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Edited Transcript of WBC.AX earnings conference call or presentation 3-Nov-19 11:00pm GMT

Full Year 2019 Westpac Banking Corp Earnings Call

Sydney Nov 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Westpac Banking Corp earnings conference call or presentation Sunday, November 3, 2019 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew Bowden

Westpac Banking Corporation - Head of IR

* Brian Charles Hartzer

Westpac Banking Corporation - MD, Group CEO & Director

* Peter Francis King

Westpac Banking Corporation - CFO

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Conference Call Participants

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* Andrew Lyons

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Andrew Triggs

JP Morgan Chase & Co, Research Division - Research Analyst

* Azib Khan

Morgans Financial Limited, Research Division - Senior Banks Analyst

* Brendan Sproules

Citigroup Inc, Research Division - VP

* Brett Le Mesurier

Shaw and Partners Limited, Research Division - Senior Analyst of Banking and Insurance

* Brian D. Johnson

Jefferies LLC, Research Division - Equity Analyst

* Edmund Anthony Biddulph Henning

CLSA Limited, Research Division - Research Analyst

* James Ellis

BofA Merrill Lynch, Research Division - Director

* Jarrod Martin

Crédit Suisse AG, Research Division - Director and Joint Lead Analyst

* Jonathan Mott

UBS Investment Bank, Research Division - MD and Banking Analyst

* Matthew Wilson

Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst

* Richard E. Wiles

Morgan Stanley, Research Division - MD

* Victor German

Macquarie Research - Analyst

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Presentation

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Andrew Bowden, Westpac Banking Corporation - Head of IR [1]

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Well, good morning, everybody, and welcome to Westpac's Full Year 2009 (sic) [2019] Results Announcement. My name is Andrew Bowden, I'm head of Westpac's Investor Relations. Welcome to all those attending as well as on the video, on the webcast and on the phone.

Before I commence, I would like to acknowledge the traditional owners of the land on which we speak, the Gadigal people of the Eora nation and pay my respects to elders past, present and emerging.

Today, as usual, we're having Brian Hartzer, our CEO present, and then followed up by Peter. And then of, course, we'll open up for questions.

But without further ado, let me get Brian up to the lectern.

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [2]

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Thanks, Andrew. Good morning, everyone. It's obviously been a difficult year for the industry with lower interest rates, lower economic growth, falling house prices, increased competition and a rise in regulatory scrutiny, all putting pressure on earnings, and this is reflected in our result. Having said that, we have actively managed returns, we've made a prudent decision to further strengthen our capital, we've acted decisively to reshape our business and we've effectively executed on our strategic priorities. So while the financial results are below the standards we expect, we're actively dealing with the environment and are setting ourselves up well to be a stronger performer over the next couple of years.

Now let's start with earnings. Reported profit was down 16% while cash earnings were down 15%. The majority of the reported earnings decline related to provisions for customer remediation along with the cost of our wealth reset. For clarity, we're calling these notable items, and they are disclosed throughout our reporting.

The following earnings flowed through to a lower EPS, and the ROE was 10.8%. Notable items also impacted margins and our cost income ratio.

The table at the bottom of this chart shows the underlying picture excluding notable items. On this basis, cash earnings were down 4% due to lower margins, lower wealth and insurance income and increased regulatory and compliance cost.

The cash ROE ex notables was 12.5%, which was down over the year as a function of both lower earnings and a 3% increase in average equity. The margin was lower over both the year and the half, mostly reflecting a fall in deposit spreads and the effects of low rates on both capital and liquidity. The cost income ratio of 43.9% is higher than we would like, but we're still targeting a sub 40% cost income ratio over time as investment costs fall away and productivity benefits come through.

Now turning to divisional performance, we are reporting with our new operating structure, which now has the BT businesses folded into our consumer and business divisions. The group business line includes what was left of the advice business and hence the large loss there. I'll exclude notables in my comments because most of these are in the business division and in the group line.

Consumer cash earnings were 6% lower over the year. The biggest decline was in insurance due to the significant weather events early this year and banking fees were also lower. Higher delinquencies meant that impairment charges were also higher.

Growth for the year was concentrated in owner-occupied mortgages and deposits although much of this was offset by a fall in margins as low rates limited the extent to which we can reprice deposits.

Mortgage growth slowed during the year. This was partly because, with slower system growth, we chose to prioritize margin. But in the second half, we also saw an impact from how and when we implemented changes to the HEM tables as well as serviceability assessment. Essentially, the way we rolled it out made it harder for customers and brokers to do business with us. So in the fourth quarter, we saw applications diverted elsewhere and balances declined.

We've largely fixed the process issues, and applications are picking up again. But with the lag between applications and settlement, this will still be a drag in the first half. I expect we'll be back at growing around system by the end of the financial year.

Business division results were down 2% over the year, which was mostly due to lower wealth earnings and higher regulatory and compliance costs. The software wealth earnings are from a combination of platform repricing moving early to remove grandfathered commissions and some of the MySuper migrations. Individually, these items were small, but collectively, they added up.

On the lending side, business credit demand remains soft. Asset quality declined a little, but mostly deterioration was in watchlist and substandard facilities. Few new companies migrated to impaired, and as a result, the impairment charge was lower.

Overall, though, I'm pleased with this business. We're #2 in market share and #1 on NPS in commercial, SME and micro business segments, and we have a strong platform for when growth returns.

WIB's result was impacted by the loss of Hastings income and from an accounting change to derivative valuation adjustments. If you take out these adjustments, the result was largely flat. WIB has continued to be very disciplined on pricing and return this year, and that has seen us walk away from some business that didn't meet our risk or return hurdles. With slower new growth and companies continuing to pay down debt, lending was lower over the year. However, we continue to have a very strong position in infrastructure, government and green energy lending.

New Zealand had a solid result with good growth across lending and deposits, a gain on the sale to Paymark and lower impairment charges. We've been using New Zealand as an innovation incubator and are beginning to import some of their success, particularly new ways of working in our core product and technology areas.

Now turning to the balance sheet. Strength is always the first priority at Westpac, and all our key ratios are in good shape. We fully funded loan growth with deposits, and this helped our funding and liquidity ratios remain comfortably above regulatory minimums. Our CET1 ratio was little change to 10.7% despite a few capital headwinds that emerged during the year. Asset quality is good, but we have seen a small 12 basis point rise in stressed assets to 1.2% over the year. Impaired assets, however, remain at sector-leading lows.

So given the strong position, the obvious question is why are we raising capital. So let me explain that decision. While our CET1 capital ratio has continued to be above APRA's unquestionably strong benchmark, there were a number of factors that weighed on our ratio this year. These included operational risk capital overlays and a new standardized model for derivatives as well as the impact of customer remediation provisions on organic capital generation. In total, these added up to a 70 basis point drag on CET1.

We're expecting some capital updates from APRA and the RBNZ and potentially for the regulatory action, which may include litigation. With our first priority on strength, we decided, therefore, that it was prudent to conduct the $2.5 billion capital raise through an underwritten institutional placement and a share purchase plan. Over the next 24 hours, we will look to raise around $2 billion from institutions and will then give existing retail investors the chance to participate at the same or lower price. This gets our pro forma ratio to 11 -- to around 11.25% and gives us a good buffer above APRA's 10.5% benchmark. That gives us the flexibility to respond to developments in the year ahead, and importantly, means that we can continue to lend and support our customers regardless of the economic cycle.

Having acted on capital, we then had to consider the dividend. Our approach on the dividend has always been to maintain a payout ratio that maximizes the distribution of franking credits while being sustainable in the medium term. We also recognize the importance of consistency for many shareholders. In this environment, we believe that a sustainable payout ratio is in the 70% to 75% range. Over recent years, we've been willing to run above that level largely because we've had good capital generation and lower asset growth. We've also held the dividend given our excess franking credits. But with the increase in shares on issue and the recent deterioration in the outlook, it would've been hard to get back into that payout ratio within a reasonable time. So rather than make an incremental change, we decided it was prudent to reset. That gives us a more sustainable base, and we'll continue to look at ways we can distribute those franking credits.

The payout ratio sits at 79% for the second half, but ex notables, it's 71%. Our dividend yield in the second half was 5.4%, and after franking, it's 7.7%, which is a good outcome in a low rate environment.

So those are the financial results. Let me now turn to how we've been responding to this new environment. At the beginning of the year, we said we would deal with outstanding issues, and we have. We exited financial planning, we've reshaped our distribution network, we consolidated 61 branches, removed 349 ATMs and entered into an agreement to sell most of our Australian offsite ATMs. That helps reduce fixed assets and cost without impacting service for our customers. It also creates the potential for further savings if our partner is able to establish an industry utility to deliver ATM services in areas where no one bank can justify a presence.

We've streamlined our management structure across both consumer and business divisions. This brings a consolidated approach to driving growth in each state across our brands while eliminating duplication in local management layers. We centralized our remediation activities and raised significant provisions to address a number of historical issues. We are currently around 60% of the way through the known customer issues. We delivered $405 million in productivity savings this year, just above our $400 million target. As part of this, we reduced FTE by 5% despite adding more than 400 people into our risk compliance and remediation projects.

While these initiatives required significant management focus this year, we've continued to deliver important milestones on the group service strategy. Our strategy focuses on delivering against key -- 3 key themes: performance disciplines, service leadership and digital transformation. This year, we've made a number of important changes to the way that we organize and manage our businesses to improve execution discipline and strengthen accountability. On the service side, we've continued to make progress with the #1 NPS position across all main business segments. In consumer, we were #2 for most of the year. We've embedded a strong service ethos across the company and improved our brand positions, which is critical to franchise growth in the future.

I'm particularly pleased with our progress on digital where we achieved a number of important milestones that will help us deliver better service and efficiency in the years ahead. The Customer Service Hub has now been rolled out for Westpac first-party mortgages, with the final lenders converting to the system over the next 2 weeks. Panorama is complete and is now the fastest growing platform in the market with over $23 billion in funds on the platform. We're the first bank to have fully rolled out the new payments platform, and we currently process around 40% of all the value transacted on the NPP.

Technology is increasingly important to our strategy to deliver great service, so let me spend a couple minutes on what we've delivered this year. The first aspect is how we're using technology to shift the digital experience. For our customers, we're delivering a simpler, easier and more personalized experience. Digital usage is up and digital channels are now 40% of all sales. Late last year, we rolled out a fully digital mortgage for our St. George and regional brands. This means a customer can get their mortgage through a mobile phone with a fully digital experience. Bankers use the same technology, and it now represents more than 30% of apps in those channels. Our new online TD renewal process has significantly increased retention. Our new Westpac chat-bot called Red has responded to over 1 million queries and solved 70% of them on the spot. And I'm pleased to say that we are ready for open banking in February.

We're also using digital technology to drive down costs through automation. The Customer Service Hub gives us the rails to automate all of our consumer origination and servicing capability. Next year, we'll migrate other mortgage products and channels onto the platform and then begin to convert our other consumer products. 80% of mortgages are now settled electronically. And earlier this year, we rolled out a new enterprise workflow system that allows us to automate our paper intensive processes.

The other piece of the digital puzzle is our Fintech partnerships. This is important because success in the digital future is going to be about much more than having a cool app. We are actively building partnerships to bring new services to customers and benefit from the technology innovation that's exploding in the whole financial services' ecosystem. Reinventure now has $150 million in invested capital across about 30 companies. On a market value basis, we are already significantly ahead, but the strategic value of these relationships is even more important. On a direct basis, we have significant investments in zipMoney, Assembly Payments and Uno Home Loans. And today, we have announced a partnership with 10x, a state-of-the-art cloud-based banking system that will allow us to expand our digital offer for customers both directly and in partnership with other institutions and Fintech companies.

We've also been building the underlying technology to set us up for a digital future. For some time now, we have been systematically modernizing our architecture across 4 categories: channel or front-end systems, customer data and origination systems, product systems and the underlying infrastructure. You can see on this chart where we're now up to.

On channels, in addition to the digital mortgage and chat-bot, we've upgraded desktop systems in our branches and call centers. The next phase of our mobile banking app is in pilot, and will go live next year. This improves the user experience and gives a big step-up on personalization and value add for customers.

On origination, the Customer Service Hub is the main story, but we've also rolled out a new big data platform that lets us analyze massive amounts of customer data and deliver real-time insights across the bank. And as I've said earlier, we're ready for the next phase of open banking.

On infrastructure, we now have a state-of-the-art hybrid cloud environment, which dramatically improves our processing speed and reducing storage costs. We've upgraded our underlying network backbone, which improves the speed and reliability of our systems. So we've set ourselves up well to compete effectively in a new digital world.

And with that, I'll hand it over to Peter to take you through the details of the result.

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Peter Francis King, Westpac Banking Corporation - CFO [3]

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Well, thanks, Brian, and good morning, everyone. I'll start with a quick recap of the year before turning to trends in the second half. And reflecting on this result, I was pleased with credit quality and balance sheet metrics, but obviously disappointed with our result including the large increases in remediation provisions and the wealth reset costs.

Excluding those items, earnings fell 4% with noninterest income, the big change, and there's 3 primary drivers here. First, our decisions to exit Hastings, financial planning and Ascalon reduced revenue by $308 million. The second was higher claims in general insurance following the large storms earlier in the year. And the third impact was lower platforms and Super income as these businesses continue to reset.

If I turn now to the second half, provisions for notable items were significantly lower, and this saw earnings rise 8%. However, backing out notable items, earnings were down 3%. And touching on the key movements, loans were flat, but we managed margins well. And combined with a better treasury result, interest income rose $95 million. Lower noninterest income included a $41 million charge from CBA methodology changes, a further drop in Advice income and lower fees as activity fell.

Expenses were slightly up as restructuring costs were higher than originally expected. And on impairments while credit metrics were sound, an increase in writeoffs saw the charge rise to 13 basis points of loans.

And moving to notable items, this reduced earnings by $377 million as we allowed for further remediation and wealth reset costs. The larger items included updated estimates for the time value and money in financial planning, further provisions for interest only refunds and additional program costs.

The bottom-left table covers our wealth reset, and the program's going well hitting its major milestone in exiting face-to-face Advice in September. On project costs having allowed for $241 million this year, we expect total costs at the bottom end of the $250 million to $300 million range. The top-right table is the normal disclosure of volatile and infrequent items, and these had no impact as gains from asset sales offset the group's CVA movements.

And consistent with our first half, loan growth was modest with our New Zealand division and Australian mortgages driving growth. And focusing on Australian mortgages, the charts on the left showed $2 billion of growth in the second half. However, this was skewed to quarter 3 with the book contracting in quarter 4. Brian set out the reasons, and they're evident in the lower new flows. There's also been slightly high runoff when we compare it to the fourth quarter last year, and this reflects high refinancing and repayments. There is a little bit of seasonality here.

On the top right, growth is in owner occupied while investor fell 1%. And we also wrote more fixed rate loans with flows of 35%.

The bottom-right table has our mortgage book continuing to reshape with interest only now 27% of the book. This is expected to continue with new flows at around 21%. Looking forward, we have implemented mortgage process improvements in the last 4 weeks. However, these will take some time to improve new flows.

Now margins. Given the volatile markets, I was pleased with the outcome. Adjusting for notable items, margins were 1 basis point lower. And looking at the components, loan spreads were up 1 basis point in our business books. Mortgage spreads were little changed as repricing offset switching and competitive impacts. Deposits were a major driver, with both at core and TD spreads 3 basis points lower. And the chart at the bottom left shows term deposits becoming more expensive during the half.

The impact from short-term wholesale reflected the sharp falls in market interest rates, while lower interest rates also reduced the earnings on capital. The 2 basis points from liquidity reflects high liquid assets, which gives us some flexibility running into 2020. And treasury also had a better performance, and that had 1 basis point here.

The bottom-right table has the balances hedged by the tractor and new information related to low rate deposits in Australia.

And on the markets and treasury where income was up 6%. On the left, while treasury revenue was down year-on-year, it lifted by $47 million in the half, and that was a good outcome. WIB markets also had a solid half with markets customer income up 4% from both FX and fixed income sales. So in summary here, I'd say markets and treasury had a solid half.

And turning to noninterest income, there's a few moving bits. So we've excluded notables, and it was down 5%. Starting on the left, net fees were lower with no large items here, income filling cards, advice, WIB and merchants, mostly related to lower activity. Insurance income rose 6% as general insurance had no claims related to major storms this half, and partially offsetting this was lower life insurance income as TPD claims increased, and we rode off deferred costs following the Protect Your Super changes. This legislative changes impacted the number of accounts and insurance levels.

Trading and other income fell $106 million. Trading income included the $41 million CVA impact I referred to before while other income reflected a swing in fair value of financial instruments and lower GST refunds in New Zealand. Overall, given all the moving bits here, I hope this helps you understand some of the underlying trends.

Our costs this year, they rose 3%, but were down 1% excluding FX impacts and notable items. Hastings was the biggest contributor given its exit in 2018. Business as usual cost was slightly higher than expected as we incurred restructuring provisions late in the half to support our 2020 productivity programs. And our work on productivity delivered $405 million, which was more than offset by BAU cost growth.

Reg and compliance spend increased as we prepared for the Code of Banking Practice invested in financial crime programs, responded to regulatory requests and implemented programs such as IFS and IFRS 9. These were partially offset by lower Royal Commission costs.

Investment costs were flat while amortization rose $91 million, and this reflected the Customer Service Hub, NPP and Panorama.

And touching on second half costs, excluding notable items, they rose 1%, and we saw similar trends here with reg and compliance increasing $95 million while amortization also rose $59 million. We're working hard on productivity taking out $259 million in the half, which included FTE being down 3%. Overall, this sees us well positioned for our productivity targets next year.

And moving to credit, and the book remains in good shape. The left-hand chart shows a small rise in the stressed ratio. The 10 basis point increase reflects higher mortgage delinquencies as well as business facilities migrating in their watchlist and substandard category. Impaired assets remain low and were unchanged this half.

The right-hand chart shows stressed exposures with the largest increase in wholesale and retail trade, and this mostly reflects challenges for motor vehicle retailers as car sales fell. Increases in other sectors, including property and business services and manufacturing, relate to individual customer circumstances as opposed to sector or any sector issues.

On Australian mortgages, they continued to perform well with realized losses of $57 million in the half. In part, this reflects 70% of customers being ahead of repayments including continued growth in offset balances. While we have seen a rise in the 30- and 90-day delinquencies, the pace of change has recently slowed, and 90-day mortgage arrears increased 10 basis points in the first half and 6 basis points in the second half. The rise in properties in position reflects a small increase in new items and slower resolution rates as the property market slowed. So overall, the book remains in good shape with some encouraging recent trends.

And on the impairment charge, it was 13 basis points and reflects good asset quality, but was up this half. Starting on the left, new IAPs of $170 million were flat and, in fact, slightly down on a year ago. Write-backs and recoveries were little changed. However, there's a $26 million gross up between write-offs and recoveries, which we've shown on the chart.

And moving to write-offs direct, these were the key drivers this half. They reflect seasonality, higher order write-offs and lower unsecured debt sales. Other movements in the collective provisions included an overlay reduction of $58 million, and this comprised an increase in agricultural overlays related to the drought, with this more than offset by a reduction in mining overlays as provisions were no longer required or utilized. So in summary here, the trends reflect the good asset quality position.

On capital, the CET1 ratio ended at 10.67%, little changed over the half as organic capital generation offset other items. Capital generation was 51 basis points and included lower IRBB (sic) [IRRBB] as the embedded gain increased as interest rates dropped. Credit risk-weighted assets reduced with volume growth offset by improved credit quality and impacts of FX translation. And in other items, we had a smaller-than-expected impact from the derivative changes at 14 basis points.

On the bottom left, we outlined capital considerations including the 8 basis point impact from the new leasing standard. There's also been a lot of discussion on New Zealand, and the bottom-right chart has our level 1 CET1 ratio after adjusting for recent APRA rules and the expected capital raise. At 11.2%, we feel well positioned for any further RBNZ changes, particularly given the 5-year transition period.

And turning to the outlook, as we said before, mortgage balances are expected to be relatively flat, with the first half '20 likely negative and a return to growth in the second half. Our exit margin ex treasury markets was 2.04%, and it was a little lower in part due to liquidity. Noninterest income is likely to be down with reductions including Advice and further impact from resetting the super and platform businesses. We're also not expecting any significant gains from asset sales in 2020. I'll cover expenses on the next slide, but on asset quality, it is in good shape. But as I've said for a couple of halves, it's unlikely to get better from here.

And excluding notable items, FY '20 expenses are expected to rise 1% reflecting higher amortization and as we boost reg and compliance spending. On reg and compliance, increases reflect a number of programs with the larger ones including financial crime, data and analytics, reporting to regulators, [LIBOR] transitions; and in New Zealand, the BS11 requirements. This uplift is expected to remain through FY '21, [at the end of fall].

Finally, on productivity, we've targeted $500 million and further cost reductions in Advice.

So thank you. And with that, I'll hand back to Brian to sum up.

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [4]

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Thanks, Peter. What I'd like to do now is just talk a little bit about the outlook economically and then some of the considerations we'd like you to think about, about how we're positioning ourselves for the long term.

So in terms of the economic outlook, we're expecting operating conditions next year will continue to be difficult with the background of low interest rates, slower growth and continued regulatory intensity. We anticipate that GDP will improve, mostly driven by government spending. The construction sector continues to contract and consumer spending will be held back by low wages growth. We are, however, expecting some stimulus from tax cuts and low rates, although the impact will be limited by continued softness in the labor market. The sentiment, already a bit fragile. The outlook will depend to an extent on the global backdrop and in particular, whether trade tensions are resolved.

On the housing market, we expect reported sale prices to continue to recover as new supply slows and investors return to the market. This effect will be strongest in Sydney and Melbourne, although in absolute volume terms, the improvement is likely be modest.

We expect system credit to increase by around 3% for both business and housing. Other personal lending is expected to contract further.

Our economists are forecasting another interest rate cut in February, but believe that any monetary stimulus after that will probably take another form.

In the banking sector, we expect a bit more clarity on capital from the regulators, but we also expect more action from regulators and potential litigation, some of which will affect us. While this backdrop will continue to drag on performance next year, we should still see some balance sheet growth without a significant deterioration in credit quality as we work through the remaining regulatory issues.

And before I open up for questions, I wanted to touch on the factors that we think will drive success over the next period. Banking is clearly going through a once-in-a-generation transition, and not all banks are going to be successful. I've already talked about the role of technology, but there are several other really important areas to consider. Scale and strength will be increasingly important. Our scale will allow us to sustain investment in technology, risk and compliance, and the capital and funding strength will allow us to withstand economic cycles. We are #1 or 2 in every major segment, and our balance sheet is in the top tier globally.

To continue to grow our customer base and revenue, we have strong service-oriented brands that aren't reliant on price and the ability to continue to invest in marketing and innovation. And in a war for talent, our strong employment brand helps us build world-class economies of skill in marketing and innovation, data analysis, risk management and technology. It's our combination of strength, scale, ability to invest and focus on brands and talent that will put us in a leading competitive position.

Finally, how we define and measure success in this operating environment is important. So we've set specific goals against which you can hold us to account. I've laid out a few of the short- and longer-term goals on this slide, but let me focus on a few.

First, we're sticking with our medium- to longer-term target of a sub 40% cost income ratio. We still have a hump of regulatory and compliance investment next year, so we've increased our productivity target for 2020. We expect to deliver $500 million in productivity savings, and this is on top of the $200 million we saved from the wealth reset.

Second, we expect to be back growing around system and mortgages by the end of the financial year, and finally, I've put a stake in the ground on NPS. We want to be #1 of the major banks across all of our segments.

And with that, Peter and I will be happy to answer your questions.

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Questions and Answers

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Andrew Bowden, Westpac Banking Corporation - Head of IR [1]

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Let's start with James.

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James Ellis, BofA Merrill Lynch, Research Division - Director [2]

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It's James Ellis from Bank of America. Just a couple of questions. Firstly, in relation to the customer remediation provisions, which have been an ongoing contributor to the pressure on capital. Just to the extent of what you know, how confident do you feel around the adequacy of those provisions?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [3]

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Well, James, we've provided for everything that we know and we can reasonably estimate. That's the short answer. In the sense, it's -- by definition, the unknown unknowns could be out there. This is something we've been working on though for a number of years. You might recall, I talked about get it right, put it right. It's been an initiative we've been running for a number of years. When I look at what we've dealt with this year, we've dealt with financial planning, we've dealt with issues in mortgages, we've dealt with issues in business bank, we've dealt with other issues in smaller [blips] last year or last couple of years. So I feel like we're getting through it. Our focus now is on paying customers back as quickly as we can because the time value money effect is significant, and that will affect what it ultimately ends up being. I guess the wildcard is probably around regulatory actions and whether there are other things that come at us that we need to deal with. But of course, we can never rule out that we might find something else.

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James Ellis, BofA Merrill Lynch, Research Division - Director [4]

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Just second question around the productivity aspiration. Acknowledging that you have stopped 40%, you have stopped with that target, your peers have got various iterations around absolute cost reduction. Not all of them are clear around the time frame, but deliberately. But can you just talk about, in an environment where there are pressures around revenues, which seem to be getting greater over time not less so, what's the efficacy of having a cost to income ratio target close to an absolute one?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [5]

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Well, James, the way I think about that is we're trying to run the bank for the long term and we're trying to acknowledge with that target, which clearly has a revenue dimension to it. And so that's a bit of a wildcard. But we're trying to give an indication that we know we have to run the bank more efficiently to stay competitive, and that is about the relationship between cost and income. We don't feel that an absolute cost target necessarily leads you to making the right decisions along the way because we're really trying to, say, how do we drive more efficiency in these businesses. And as we grow, we may need to invest more in some areas. So I know it's a bit tricky particularly because in the last couple of years, we've had all the variation on the revenue line. But it's really a way of signaling that efficiency is incredibly important. It's a really important part of our priority, and we're driving that through simplification, automation, digitization. We'll continue to do that. I actually feel -- I know that there's a lot of noise in the result. I actually feel the productivity result this year is a really good one. We've worked really hard on this. And I think the absolute reduction of FTE by 5% a year is indicative of the fact that we're making real progress on this.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [6]

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Jarrod?

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Jarrod Martin, Crédit Suisse AG, Research Division - Director and Joint Lead Analyst [7]

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Jarrod Martin from Crédit Suisse. Could you give a bit more color on the issues you've had in mortgage business and what has caused the slowdown in growth? I understand there was implementation of new HEM tables that didn't go well. And if I heard you correctly, most of this happened, in fact, in 4Q, and they're being fixed now. Why is it going to take an entire year to get back the system? Why wouldn't system growth come in the second quarter if applications takes sort of 3 months? Why is it going to take a full year to get back to system?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [8]

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Well, Jarrod, I guess we're trying to give an indication of where we're headed. I mean there's a lot of -- we still have to make tradeoffs in terms of volume and margin and the like, and obviously, it's a really competitive market at the moment. The short answer to the delay is the lag effect as applications build up. It takes a while for them to flow in. And we've got work to do in a number of areas. So we feel like that's -- if we can get there faster, we will, but I don't want to be completely focused on volume growth because we still are making margin tradeoffs along the way. But as an indication, I think that's where we're getting. The way you characterize, it's a pretty accurate summary of what happened. We had new HEM tables plus the new HEM tables that we collect data, the expense categories at a more detailed level. And so there was a tool put out to the brokers in particular around how we needed to collect that data. The tool was, frankly, pretty clunky, so we've gone back and reworked that. It's a better experience now. And as I said, we're seeing the applications rise.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [9]

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Andrew?

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Andrew Lyons, Goldman Sachs Group Inc., Research Division - Equity Analyst [10]

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Andrew Lyons from Goldman. Just 2 questions. Firstly, just on your margin. You've provided some commentary around the exit NIM versus the half NIM. Can you provide any more commentary around how the trajectory trended in October with the rate cut? And then just secondly, your economic profit disclosures highlight you've held on to your 11% cost of capital assumption. Just 2 questions. Have you had any consideration of reducing this given the rate environment? And then secondly, just given one of your domestic peers has been progressively reducing this over the last 12 months, have you seen any noticeable change in the competitive environment, particularly within institutional banking?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [11]

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Why don't you talk about margin, and I'll do the second one?

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Peter Francis King, Westpac Banking Corporation - CFO [12]

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We've given what we can in terms of margins. So in particular, I'd highlight the new disclosure on low rate deposits in Australia on the margin slide. One of the challenge, I think, that you could see it in the half's result how volatile the different parts of the margin were, and we're just going to have to see what the first half looks like because we're dealing with movements in market rates, competitive impacts both in lending and deposits. So I wouldn't want to indicate something for October because I just think the whole half will be very different depending on how the industry navigates this future period. But I think we've given a lot of information so that you can hopefully understand the balance sheet piece. So no, I didn't want to add anything on October.

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [13]

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And on the cost of capital, this is a bit of an academic debate around what the cost of capital is. To be honest, it's not something we obsess about. Clearly, you would think that lower interest rates would be a contributor to that, but there are other debates. I think the important thing is how we manage the businesses around the allocation of capital to different businesses. We then expect them to make tradeoffs between margin and volume to optimize the value that they can create. We don't -- there's not a direct link in terms of us obsessing about a cost of capital and then how we feel we want to price in the market. It's an input, but there's lots of other things that we think about. And so I don't see it as a fundamental issue in terms of constraining our opportunity. We have -- you referred to WIB. We have prioritized return and managing margins in that business. That has meant some deals haven't met the hurdle, but it's typically not been a line ball issue. Really, we're continuing to back the customers that we believe in and then we think will generate long-term value. So I don't -- it's kind of interesting, this discussion, but I don't see it as a major driver for us in how we actually manage the business.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [14]

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Jon?

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Jonathan Mott, UBS Investment Bank, Research Division - MD and Banking Analyst [15]

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Jon Mott from UBS. Question on Slide 19, I think, Peter, you gave us quite a bit of detail on the tractor, and I just want to make sure the math is right as a headwind. If you look at and you get the ruler out, the tractor is currently yielding about 195 or 200 basis points; the 3-year swaps, about 75 bps, if that's right. And I think the RBA is saying we're going to be extended to a lower rate environment. Do we then use the capital hedge and the deposit hedge to that $90 billion, and you potentially got 120 basis point headwind over the next 3 years on that tractor rates that will...

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Peter Francis King, Westpac Banking Corporation - CFO [16]

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Yes. So that is the right -- so we're giving you the balances on the right-hand side and a pictorial of the right, and we'll have to wait and see what interest rates do and whatnot over time.

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Jonathan Mott, UBS Investment Bank, Research Division - MD and Banking Analyst [17]

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Sorry. It's about a $1 billion headwind over 3 years if rates stay at current levels.

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Peter Francis King, Westpac Banking Corporation - CFO [18]

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Well, I'll let you do the modeling. That assumes an interest rate in the future, and we'll have to wait and see...

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Jonathan Mott, UBS Investment Bank, Research Division - MD and Banking Analyst [19]

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I think you said offsetting that, you had some flexibility on liquidity. What are you trying -- are you alluding you could release some liquidity to help you in NIM...

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Peter Francis King, Westpac Banking Corporation - CFO [20]

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I'll just point out that we ended up a little bit more liquid at the end of the year, so we can time our wholesale funding in the next year.

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Jonathan Mott, UBS Investment Bank, Research Division - MD and Banking Analyst [21]

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And quick follow-up question. The interest rate risk in the banking book has fallen from 13 billion as a risk weighted asset to 500, and I think you said that embedded gains as rates have fallen. Can that go negative?

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Peter Francis King, Westpac Banking Corporation - CFO [22]

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No, I don't think so.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [23]

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No. The standard doesn't much go negative. It can go to 0, but not any lower.

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Peter Francis King, Westpac Banking Corporation - CFO [24]

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So I think it's hit 0 3 times. This is the third time it's hit 0 in the last decade.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [25]

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Brian?

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Brian D. Johnson, Jefferies LLC, Research Division - Equity Analyst [26]

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Brian Johnson, Jefferies. Two questions, if I may. And Brian, I suspect you'll try and dodge the first one, so I'd like to put a little bit of context in it. 2009, ANZ came out and did a capital raising that was underwritten. Also, more or less announced the big profit miss, share price fell, there was a shortfall. When we spoke to them on the evening, there was no discussion as to whether there's a shortfall. In fact, we were told the other way around. Could we get some -- could you tell us what is the protocol if the underwriters are left with a shortfall? Because I think it's something the market deserves to know. And then the second one is that when we have a look at the replicating portfolio, it seems to me that you're progressively becoming more unhedged as basically interest rates fall because that balance of interest rate and sensitive deposits goes up as rates actually fall. Do you need to top up the size of the tractor?

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Peter Francis King, Westpac Banking Corporation - CFO [27]

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I'm happy to take that.

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [28]

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Okay.

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Peter Francis King, Westpac Banking Corporation - CFO [29]

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Brian, on the capital deal, we will make appropriate announcements. So I'll just leave it at that.

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Brian D. Johnson, Jefferies LLC, Research Division - Equity Analyst [30]

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ANZ's disclosures are proper?

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Peter Francis King, Westpac Banking Corporation - CFO [31]

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I'm not going to comment on ANZ. On how we manage margins in a low rate environment, the concept behind the deposit hedge is you hedge in determinant 0 rate deposits. And for the rest of the deposit book, you're managing that against your assets. So that's how we think about it. Whether it makes sense or not to hit -- to lengthen the duration of the deposits, we'll increase the hedging, I'm not sure. And we'll more manage that through the asset liability mix than specifically hedging it.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [32]

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Victor?

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Victor German, Macquarie Research - Analyst [33]

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Victor German from Macquarie. If I just can follow up on costs and ROE. So in terms of costs, you're effectively telling us that you've got around $700 million of cost saves in the period, yet, effectively, it implies that the underlying cost growth is in the order of $800 million. There's $450 million or so explained by some of the drivers that you've highlighted. Is the rest simply inflation? And as we move into the following year, do you see a scenario where you can actually keep costs flat or reduce them? Because it sort of feels like every half, there is something extra that we find out that you need to spend on.

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Peter Francis King, Westpac Banking Corporation - CFO [34]

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So tell you, I haven't redone your calculations. But in terms of sort of the BAU cost growth, if you like, the one thing that I'd highlight is the new accounting standard change on credit cards. So remember that AASB 15 thing, that sees cost growth a bit impacted by what's happening in the cards portfolio on spends. That's some of that impact, and then the rest is really sort of activity and inflation. In relation to '20, I'm not going to go out that far because we've been pretty clear on what we're targeting for 2020.

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Victor German, Macquarie Research - Analyst [35]

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Maybe just to follow up on ROE question. Brian, obviously in the past, you've talked about ROE targets that you're trying to achieve. I've noticed today, you've announced 10x or 10 times, I don't know, whatever...

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [36]

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10x.

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Victor German, Macquarie Research - Analyst [37]

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10x, the partnership is, which is an interesting step for a very large incumbent to be looking to offer banking services. Just interested in your observation, how do you sort of look at the landscape of next 3 years? Do you see yourself as someone that in sort of a defensive position who needs to offer these sort of things for the Fintech players to sort of thrive? And what does it do to longer-term ROEs for the industry?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [38]

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I guess you can see it either as defensive or offensive. I mean it depends -- the way I think about it is if big banks like us did nothing, then there would be a vulnerability. But our strategy has been to get on the front foot about this stuff and see it as an opportunity that customers needs the way they want to bank is changing, the technology is creating new ways to deliver services. And we, for quite a number of years now, have viewed that as an opportunity and have been investing for that. The 10x opportunity is taking advantage of some new technology that's come along that's really globally leading, and we've built a good relationship with them. It's opened up some new opportunities for us to grow through partnerships and potentially through the creation of some new services. I don't want to go into too much detail about that at this point, but we're pretty excited about a new avenue that it opens up for us.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [39]

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Richard?

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Richard E. Wiles, Morgan Stanley, Research Division - MD [40]

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Richard Wiles, Morgan Stanley. Brian, I'd like to ask you some -- for some further comments on what you're thinking about with the dividend. Your outlook commentary implies that your average volumes will be flat next year. Your margins will probably be down, your noninterest income will be down and your costs will be up. So there's a challenging earnings environment facing you in 2020, and that could maim the dividend. If you hold the dividend at $0.80 per half next year, the payout ratio might well go above that 70% to 75% target range. So a couple of questions, did the board consider what the FY '20 payout ratio could be when it cut the dividend to $0.80 this year? And what have you taken into account in terms of credit quality and sustainable levels of loan losses in setting that dividend?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [41]

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Richard, I can't provide any guidance on what we're going to do over the next little while. I mean you'll obviously come to your own conclusions. I can say we certainly have considered carefully the level that we've changed the dividend to and feel comfortable with the decision that we've made at this point in time. And on credit, as I've said and I think Peter said as well, we feel that the book is in pretty good shape. With low interest rates, we continue to feel pretty good about the quality of the credit book, although it is probably about as low as it's going to be although we've been saying that for a while. But given where we're at with the capital is and the like, there's not much more I can say, I'm afraid.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [42]

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We'll take a call from the phone. Matthew Wilson, please, from Evans?

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Matthew Wilson, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [43]

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Matt Wilson, Evans & Partners. Just to further add to Richard's quick comments on the dividend, when does the industry get in front of this issue and reset properly? It's pretty clear given the early comments you've made today that the dividend will again be under pressure in 2020.

And then secondly, a detailed question on Slide 25, properties in possession excluding WA and Queensland has jumped 30% in the half. Could you add some color to that movement, please?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [44]

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I might do the second one, and then you want to go on the first one? On the second one, Matthew, the properties in possession number is up, but it is still a very, very small number. We're talking about fewer than 600 properties in possession on a mortgage book of well over -- I think it's about 1.2 million home loans. So these are very small movements in the scheme of things, and it really represents that it's taking a bit longer for people to clear properties in a slower moving housing market. So it's not anything that we're unduly concerned about.

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Matthew Wilson, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [45]

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Is there a state that stands out? Or...

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [46]

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We saw a bit more of an increase in Queensland. WA has continued to be a bit of an issue. But honestly, it's -- the numbers are pretty small in the scheme of things.

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Peter Francis King, Westpac Banking Corporation - CFO [47]

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And then, Matt, on your observation about next year, I'll just reiterate what Brian said, it's -- we've said what we can or we want to on the outlook. We're not providing detailed guidance on 2020, and the dividend decision is always one that you make based on what you can see at this time. And I think Brian set up pretty well how we thought about that at this time.

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Matthew Wilson, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [48]

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Okay. We will have a new chairman next year. Is that correct?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [49]

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I don't think that's something that we've said at this stage.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [50]

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There's been no announcement on anything, any change.

Andrew Triggs?

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Andrew Triggs, JP Morgan Chase & Co, Research Division - Research Analyst [51]

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It's Andrew Triggs from JPMorgan. Two questions, please. Firstly on the term deposit portfolio. I'm just interested, I think I saw in the chart the average cost above the benchmark still rises. Just interested in your observations on the pricing environment and the term deposit book.

And then the second question, just to follow up again on dividend. I'm just interested to what extent the franking balance had a say in the sort of the setting of the dividend policy generally.

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [52]

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Short answer is it is still a very competitive market on term deposits as we've seen, and that's what that outcome reflects. And then yes, franking and the large franking balances, as I said in my talk, something that we consider very carefully, more conscious that the franking credits have value to shareholders that -- not value to us, and so we'd like to distribute them.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [53]

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I'll take a call from the phone again, please. Brendan Sproules?

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Brendan Sproules, Citigroup Inc, Research Division - VP [54]

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Look, I've just got a question on your cost guidance on Slide 29. When you announced the wealth restructure, you said there was one-off impacts, which you've talked about here today between $250 million, $300 million, if that comes in the low end. You also talked about the ongoing impacts. Then back in March, you said that, that business in 2018 had operating cost of $260 million, and you said that most of those costs you expect it to be eliminated in FY '20. And secondly, the divisional restructure at the time, which is another $20 million, which you thought would start benefit for FY '20, I was just wondering where that second component sit within your guidance.

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Peter Francis King, Westpac Banking Corporation - CFO [55]

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Yes. Brendan, the $200 million that we're calling out for wealth reset is the majority of that $280 million that you referred to. We got a little bit this year, and there's probably a tiny bit left for the third year.

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Brendan Sproules, Citigroup Inc, Research Division - VP [56]

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So the one-off impact is on top of that because they're not going to repeat?

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Peter Francis King, Westpac Banking Corporation - CFO [57]

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The one-off impact is in notables, which we haven't included in -- the FY '20 point is excluding notables.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [58]

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I'll take a question from Azib Khan on from Morgans on the phone.

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Azib Khan, Morgans Financial Limited, Research Division - Senior Banks Analyst [59]

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Andrew, can you hear me?

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Andrew Bowden, Westpac Banking Corporation - Head of IR [60]

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Yes. You're right.

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Azib Khan, Morgans Financial Limited, Research Division - Senior Banks Analyst [61]

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So Brian, you've said that you're expecting system housing growth to lift from 3.1 to 3.5, but you think business credit growth will slow from 3.3 to 3. What do you see is driving the slowdown in business credit growth? Will it be more SME or the larger end of business lending?

Second question is are you now pretty much done with the RWA optimization in your institutional business? Or is there more to come on that front?

And the third question is can you please tell us what the magnitude of the investment is in 10x and what percentage shareholding this gives you on 10x?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [62]

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I'll do those in reverse order. So no, I can't tell you. We're not disclosing that at this point in time. The RWAs on WIB, I think, is largely done.

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Peter Francis King, Westpac Banking Corporation - CFO [63]

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Yes. As if I just say, the -- from here, RWA is really about restructuring of customer facilities, which you just do every time you roll a deal. It's not modeling or that type of thing.

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [64]

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And then on the system growth, there's not a huge amount of insight there. I would say it's reasonably well spread. The commercial credit demand has just been relatively weak, and that's partly been people paying down debt and probably been just a lack of business confidence to make further investments.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [65]

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Okay. I'll take a call from Brett Le Mesurier on the phone.

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Brett Le Mesurier, Shaw and Partners Limited, Research Division - Senior Analyst of Banking and Insurance [66]

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So firstly, we heard from ANZ that they were thinking about reducing their return hurdle on the institutional bank. I noticed you're using 11%. Do you have any plans to review any of your return hurdle?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [67]

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Brett, we don't think of it in quite -- such a black and white way. We think about how we allocate capital across our different businesses and ask the businesses to then target generating as much value as they can, and that involves making tradeoffs between margin and volume. So no, we don't have a plan to make a fundamental change there, but equally, that's -- it's only one input into how we think about pricing deals.

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Brett Le Mesurier, Shaw and Partners Limited, Research Division - Senior Analyst of Banking and Insurance [68]

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The second question I had was you referred to -- in FY '20, you expect $100 million less income from wealth management, that's excluding the financial planning business, but there's a $50 million decline. To what extent are you confident that that's the end of the decline in revenue from that business?

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Peter Francis King, Westpac Banking Corporation - CFO [69]

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Well, Brett, I think the -- just giving you a bit of insight into that particular drivers, it's things like the legislative change for Protect Your Super, lower interest rates that impact the returns out of the platforms, migrating some of our Super activity into lower spread products and then the repricing of BT Open flowing through. So they're the drivers. We can never work -- legislative change is not in our control as is cash rates will go wherever they go. So we'll just have to see.

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Brett Le Mesurier, Shaw and Partners Limited, Research Division - Senior Analyst of Banking and Insurance [70]

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The insurance income is declining. I've noticed that you've got increases in claims rate. You've also referred obviously to lapse rate having a significant incline. To what extent are you confident that the claims experience has stabilized?

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Peter Francis King, Westpac Banking Corporation - CFO [71]

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Well, I think that's something for you to decide. I can't predict storms into the future, unfortunately.

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Brett Le Mesurier, Shaw and Partners Limited, Research Division - Senior Analyst of Banking and Insurance [72]

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No, I'm actually referring to life insurance.

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Peter Francis King, Westpac Banking Corporation - CFO [73]

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Again, we haven't given any detailed guidance on claims in life insurance. So we've set out the historical trends in the report, and I'd refer to those.

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Edmund Anthony Biddulph Henning, CLSA Limited, Research Division - Research Analyst [74]

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Ed Henning from CLSA. Just a follow-up on growth and costs. Firstly on growth in business and [in-store]. You talked about the competitive environment you saw appear. Obviously, we talked about before around cost of capital. Do you anticipate -- and with your margin management, do you anticipate to be a below system in business and in scope at least in the next year? And then just again on costs, you talked about higher spending in '21 and the fall thereafter. Does that mean absolute cost up in '21 and down in '22?

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Brian Charles Hartzer, Westpac Banking Corporation - MD, Group CEO & Director [75]

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I'll do the first bit, and you can do the cost bit. I think separate our business division and WIB, WIB growth tends to really be a function of the transactions in the market, and the mix of customers that are doing things. And we've got a great customer franchise, and we're happy to support transactions from good customers and the returns are still pretty good on our portfolio and relationship basis. So I think what happens there will be a function of what our customers choose to do.

On the business side, I think we're very well positioned. We're #2 in market share and have a great distribution capability across all of our brands and segments. We've got leading customer advocacy in each segment of business, so I think we will continue to do very well there. And if growth comes back, I expect we'll benefit from that.

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Peter Francis King, Westpac Banking Corporation - CFO [76]

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And then on the cost question, I'll just go back to what I've said. So we indicated 1% for '20, and then we expect reg and compliance costs to stay elevated into '21 before reducing.

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Andrew Bowden, Westpac Banking Corporation - Head of IR [77]

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Okay. With that -- if you don't have other questions, so we'll call it to a close. Thank you very much, and good morning.