Hello, and welcome to the Commonwealth Bank of Australia's results briefing for the half year ended 31 December 2021. I'm Melanie Kirk, and I'm Head of Investor Relations. Thank you for joining us for this virtual briefing. We are coming to you from Sydney that is currently subject to COVID-19 health restrictions. We are complying with the New South Wales safety requirements as well as our own strict safety standards. For this briefing, we will have presentations from our CEO, Matt Comyn, with an update on the business and an overview of the result. Our CFO, Alan Docherty, will provide the details of the financial results, and then Matt will provide an outlook and summary. The presentations will be followed by the opportunity for analysts and investors to ask questions. I'll now hand over to Matt. Thank you, Matt.
Well, thanks very much, Mel, and good morning, everyone. It's great to be joining you today. While we're again meeting virtually, there are many signs that we can be much more optimistic about 2022. We've continued to support our customers and communities over the past six months and will continue to do so as the economy recovers. Overall, the bank has delivered strong financial performance despite the low- rate environment. Our continued customer focus and disciplined operational execution is reflected in very strong volume growth for the half. We've continued to strengthen our balance sheet and are today announcing an AUD 3 billion dividend of AUD 1.75 per share, plus an AUD 2 billion on-market buyback, adding to the AUD 12 billion returned to shareholders in the past 12 months.
We've also been focused on our strategic agenda, building further differentiation with a strong pipeline of new products and services. Now turning to our results. Statutory net profit was AUD 4.7 billion. Cash profit was also AUD 4.7 billion, up 23% due to above-system growth, lower collective provisions from an improvement in the economic outlook, and a reduction in remediation expenses. Operating performance was AUD 6.6 billion, up 4%. This good operating performance and our strong capital position has allowed the board to declare a AUD 1.75 dividend for the half, fully franked, with the dividend reinvestment plan to be fully neutralized. Now looking at the results in some more detail. Operating income was 2% up for the half, with strong core volume growth continuing to offset lower rates, which has impacted the net interest margin.
Operating expenses were flat with lower remediation costs offsetting increases relating to volume growth and increased investment spend. Loan impairment expenses were significantly lower on the prior corresponding period, driven by lower collective provisions, reflecting an improvement in economic conditions and sound portfolio credit quality. This combination of 4% growth in operating performance and lower loan impairment expenses resulted in cash profit up 23% on the same period last year. Over the past three years, we've been prepared to invest to strengthen our franchise to deliver strong operational execution and strong above-system volume growth. One measure of that franchise strength has been the growth in transaction banking relationships and balances. We've seen transaction balances across our Australia and New Zealand businesses grow 70% from AUD 189 billion to AUD 317 billion over the past three years.
In the past six months, we have delivered the strongest volume growth ever in aggregate across our core product areas. Transaction balances are up 22% year on year, with more than 197,000 new business transaction accounts opened in the past 12 months, bringing the total to 1 million business accounts. Business lending was up 12.5%, growing at 1.7x system over the past 12 months, with margins stable in the half and up over the past 12 months. Home lendings, new fundings were up 45% to a record first half of AUD 94 billion, with 58% originated through our proprietary channels. CBA now accounts for 35% of proprietary originated home loans in Australia. This strong growth has been achieved despite a very competitive home loan market.
We've taken a range of actions on both sides of the balance sheet over the past three years to manage margins in this historically low interest rate environment. Despite continued action, margins in the half were impacted by increases in the swap rate and switching to lower margin fixed- rate loans. Alan will step you through our margin outcomes and outlook in more detail shortly. Volume growth continues to be delivered through customer focus and disciplined execution. Our business and institutional franchises have retained their number one Net Promoter Score positions. Despite our consumer NPS being at the highest level since tracking began in July 2015, we're very focused on increasing our absolute NPS score and regaining the number one position.
Our mobile banking app still leads the market, and we continue to see it as enabling us to move beyond customer service to redefining and extending the relationship we have with our customers. Digitization and technology help to drive strong operational performance in both home and business lending. 65% of home loan applications are auto- decisioned the same day, and 80% of referred applications are also decisioned the same day. In business lending, we're now executing 90% of documents digitally, leading to faster funding, while focusing on simplifying processes has seen a nearly 33% reduction in annual review times. A highlight of the result is our continued capital and balance sheet strength. Our disciplined and balanced approach to capital optimizes growth, reinvestment, shareholder returns, and flexibility.
Consistent balance sheet discipline has allowed us to return excess capital to our shareholders and lower our share count while remaining strongly capitalized and provisioned. Our balance sheet remains strong with 73% deposit funding. We've seen troublesome and impaired assets reduced by AUD 680 million in the half. We're well-provisioned with total provisions of AUD 5.9 billion, substantially higher than our central economic scenario. Following the successful completion of our AUD 6 billion off-market share buyback, our Common Equity Tier 1 capital ratio is 11.8%, which is 18.4% on an internationally comparable basis. Our strong capital position, with a surplus of currently almost AUD 6 billion, continues to create flexibility to support our customers and manage ongoing uncertainty.
It also allows us to return a portion of that excess to our shareholders via an on-market buyback of up to AUD 2 billion, commencing after we complete the dividend reinvestment neutralization. Following completion of this buyback, we'll have a surplus of almost AUD 4 billion, and this strong residual capital surplus provides us with flexibility to consider further capital management initiatives. Last year, we refreshed our strategy to set a more ambitious agenda to build tomorrow's bank today for our customers. We remain focused on four strategic priorities. Leadership in Australia's economic recovery and transition, reimagined products and services, global best digital experiences and technology, and simpler, better foundations. I'll spend a few moments sharing our progress on each of these. Throughout the half, we've continued to support both households and small businesses.
The most significant initiative over the past couple of years has been the deferral of 163,000 home loans and over 80,000 business loans for our customers, which we've been managing very well. The vast majority of customers use the deferral period to get ahead on their loans, and as a result, we've seen a low level of arrears. Our Customer Engagement Engine has been critical in helping prompt customers into and out of these deferral arrangements. It has also helped customers initiate 1.8 million claims and access over AUD 500 million in entitlements through Benefits Finder, as well as help contact 1.8 million customers regarding natural disasters. We've also helped households with AUD 186 billion in new lending, and we remain focused on building Australia's future economy.
We're ranked number one in Australian debt capital markets and have supported businesses with AUD 60 billion in new lending, including 60% of all loans written under the third SME loan guarantee scheme. Our second strategic priority is to reimagine our products and services. We're looking to create a more differentiated proposition for both our retail and business customers through a combination of new products, partnerships, and investments. We're focusing that activity around five areas. We're differentiating our home loan proposition, offering access to additional services like broadband, energy, green loans, and property management to drive greater consideration and engagement. Given high demand across younger consumers, we're focused on bringing investing into the CommBank app, making it simpler and easier for our customers to invest in small increments across a range of asset classes.
Everyday banking remains critical for consumers and business customers, and we're looking at a range of ways to make it easier for customers to manage uneven income and uneven expense profiles. Another particular area of focus is connecting our almost 1 million business customers with our 11 million retail customers to bring unique deals and offers to save people money, while at the same time, bringing incremental growth to CBA business customers. We also remain focused on carbon and helping our customers navigate the path to a low-carbon future, whether that be through financing the transition or providing tools for customers to buy or sell carbon offsets. A few recent examples of new products we're bringing to market include StepPay, Doshii, and our new payments terminal. We're pleased with the early progress of StepPay.
Our interest-free buy now, pay later card has more than 150,000 customers in its first four months since launch and has now processed 2 million transactions. At one- quarter of the cost for the average merchant, StepPay allows customers to activate and originate in minutes. Last year, we announced the acquisition of Doshii, which looks to simplify the process of taking a hospitality venue online. This has obviously been particularly important for restaurants during COVID as home delivery has grown substantially. In 2021, Doshii doubled its customer base, facilitated over 170 million orders, and almost tripled its venue coverage to 70% of the market. In last October, we began replacing our smart terminal fleet with a new point-of-sale device.
This device is already being used by more than 2,200 business customers, of which 60% are new to bank. We're also now piloting live in market our fully mobile mini pay tap and pay reader, which will be rolled out this year. We've made several minority equity investments in the half, primarily to secure exclusivity with key strategic partners. In November, we announced an exclusive partnership and minority stake in H2O.ai, a global leader in artificial intelligence. AI is a key area of focus for us, and we are increasingly using this technology to drive value, whether that be delivering on our aspiration to be one of the highest quality, lowest cost sources of sales leads to merchant customers, or improving home loan customer engagement and retention, or driving higher engagement and better customer outcomes in our app.
We've partnered with both Gemini and Chainalysis, and late last year launched a small pilot allowing customers the ability to buy, sell or hold crypto assets through the CommBank app. Through our venture arm x15ventures, we've signed exclusive partnerships with two exciting Australian startups focused on the home, where we are very focused on differentiating our offer. We made a small investment in Different, which is digitizing the property management space and using digital tools to make life easier for both investment property owners and tenants. Last week, we announced an investment alongside Square Peg in OwnHome, which is a very interesting model to help customers get into their own home sooner. We also now own just under 24% of PEXA, having invested AUD 200 million in the half, with PEXA now representing 91% of CBA's home loan settlements.
Our third strategic priority is global best digital experiences and technology. Our mobile app consistently ranks number one in the Asia-Pacific region and in the top handful globally in the annual Forrester survey. We're continuing to use technology to build deeper, trusted relationships with our 7.5 million digitally active customers and 6.6 million app users. We're integrating more and more services into the CommBank app, including shopping services and investing products, so that the app sits at the trusted center of our customers' financial lives. Our Customer Engagement Engine allows us to orchestrate relevant and personalized experiences across this growing set of products and services, supported by over 400 machine learning models running across 157 billion data points. We're seeing a steady increase in the way and frequency that our customers are engaging with our app.
For example, with 1.9 million monthly engaged users on the recently launched For You section of the app, where customers can access deals and offers. This is fundamental to the strength of the franchise and being the primary holder of transaction balances and lending relationships for our customers. Our fourth strategic priority is simpler, better foundations, reflecting our focus on creating a simpler, better bank. We've made further progress simplifying the business with the completion of the sale of 55% of Colonial First State to KKR. During the half, we also completed our remedial action plan to improve governance, culture and accountability across the organization.
While the program of work is now complete, we also know there is still more work for us to do, and we're very focused on both sustaining this progress and continuously improving and strengthening the changes that we have made. We continue our long-term focus on discipline and balanced capital management that optimizes growth, reinvestment, shareholder returns, and flexibility. Of course, our people are central to everything we do, and their positivity and pride in the organization is reflected in strong ongoing employee engagement at 80%. I'll now hand to Alan to take you through the result in a bit more detail.
Well, thank you, Matt, and good morning to everyone who has dialed in. I'll provide some more detail on the financial results and also take the opportunity to provide further color on our outlook for net interest margin, as well as our considerations around the dividend and capital management. To summarize, the financial results reflect how we are navigating the low-rate environment and our consistent, disciplined operational execution. You can again see the results of the good work of our people reflected in market share gains across all core products, improved revenue momentum, and growth in pre-provision operating profits. This has provided us with the platform to reinvest in and strengthen our franchise, increase our interim dividend, and also continue to gradually return excess capital to our shareholders.
The financial performance in this last six-month period has been pleasing, and we believe our strategy represents the optimal long-term approach to build on our existing competitive advantages. However, we do need to remain mindful of near-term profitability headwinds. In particular, net interest margins have reduced over the last six months, and the outlook for margins will remain pressured until we see a rise in cash rate environment. This is a key dynamic as we look ahead, and I will spend some time on this topic a little later in the presentation. Now on to the detail. Statutory profits from continuing operations were AUD 4.7 billion for the six-month period. Non-cash items within continuing operations were relatively minor this period, and so continuing cash profits were also AUD 4.7 billion.
As Matt has mentioned, that cash profit is up 23% on the same half last year, with operating income growth of 2%, operating expenses down slightly, good growth in pre-provision profits of approximately 4%, and a loan impairment benefit during the period, which drives the remainder of that large positive variance in cash profit. Looking firstly at operating income. Both net interest income and other banking income increased over the prior comparative half due to another strong period of volume-driven growth in home loans, business lending, and deposit revenues in both Australia and New Zealand. Other banking income also benefited from the non-recurrence of aircraft impairments in the prior comparative half and higher profits from our minority investments. Insurance income fell this period due to the impact of storm-related weather events in October last year.
Revenue growth was moderated by a decline in net interest margins over the period, and it's worthwhile going into more detail on the next few slides on, firstly, the key margin movements that we've seen over the last six months. Secondly, zooming out and looking at how margins have performed over the last three years. Finally, walk through what we might expect as we look to the future. Over the most recent six months, underlying margins decreased 9 basis points. The dilutive effect of higher liquids drove a further 8 basis points reduction in headline margin, though, as you know, that has little to no impact on net interest income. On the left- hand of the chart, fixed home loan pricing changes contributed 2 basis points of margin decline, with long-term swap rates rising faster than fixed rate repricing during the last six months.
A further 4 basis points of margin decline was due to customers switching from variable to fixed- rate home loans during another period of historically low rates. 3 basis points of the underlying margin decline was driven by continued competitive pressure for standard variable rate home loans. Deposit repricing and mix delivered 3 basis points of benefit, and the impact of lower tracker rates on deposit and equity hedges were the main components of the residual 3 points of decline. Now, before I provide some forward-looking considerations on margin, I think it will be useful to provide some broader context around the various moving parts over the last three years during a period of unusually low rates. The most significant driver of margin reduction over the three-year period has been the impact of falling cash rates on our portfolio of low- rate deposits.
To limit the earnings volatility through a rate cycle, we hedge some of those deposits through a replicating portfolio, and you can see in the first two bars on the left that the 140 basis points in cash rate cuts led to a net 15 basis point reduction in our net interest margin. To put that into context, 15 basis points of margin is the equivalent of a reduction in net interest income of AUD 1.4 billion per year. The next item is the group's equity hedge. As three-year swap rates fell, this led to an 8 basis point reduction in margin. If we look at fixed- rate home loans, the biggest margin impact has been the 12- basis- point mix change caused by customers switching as fixed- rate pricing fell below variable rate for an extended period of time.
A competitive environment for standard variable rate home loans has driven a 13 basis point reduction, so a consistent trend of 3-4 points of margin contraction per year for each of the last three years. Against these margin headwinds, we've seen the partially offsetting benefits of both lower wholesale funding costs and also significant management repricing actions on both sides of the balance sheet. Now, as you know, all of this occurred in a three-year period of both falling overnight cash rates and falling long-term swap rates. If we now look ahead to the remainder of this financial year and beyond, long-term swap rates have risen significantly, and there is broad agreement on the likelihood of RBA cash rate rises, though with differences of opinion on the expected timing. That has implications for the trajectory of our net interest margins.
The first and most obvious point to make is that until there is a rise in cash rates, our margins will remain under pressure, and that is highly likely to be the situation in the second half of the current financial year. Looking at each of the key drivers on this slide, the first two drivers are expected to be broadly neutral in the second half. This is because our portfolio of low-rate deposits has already borne the full impact of falling cash rates, and the earnings on the equity hedge takes some time to reflect the benefit of the higher level of the three-year swap rate. On fixed-rate home lending, we still expect to see a few more months of margin pressure from both pricing and mix effects. On fixed-rate pricing.
Despite leading the market with five separate rate increases since October, this has only partly offset the margin pressure from rising long-term swap rates. As a result, new business margins on fixed- rate home loans are lower now than they were in the first quarter of this financial year. On fixed rate mix, we experienced very strong December quarter new business volumes, and we also have the usual funding lag for pre-Christmas applications that settle over the next few months. Taking these two factors together, we expect the portfolio mix of lower margin fixed rate home loans to peak during the second half of this financial year. On standard variable rate home loans, it will surprise no one that we would expect to see continued price competition. All the other key margin drivers we expect to be broadly neutral or offsetting over the course of the next six months.
If we look further ahead and consider what might change in a rising cash rate environment, there are a few important points to note. Firstly, the low- rate deposit balances that experience such a large headwind from falling cash rates would be expected to generate a strong tailwind as rates rise. We have approximately AUD 170 billion of low- rate deposit balances that are insensitive to rising rates, and we would expect this portfolio to deliver 4 basis points of margin benefit over time for every 25 basis point increase in the cash rate. On the equity hedge, if three-year swap rates remain at current levels, then we would expect to see a gradual benefit to our margins as the tracker rate increases.
On the fixed home loan portfolio mix, as rates normalize, we would expect to see a reversal of the situation over the last three years and a decreasing proportion of fixed- rate home loans after reaching a peak in the coming months. Lastly, you would naturally expect a rising rate environment to result in higher wholesale funding costs. Now, that's a little more detail on the margin outlook than we usually provide. But given the number of moving parts and the historically unique inflection point that we have reached on interest rates, I hope that provides some useful transparency around how we're thinking about it. Turning now to operating expenses. They were down slightly on the comparative period. Pleasingly, remediation costs decreased to AUD 149 million. Excluding that, underlying costs were up 2.7%.
Investment spend was slightly higher, up AUD 24 million or 0.5% as we continue to invest in the long-term health of the franchise. As you can see, volume-related costs increased 1.4% over the same half last year, reflecting continued strength in new origination flows in both the retail and business bank. Lastly, our ongoing business simplification initiatives resulted in incremental productivity savings of AUD 92 million, which helped offset other inflationary cost increases. Turning to our balance sheet settings and looking firstly at credit risk. Loan impairments was again a benefit to P&L in the current half, with another benign period for both consumer arrears and another significant reduction in corporate troublesome exposures during the half.
These strong portfolio trends, along with an improved macroeconomic outlook, have resulted in a further reduction to our loan loss provisions, with collective provisions down AUD 250 million to AUD 5 billion. As you can see on the right-hand side of this slide, while expected credit losses under our central economic scenario have significantly reduced over the past 12 months, we've continued to exercise caution around the level of provisioning and retain significant provisioning coverage. This is in recognition of the continuing uncertainty from both the pandemic and also forward-looking adjustments for the potential impact of higher inflation and interest rates on our customers and the economy.
Our balance sheet funding settings remain very strong, with our customer deposit ratio remaining at 73%, continued low levels of short-term wholesale funding, and we continue to conservatively manage our liquidity coverage ratio and net stable funding ratio as we manage the withdrawal of the Committed Liquidity Facility over the course of the next 12 months. On capital, we've delivered a Common Equity Tier 1 ratio of 11.8%, which is down 130 basis points over the last six months due to the successful completion of our AUD 6 billion off-market buyback in October. Capital generation was flat over the six-month period, with the benefit of the Colonial First State divestment and higher retained profits offset by increases in risk-weighted assets.
The increase in credit risk-weighted assets was a function of continued strong volume growth in home and business lending and strengthening portfolio credit quality. Interest Rate Risk in the Banking Book also increased significantly over the half due to the sharp increase in swap rates that occurred in the final calendar quarter of 2021. The board continues to take a disciplined and balanced approach to the consideration of capital management activities. We will continue to reinvest between 20% and 30% of our cash profits into the retained earnings that support our long-term growth. We continue to invest in innovative products, services, and partnerships in support of our strategy. We will aim to continue to pay strong and sustainable dividends and to return excess capital in a manner which lowers our share count and supports shareholders' long-term return on equity and dividend per share outcomes.
Finally, we will continue to hold strong levels of capital above APRA's requirements in order to remain resilient to potential future stress events. The interim dividend of AUD 1.75 represents a AUD 0.25 increase on the equivalent period last year and a normalized payout ratio of 70% in line with our long-standing dividend policy. Given our very strong capital position, the board have also decided to again neutralize the DRP in respect to the interim dividend. Our capital surplus is currently almost AUD 6 billion above the unquestionably strong benchmark. We are well-placed to continue to support our customers and manage ongoing uncertainties while also returning a portion of that excess to our shareholders via a AUD 2 billion on-market buyback of shares.
This would see us with our residual pro forma capital surplus of approximately AUD 4 billion, providing the board with the flexibility to consider further capital management initiatives. I'll now hand back to Matt, who will take you through the outlook and a closing summary. Thank you.
Thanks very much, Alan. Despite some challenges from the pandemic, the Australian economy is looking strong against a number of metrics. In December 2021, we saw the unemployment rate drop to 4.2%, the lowest in 13 years, with underemployment at historic lows and the participation rate looking very strong. Households have now accumulated AUD 240 billion of additional savings, and income growth has remained robust. The impact of Omicron on the economy and spending has been more modest than expected, with spending slowing only marginally. Non-mining investment is strong, confidence has held up reasonably well, and both exports and infrastructure investment are providing good support. We expect this strong economic momentum to carry through to at least the end of 2023, and are feeling very positive about the outlook for the Australian economy over this period.
We've seen house price growth slowing and expect only modest increases this year before the peak is reached and prices start to settle. Globally, we see growth moderating this year after the sharp recovery in 2021. A big thematic for the year is likely to be rising inflation and tightening monetary policy by some of the world's major central banks, especially the U.S. Federal Reserve. Inflation is well above target in the U.S., U.K., New Zealand, and Canada, and each of these central banks have started tightening monetary policy. However, the inflationary risk does not appear as extreme in Australia. Our economists do expect underlying inflation in Australia to average 3%-3.5% in 2022, which is above the top end of the RBA's target range.
As a result of the inflation outlook and the improving labor market, the RBA will tomorrow conclude its bond purchase program. Our economics team expect the first interest rate increase from the RBA in August this year, followed by a gradual and modest tightening cycle. Despite this, we see strong underlying momentum in Australia and are upbeat on the outlook through to the end of 2023. In summary, we've delivered a strong result in a low-rate environment. Our continued customer focus and disciplined operational execution is reflected in our volume growth for the half. We've continued to strengthen our balance sheet, enabling us to pay a AUD 3 billion dividend to shareholders this half, and plan to commence an on-market buyback of up to a further AUD 2 billion.
Now looking ahead, we'll continue to focus on our operational and strategic execution, and we believe that our balance sheet is extremely well-positioned for anticipating a change in the interest rate cycle. We'll continue to invest to differentiate our product offering to our retail and business customers and extend our digital leadership, as well as continuing to support our customers as the economy continues to rebound. I'll now hand over to Mel to go through the questions.
Great. Thank you, Matt. For this briefing, we will be taking questions from analysts and investors. We'll announce the question and then your phone line will open. Please state your name and the organization that you represent. To allow as many as possible to ask questions, please limit your questions to no more than two questions. The first call comes from Richard Wiles.
Good morning, Matt. Good morning, Alan. I've got a couple of questions relating to slide 25 on the future margin considerations. Thanks for the detail. On the second half margin, you're clearly saying the margin will be down. Do you think the lending headwinds will ease even though that downward pressure will continue? On the medium term, why is the impact of price competition on SVR home loans not negative? Have you just left that blank because you're not allowed to talk about future pricing?
Why don't I. Firstly, morning, Richard. Why don't I start and then, Alan, you take it from there. Look, I mean, look, as you said, Richard, what we've tried to do is provide as much, you know, information and disclosure as possible to try and, you know, help our investors and analysts understand what's going on. There's, you know, there's a number of different dynamics, as we pointed out, as you can see in the first half, some of which those are gonna continue. I mean, I think particularly what we saw when we called out was, you know, high switching to lower margin fixed rate home loans. We saw that at about 47% of flow over the half. I think the portfolio is now at 38%.
Clearly, we expected that to moderate, but moderate gradually over the period of the next six months, probably towards an average of also 30% or so of fixed rate flows in the second half. There will be some, I guess, continuation of that. Look, specifically, I mean, and Alan, you should talk to this, it's probably we didn't specifically exclude it for any other reason than often in a rising rate environment, we anticipate there might be stronger competition in liabilities. You know, we think we've got a very good deposit gathering franchise. You know, as you would have seen over a long period of time, often as competition intensifies on one side of the balance sheet, perhaps it eases or moderates on the sec.
On the other side, you could easily also try and extend some sort of continuation. As you said, there's challenges in the second half. We'll continue to do everything we can as we've tried to do so over the last three years to moderate that impact. Then clearly, as Alan sort of stepped through, there's a number of, you know, positives over the medium term.
Yep. Maybe just to add briefly to that. One of the things we wanted to make sure we got across was that there was very strong volumes written in that December quarter in particular. In terms of that mix effect on the home loan portfolio and the switching that we've seen in that period, we expect that to have a full six-month effect of that in the second half of the financial year. I thought that was an important dynamic to, in particular, call out. On the right-hand side of that page, I mean, it's really. There aren't things we expect to change. You know, in many respects, we're in a competitive environment. I don't expect that to change. That, you know, that's another consideration.
The standard variable rate should still be reined in in the medium term. It's been reined in for years. You're not suggesting that suddenly, as the interest rate environment changes?
Yeah.
That inflection point you talked about, you're not suggesting that suddenly.
No.
Front book versus back book competition disappears.
No.
Yeah. It's hard to see that reversing, Richard, and you'd expect it to remain competitive.
Sounds like it should have been red, too.
Perhaps.
Thank you.
Thank you.
Thank you, Richard. The next question comes from Andrew Triggs.
Thank you, Mel. Morning, Matt and Alan. First question, just to follow up on Richard's question on that same slide there. The other line at the bottom for the second half, 2022, broadly neutral and offsetting. Do we read that we can read that one of two ways, either that the funding cost tailwinds are negligible or that there's still a liquidity drag, which is offsetting those those funding cost benefits that are still coming through. Also on the medium-term considerations, you call out the benefit on the transaction account portfolio from rising rates. Suggest there's additional benefit to be had there from the benefit from free funds.
Thanks. Thanks, Andrew. On the first point on the other broadly neutral offsetting, yeah, there's, well, there's a number of moving parts in there, and you've touched on, you know, a couple of the important ones. One is funding costs, and you'll have seen that we've been active, more active in the long-term debt markets, over recent weeks. We expect that will continue. You would expect to see higher funding, higher wholesale funding costs as we move forward. Liquidity, I mean, the Committed Liquidity Facility, you know, we're gonna see that wind down over the course of the next 12 months. Again, you would expect to see rise in liquidity costs.
On the other side of the ledger, you know, you'd expect to see, you know, continued positive mix changes from continued very strong growth in at-call transaction deposits. So we see some funding mix benefits rising from that. As activity rebounds and consumer spending increases, which is our expectation over the next 12 months, you might see a reversal of the unfavorable mix effect that we've seen on lower consumer finance balances over the last two or three years. So when we take all those things together, we expect either individually neutral or broadly offsetting is the best way to describe how we think about that over the course of the next six months, in particular. On your second question, Andrew, that was on that, whether there's benefit of free funds in addition.
Effectively, what I'm describing there is the benefit of free funds effect from the rate- insensitive deposits. You'd see that manifest both through the low- rate deposits. You know, we've netted that off against the assumed switching that you might see to higher deposit products during a rise in rate environment. The other dynamic there is the equity balances, which obviously behave like rate- insensitive deposits. That's the second item. Really those first two items are the benefit of free funding.
Thanks, Alan. Just second question on the other operating income line. It was stronger again than what was a strong previous half. Noted a couple of call-outs there around the AIA milestone payment and also higher treasury income. What should we-
Going forward, please.
Yes.
I know it's hard to call out a normal half.
Yeah, this is on the sort of other income.
Yeah.
Yeah. I mean, there's been a few moving parts in there. I mean, I think I'd say that, you know, we've had a number of movements with other banking income, and we've had, for example, lower trading income in the current half versus the same half last year. You'll recall we had very favorable trading conditions in the prior comparative period due to opportunities we had in our precious metals commodities business. There's been a headwind on the trading income side. You've also seen headwinds on, for example, merchants income, because there's been less activity. We've had lockdown restrictions. We've provided fee waivers to many of our merchant customers. You know, there's a number of offsetting headwinds. Yes, we've had some tailwinds as well.
I think if you stand back from it and look at the other operating income, the net driver underlying all of that has been very strong growth in volume-related fees across home lending, business lending, and deposits. The underlying franchise momentum has been strong there. Other income. Yep, that's a higher than normal half, but you know, there was offsetting headwinds in other line items. I think when you take it together, it was a strong period. We were very pleased with the volume performance.
Thanks, Alan.
Thank you, Andrew. The next question comes from Brian Johnson.
Thank you for the opportunity to ask some questions and congratulations on clearly what is a great result. Alan, two questions from me. The first one is the Interest Rate Risk in the Banking Book unsurprisingly kind of thumped you during the period. Can I just get a feel, the move in bond rates that we've actually seen subsequently.
Mm.
Should we be kind of thinking in this environment that you get a similar hit on the capital for the Interest Rate Risk in the Banking Book in the next half year?
Yeah. Thanks, Brian. Yeah, certainly swap rates have continued to increase. They haven't increased as much. I mean, there was a big rate spike at the end of October, as you'll recall. That embedded loss, if you like, amortizes over a period.
You'll see the sort of amortization effect of that embedded loss over the course of the next couple of years. Against that, we need to watch what happens with two and three-year swap rates. As you say, they've increased a little since the end of the year. That will provide an opposing headwind on IRBB. Yeah. I mean, it's certainly a little higher now than it was at the end of the year, but it was a very big move that we've seen in that final calendar quarter, so not of the same order of magnitude.
The next one is for Matt, and I've got to hold back a sense of glee as I ask this question. Just if we have a look at the collapse of a lot of the buy now, pay later valuations. In the previous half, you had marked to market the stake in Klarna up to what you thought the market value would be. Didn't go through cash earnings. Went through the statement of comprehensive income. Could we just find out, and I'm sure it's here somewhere in the text, but I haven't seen it yet. Could you just run us through what you've done with the Klarna valuation, if anything, in this half year?
Yeah, sure, BJ.
What is it held at?
Yeah. Alan, you I think there's a very modest movement. You're right. I mean, we'd marked it up, not through cash. I think probably trying to take a relatively conservative view, and hence when we did the revaluation, it was a pretty sort of modest movement. You know, as we've seen their performance globally, it's continued to be very strong. I think we still believe that business will perform well, both domestically and internationally. As I recall, it's a pretty modest, maybe like AUD 100 million or so, reduction in their carrying value on books.
Yep. You.
Matt, when we get to the IPO, basically the big impact of it is that if you're to sell down, it releases capital. That, that's the impact of it rather than a cash earnings impact?
That's right.
Does it go back through the cash earnings?
No, it would go through capital.
Okay. Thank you. What is the holdup? What is the value now, Matt?
2.2. Where does it set out?
Yeah. You'll find the sort of in the page 106 of the profit announcement, Brian, is probably the best place to see the net loss on investment securities. That's AUD 84 million after tax. That's the after-tax effect of the revaluation of Klarna. We have reduced the multiple that we're carrying that at, although the underlying business has generated much stronger global revenues over the past six-month period, and that's moderated the net impact. Yes, Matt says about AUD 100 million net reduction on the very large increase that we booked to June.
Thank you very much.
Thank you, Brian. The next question comes from Jonathan Mott.
Yeah. Hi, guys. Sorry to harp on about the margin, but it's probably worth going into, especially given that you did call out more headwinds than tailwinds for the margin last half, and I don't think anyone expected it to be down as sharply as it was. If you look at the second quarter, you can estimate that the margin was down about 6 basis points, down to about 189, and obviously has called out more of these headwinds. Do you anticipate that the margin will continue to decline at the same rate through the third and fourth quarter of this year, so ongoing margin decline from a lower starting point? Or would you expect this margin headwind to basically be in that second quarter number, just given the movement through the period that you had in that first half? Okay.
Thank you, guys.
Yeah. I mean, we haven't provided the quarterly breakdown, but as you say, you can infer based on the Q1 update and the half- year margins that we've published today, you know, that the number that you quoted for the second quarter is, you know, I think that's in the ballpark of what we've seen. Now, you know, we've called out what we expect to be the key headwinds over the course of the second half. The fixed home loan portfolio mix is a really key one. You can see in our disclosures that the stock mix of fixed home loans is 38% for the group.
Now, we've seen, as I mentioned, very strong December quarter volumes, but given the repricing that's been underway over the past few months, we're starting to see the new business flows start to significantly reduce. We expect for that to continue to reduce over the course of the next few months. The averaging effect of those loans that we wrote towards the end of the calendar year, you're gonna see a full six-month impact to that. I would expect that 38% average mix number to continue to increase over the course of the next few months. But we wouldn't see an accelerating trend of margin reduction to your point around against what we've seen in that second quarter.
Yeah, Jon, I guess the only thing I'd add. I think Alan touched on. Obviously, the swap rate's moving very sharply, particularly in October. Obviously, I think we've done five at the most, maybe the 6th most recently on 4th of February. We saw a sort of 2 basis points. We weren't keeping pace with the swap rates. That's probably the other variable. You'd think most of the volatility in swaps has come through, but that'd be the other factor as well. It's hard to see that accelerating, certainly.
Thank you. A second question on slide 40, which you always put this in, which is your MFI share, across all the different age brackets. You can see there in the key market, which is 25-34-year-olds, that you've seen a further slip in your MFI share over the last 12 months or so. These are the people who are probably the most digitally savvy of all your customers and really should be benefiting from a lot of the investment that you've got going through. Is this really that you're losing out to the brokers as these people are, the age demographic are moving to the housing market? Or is it that really they're just a lot more price sensitive and their investment in technology is secondary to price?
Jon, look, you know, thanks for the question. As you know, we've been, I think, publishing this report, the MFI share, I guess, over the last seven or eight years. You know, depending on the time series and there's a number of different areas where we've increased, but you're quite right. When we look at 25-34 and you look over that 12-month period, as always, with, you know, a survey, which is directionally accurate but maybe precisely inaccurate, it's hard to get perfect causality. There's a few things that we're definitely looking at very closely. One, I know we've mentioned this before, but we definitely think the number has the fact that there's been no migrants into the country has hurt us a bit.
We typically get about 45% or so share of new migrant accounts. We look at our growth in transaction account numbers and balances and engagement with both the app, and we certainly take some, you know, positive signs from that. I guess more importantly, we look at strategically, as you alluded to, we do think that, you know, customers increasingly will, you know, obviously not only around price, we still believe that there's, you know, people have a preference to consolidate with convenience. We think it's really important that we can differentiate our offering. A lot of the investments we're making, as you rightly indicated, both in terms of helping customers, you know, track and manage their spend, getting a differentiated proposition and value created in our home buying experience, in our everyday banking and payments and shopping.
I mean, we'll continue to watch it closely. We think there's a variety of factors. We're certainly investing against those. It's not clear that it's just price. I think there's perhaps customers have, you know, more relationships at that stage than perhaps they did a decade or so ago. We see particularly that main relationship with the transaction account. We feel that we're just as relevant. We wanna make sure that we're, you know, broadening and deepening our relationships with customers across the board.
Thank you.
Thank you, Jon. The next question comes from Victor German.
Thank you, Mel. Two questions for me. One I was hoping to just clarify, Alan, and I appreciate there's some moving parts with the other operating income, but it looks like you booked treasury income in the other income line. I'm not sure if you can give us what that contribution was, but maybe at least you can give us some color in terms of how this half compares to the average of last three halves or, sorry, last three years. I think that would be helpful. The second question is on costs. I guess from a short-term perspective, if I look at the second half quarter cost number, it's about AUD 100 million down on first quarter.
Do you think that's kind of the right run rate for us to think about as we go into second half? Or is it just sort of managing lead balances and things like that that have impacted it? From a longer- term perspective, Matt, it'd be pretty interesting. You've used, you know, we've seen some results from U.S. banks that are looking to increase their investment spend substantially over the medium term. You've been investing quite significantly in your business for a while now. With the change in the interest rate environment and potentially they're becoming more of a tailwind rather than headwind, do you see the need to invest more in the business, and is there a capacity to invest more?
Do you feel your current investment spend is broadly right and you're already there, you don't need to increase it from here? Thank you.
No problem. Why don't we start with the third, and we'll sort of go in reverse order, Alan, if that works for you. Victor obviously watched the international results closely. No plans. Alan and I, you know, been through this in some detail. If we look at our investment spend, you know, we've increased it, you know, quite significantly over the last few years. We think that investment in the franchise and our offering has paid off, and we see that reflected in higher volume costs. We're certainly stabilizing the investment spend at this point in time. We'll continue to reconsider that over time, but at the moment, you know, we feel like we've got a good, you know, pipeline of new products and services.
We're still spending a lot in our regulatory spend, but that's coming down. We think there's opportunities still to invest in, you know, greater digitization to help with the, you know, medium-term cost outlook.
On your first two questions, Victor, on other income, no, I mean, treasury performed okay. It wasn't a material impact in the half. Against the sequential half, you'll recall that we sold some or we bought back some debt in the second half, which caused a loss in other income. So you got non-recurrence of that loss, which is the reason for the callout for treasury income on the sequential half. But no, it's not a material driver in the current half. On the second quarter operating expenses, I mean, one of the good things that happened in the second quarter was a lot of our people took a well-deserved break.
The annual leave costs or the provision increase that we called out in the first quarter, we had a partial reversal of that in the second quarter. That was probably the key driver there. That's a temporary tailwind which reversed the headwind in the first quarter. We're not, you know, baking that in in terms of the second half.
Let's say, is the first quarter a better guide for kind of underlying costs or second quarter or what average of the two?
Sorry.
What's kind of the better guide for the kind of run rate? Is it the first quarter or second quarter or kind of the average of the two?
Yeah, I think if you take the average of the two, because the annual leave swing factor was a big swing between 1Q to 2Q.
Understood. Thank you.
Thank you, Victor. The next question comes from Jarrod Martin.
Thanks, Mel. Thanks, Matt and Alan. Look, Alan, you're probably gonna regret putting slide 25 in the pack, but it is very useful. Just one question on the medium-term impact, and particularly around the unwind of the TFF. You've got AUD 50 billion of TFF current, sort of three to five-year swap rates just above 2%. So let's call it a 2% differential between the current funding rate of 10 basis points, which equates to, and keeping the numbers simple here, AUD 1 billion of increased net interest expense or 10 basis points on margin.
Is it fair to say that the first couple of rate rises, the benefits are likely to be offset by the fact that you gotta refinance the TFF, and you need probably three or four rate rises before you get some real benefit coming through?
I mean, it depends on the timing of the rate rises, you know, Jarrod. There's lots of differences of opinion there. I don't wanna add mine to the mix. Yeah, you can look, you can model out those changes in cash rate, the timing when they come through. The TFF unwind, I mean, the question there is what's the funding mix that replaces the TFF? To the extent it's a straight swap of long-term wholesale funding for TFF, then yeah, you're gonna have a significant cost headwind as we've called out. There's also, you know, we've got continued strong franchise growth and deposits. Depending on the mix of transaction savings and term deposits, that could offset some of that TFF unwind.
We're also running historically, as you can see, very low levels of short-term wholesale funding. Again, there's a decision to make around the short versus long-run wholesale funding mix. Then within that, the tenor of the short-term wholesale funding that we run at. I wouldn't say it's as simple as taking the TFF and applying the differential to the current long-term rate. Certainly it's a headwind over the next two to three years. You know, that's the reason we called it out. I'm very happy to provide this level of granularity around how we're thinking about it, because I think it's, you know, I think it's helpful to investors and to the market around how we are thinking about it. Hopefully I don't ever regret the transparency.
Cheers, Alan.
Thanks, Jarrod. The next question comes from Brendan Sproules.
Thanks, Mel. Good morning, gentlemen. I've got a couple of questions. Firstly, on slide 26 on your operating expenses. I mean, the number of FTEs that you've had to add to the business in the half, you know, quite high. Is there a chance as volumes slow that, you know, you can, you'll get a reversal of that in the sense that some of these additional staff costs are temporary? Then I have a second question.
Yeah, no. Thanks, Brendan. Look, I think there's a number of different categories that contributed to the higher FTE. Some of that was related to, as you said, you know, operational volumes. We've added home lenders, business lenders, but there's also a number of FTE that have come on, you know, additional financial crimes operations, quite a significant number. They're clearly unlikely to reverse in the near term. Additional FTE, which is supporting the higher change investment spend. It's certainly something that, you know, we're cognizant of the operating expense environment that we're in. Some of the challenges in the near term, perhaps over the medium term are certainly looking rosier.
I guess we're cognizant of that, overall environment, but it's not like we could reduce or would choose to reduce the FTE in the non-operational areas. We've certainly, as we have shown, been prepared to invest, and we think that's gonna recur in terms of higher volume growth over time.
Thank you. The second question is just on slide 77. I've got a question about ASB. I mean, it's very strong performance with 22% NPAT. I was wondering if you could help me understand how mortgage volumes in that business in the last few months have been going. I mean, you've had a number of changes with the higher swap rates that you show here on the. And the higher fixed rate costs. But also you've had changes in legislation in New Zealand, and you've also had the Central Bank put in some LVR restrictions. I wonder if you can comment on your home loan volumes in recent months, and also to what extent is the combination of those changes impacting borrowing capacity for your New Zealand borrowers?
Yeah, no, happy to. I mean, if you took a 12-month view, clearly, you know, lending volumes have been very strong. But you're quite right. I think there's a number of different factors that have come together that are, you know, dampening volumes and probably in some cases our appetite as well. That's, I guess, a combination, as you said, of, you know, further restrictions. The CCCFA changes which are equivalent to responsible lending in Australia, substantially similar. There's some slight differences in terms of the implementation around categorization and of course then the phase changes to the tax framework in New Zealand, which I think comes in over either four or five years. We definitely think that that's gonna have an impact on volumes in credit growth and housing in New Zealand.
Given the strength of the housing market, both from a price as well as credit growth perspective, we don't think that's a bad thing at this point in the cycle. It's all things being considered, you know, a good thing for it to moderate over time. I guess if we've seen in Australia, when you have a multitude of factors that come together in a relatively short period of time, that can also, you know, cause some short-term disruption and issues and that's certainly been one of our observations of New Zealand in recent times.
Do you have a view on how much borrowing capacity has been impacted? Because in Australia, obviously, when responsible lending through the Royal Commission change, it was quite an impact on borrowing capacity. Are you expecting a similar outcome in New Zealand from the combination of changes that have happened there?
Yeah, I mean, look, directionally similar, but perhaps not to the same magnitude. I think even if you look back on the experience in Australia, it probably varied by institution, both the change impact and the reduction in the borrowing capacity. It depends a little bit on the relative starting point of the institution. But there's no question the combination of those factors in implementation and, you know, as we saw here, there's more friction and steps going into the processes. I mean, definitely causes some short-term disruption. You would expect moderate borrowing capacity. But all things being equal, that's the sort of desired impact, provided it doesn't go too far.
Thank you.
Thanks, Brendan. We'll have to take the final question from Andrew Lyons. Andrew.
Thanks, Mel. Morning, Matt and Alan. Just a question on the composition of your costs, which were very well managed in the half and particularly in the second quarter, as was noted. Not surprisingly, you've seen a material uplift in your staff expenses, as you pointed out. But against that, your occupancy and other expenses were both down about 15% each, half over half and on PCP, and your IT expenses were down about 5%. Just two questions. Firstly, can you perhaps just talk to the sustainability of the cost reductions across those items? Then secondly, just whether your ongoing simplification initiatives can drive these costs lower further, or will they need to be more focused on staff expenses from here?
Why don't I start and Alan, you add to it. Look, one of the things I could have mentioned to Brendan's question in terms of higher FTE was, you know, we've taken on higher in some areas, IT-run staff, and so some of that sort of we're insourcing activities that we'd previously outsourced. I mean, specifically, as you said, there's a, you know, reduction in property and occupancy. The most substantial component of that was, you know, as we've now completed, albeit in a largely remote environment, the shift to South Eveleigh, we exited our corporate location in Parramatta. There are other contributing factors, you know, lower capital works over the period, which wouldn't come as a surprise.
You know, slight reduction in the branch network, slight reduction in our ATM network. Clearly FTE overall will be a you know, considerable driver of our our operational expense going forward. I mean, just getting that balance right between sort of optimizing where we think the activity should sit, you know, bringing some from a partnership or an external partner, bringing those in-house. Investing in volume and you know, better revenue performance, higher change, but also, as I said earlier, sort of cognizant of the the overall income environment that we're operating in.
Very briefly to add, I think we were pleased with the ongoing simplification. I mean, we budgeted to increase staff in the areas that Matt mentioned. We're really pleased to add staff to help with the operational volumes because they've been so strong. Then the simplification program, yep, the consolidation of commercial offices, which you're seeing across both here domestically and internationally, we've continued with that program. That's a sustainable recurring source of cost benefit in terms of the saves that have been made there. We continue to pursue a number of other productivity initiatives across both FTE and non-FTE line items.
Yeah, pleased that that's helped offset a number of those inflationary cost increases that we've seen over the past 12 months.
Thank you.
Thank you, Andrew, and thank you everyone for joining us for this briefing. Please follow up with the Investor Relations team if you have further questions. Thank you for joining us.