry coming to terms with the differences between retirement and accumulation. There is -- and those conversations are very productive. Certainly, it's the case that the focus on the retirement phase that the retirement income review has created is bringing more focused attention in that area. It's worth saying that it's difficult for the funds to move ahead in a precise way without clarity on exactly what the covenant is going to look like, draft legislation for that. In many ways, these funds are creatures of legislation. So as productive as our conversations have been and given the importance of the retirement phase, it is important from a product policy perspective that we continue the journey and get clarity on what that covenant will look like. -------------------------------------------------------------------------------- Operator [52] -------------------------------------------------------------------------------- The next question comes from Simon Fitzgerald from E&P. -------------------------------------------------------------------------------- Simon Fitzgerald, Evans & Partners Pty. Ltd., Research Division - Executive Director of Diversified Financials [53] -------------------------------------------------------------------------------- Just a quick follow-up question in regards to the bank. You did talk about how sort of that driving medium-term earnings. So I was just wondering if you could add a little bit more detail in terms of, is this going to be from new products that you expect to offer? Are you going to be targeting sort of customers pre-retirement? And maybe you could also touch on whether -- the sort of current asset pools that you have at the moment, whether that can support a higher TD rate that's currently being offered by MyLife MyFinancial (sic) [MyLife MyFinance]? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [54] -------------------------------------------------------------------------------- Yes. Thanks for your follow-up question, Simon. And perhaps just taking a little bit of a step back, it's worth mentioning that the possibility of an ADI within Challenger is something we've looked at quite a lot and over a number of years. We've looked at, for example, the counterfactual of building and applying for a license ourselves. And the opportunity to acquire MyLife MyFinance represented an opportunity for us to get a contemporary fit-for-purpose license and core banking system or it uses Temenos T24, which is a very contemporary system, and really very fit for our purpose and gives us a platform to build the capability that we want on there. Also to say that it has a functional term deposit offering in the market at the moment, not as competitive as, say, our term deposit rates, and we think we've got a role to play in improving that competitiveness. And we also see that there's an opportunity to access broader distribution channels as well. So an important feature of our strategy, which I alluded to in the presentation, is that we will be targeting the direct market more. So the familiarity in government guarantee that goes with term deposits puts us in a position where we can more directly acquire customers than has been the case within our annuities business. It also gives us an opportunity to bring on board customers and provide solutions to them earlier in their journey towards retirement. That's not to say that we're deviating from our mission to provide financial security for retirement, but we've got an opportunity here to build relationships with customers earlier. There are product innovation opportunities that will avail themselves in due course, as you're alluding to. But our real focus in the shorter term is around term deposits and broadening out the range of channels that we can go to market with that. So that's -- we will continue to go into the advice market. It gives us an opportunity to go directly. There are deposit broker markets, which have been very productive for some of the non-major bank -- regional banks and neobanks in recent times. And that will be an opportunity for us as well. So that's how we're thinking about the immediate-term growth, but then longer term, there will be opportunities for product innovation as well. -------------------------------------------------------------------------------- Operator [55] -------------------------------------------------------------------------------- The next question comes from Andrei Stadnik from Morgan Stanley. -------------------------------------------------------------------------------- Andrei Stadnik, Morgan Stanley, Research Division - VP [56] -------------------------------------------------------------------------------- I wanted to ask 2 questions. Firstly, on shifting some of the strategy towards the bank, do you see an opportunity to drive faster growth in term deposits than in term annuities. And particularly given how big the term deposit market is but also given how aggressively banks have been actually reduced in price in term deposits, recently, we saw a good example of that this morning with Suncorp as well that -- the margin benefit they got from really reducing the price unveiled to their customers. So do you think the term deposit market, else combined with the simpler selling mechanisms that's around the statement of advice, do you think there's actually a sales growth opportunity as well? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [57] -------------------------------------------------------------------------------- Yes. Andrei, I do think the timing is really quite good in this regard. It is true that term deposit pricing has been backing off considerably. There's an opportunity for us in continuing to target our ROE targets to be able to price those term deposits competitively and win share. Given, as you say, it's a much bigger market, it's a $1 trillion market, there are other channels, which we can avail ourselves of that have been less the case in term deposits, for example, the deposit broking channel. And it's also true that some of the channels that we exist -- that we use currently for term deposits can be simpler from -- sorry, term annuities can be simpler in terms of term deposits. So for example, a financial adviser only needs to issue what's called a record of advice versus a more compliance-laden statement of advice in talking to their clients about term deposits. So the anecdotal feedback -- well, and the feedback from the work we've done with advisers suggests that there's good prospects there. Likewise, our institutional channels can also represent a market for term deposits. So I do think both in terms of broadening the reach more generally but also in terms of the timing that it's a good time to be implementing this initiative. -------------------------------------------------------------------------------- Andrei Stadnik, Morgan Stanley, Research Division - VP [58] -------------------------------------------------------------------------------- Can I ask sort of a second question on the Funds Management? So it's delivering very strong flow momentum, but it's fairly -- has a fairly modest impact in terms of group profit. Like what do you think you need to do to translate for the Funds Management business to have a bigger impact at group level? And in particular, you alluded to seeing more wins out of North America and Europe. Does that mean you're happy to look for inorganic growth opportunities in North America and Europe? -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [59] -------------------------------------------------------------------------------- So it's pleasing that the earnings outcomes from FM have been growing, and that's on the back of strong organic growth in net flows. And it's also true that the sources of growth are not just domestic but offshore as well. Not only are we enjoying growth on the back of new boutiques that we bring on board and other partnerships that we create within Fidante, but exporting the capability we have within the Fidante family to Europe and North America and Japan and Asia will be -- there's good opportunities for that going forward as well as opportunities to bring on more managers. So we see FM playing an increasing role from a profitability point of view, and it's a business that scales very well from that perspective. -------------------------------------------------------------------------------- Operator [60] -------------------------------------------------------------------------------- The next question comes from Shaun Ler from Morningstar. -------------------------------------------------------------------------------- Shaun Ler, Morningstar Inc., Research Division - Equity Analyst [61] -------------------------------------------------------------------------------- I guess I'd just like to continue the conversation on the banks. I appreciate that a lot of concerns have been answered, but I just wanted to dig a little bit deeper in the rationale. My understanding was historically Challenger has sought to differentiate itself from TDs, and it seems to be there's some change of tonality over here. So I guess is it wrong for us to think that there will be some form of potential cannibalization given these are solo anyway? Or do you guys expect this to sit side by side with the annuities just to provide more optionality? And I guess the follow-up on that is also, how soon could you expect this channel -- this TD channel to contribute a larger portion of learnings, I guess, given the significantly smaller customer base relative to other banks? So some time frame around here would be great. -------------------------------------------------------------------------------- Richard J. Howes, Challenger Limited - MD, CEO & Director [62] -------------------------------------------------------------------------------- Thanks very much for the question, Shaun. Strategically, the premise for the acquisition was -- is around being able to serve our target customer base in broader ways. We see that guaranteed product issued by both the life company and the ADI have a really important role to play in both the journey to retirement and in retirement for our customers. There is a familiarity that comes with term deposits, which means that a broader range of distribution is available to us. So -- but more than anything, our ability to serve in these broader ways will drive strong medium- and longer-term growth for our business into the future. It will certainly be the case that some customers choose a term deposit over a term annuity. And partly, that's due to the simplicity and familiarity of the product. There'll still be a really important role for term annuities to play and, even more importantly, for lifetime annuities, which uniquely provide peace of mind by ensuring that no matter how long you live, no matter what happens to markets or inflation, those basic living needs can be met. So I think that the 2 guaranteed parts of our business, if you like, life and the ADI, will work very well together in providing financial security for our customers in retirement. -------------------------------------------------------------------------------- Operator [63] -------------------------------------------------------------------------------- As we have no further questions at this point, I'll now hand it back over to you, Stuart, to close today's session. -------------------------------------------------------------------------------- Stuart Kingham, Challenger Limited - Head of IR [64] -------------------------------------------------------------------------------- Great. Thank you very much for your interest in Challenger. Mark and I are available on the phones if you've got any further questions. Thank you, and have a good day. -------------------------------------------------------------------------------- Operator [65] -------------------------------------------------------------------------------- That concludes the Challenger 2021 (technical difficulty)