Thank you for standing by. Welcome to the Judo Capital Holdings Limited (Judo Bank) 1H 2023 result webcast. All participants are in listen-only mode. There will be a presentation followed by a question-and-answer session. If you wish to ask a question, you will need to press the star phone, star key followed by the number one on your telephone keypad. I would now like to hand the conference over to Mr. Andrew Dempster, General Manager, Investor Relations. Please go ahead.
Good morning, welcome to the Judo Bank result briefing for the half year ended 31 December 2022. My name is Andrew Dempster, and I am General Manager of Investor Relations at Judo. I'd like to begin by acknowledging the traditional owners of the land we are meeting on today and pay my respects to elders, past and present. Our result material was lodged earlier this morning with the ASX. The material is also available on the investor section of the Judo website. This morning, we will first hear from our CEO and co-founder, Joseph Healy, with an overview of the results and an update on our progress.
Andrew Leslie, our CFO, will then discuss our financials in detail. Joseph will then return to provide an outlook and commentary. There will also be time for questions with Joseph, Andrew and our Chief Relationship Officer and Deputy CEO, Chris Bayliss. A replay of this session, including the Q&A, will be available on our website later today. I will now hand over to Joseph.
Thank you, Andrew, and good morning to everyone joining us on the call. We are pleased to be presenting our results for the 1st half of financial year 2023. These results are the outcome of our strong connection to our purpose to be the most trusted SME business bank in Australia and to our vision to be a world-class SME bank. The disclosures that we have provided today are detailed and provide a high degree of transparency, which underscores the confidence we have in the performance of our business. I'm joined on today's call by Andrew Leslie and Chris Bayliss. Andrew was appointed our CFO towards the end of last year after being with Judo for over three years, playing a key role in the finance team, building on his longer career in investment banking.
Andrew's appointment coincided with Chris Bayliss moving to the role of Chief Relationship Officer, and Chris retains his responsibilities as Deputy CEO. These changes highlight our commitment to talent development and succession planning. Today, I'll provide an update on the business before handing over to Andrew to run through the detail of the financials. I will then discuss the outlook and some of our organization priorities before moving to Q&A. As well as Andrew and I, Chris will be happy to take questions during Q&A on how we are performing in the market and how we are seeing competition. We consider this set of results to be another black belt performance, which clearly demonstrates the power of our pure play specialist business model and management's ability to execute against what we promised.
Our business is continuing to successfully scale, delivering revenue growth of 67% and profit growth of over 300% with a profit before tax in the half of AUD 53 million. We are on track to achieve the guidance we provided for FY 2023, including a loan book of over AUD 9 billion. We're also making steady progress towards our key business metric to scale that we announced at the time of the IPO in November 2021. Our business is now generating sustainable and growing profit. We've achieved this outcome faster than any other new bank anywhere in the world. You will hear me say several times that Judo represents a unique pure-play business model. This is an important aspect of our business that we want the market to better understand. We are truly unique. We're not a fintech, not a neobank, and not an NBFI.
We are a genuine purpose-built challenger bank led by people who know this business inside out. Importantly, as Andrew will detail, we've continued to increase the diversity and sophistication of our funding program. We're accessing multiple sources of funding and are not overly reliant on any single channel. This gives us real confidence in our ability to continue funding growth as well as repay our TFF funding by June 2024. Our business model is performing well, and we believe our strong relationship-based approach provides us with a strategic edge that will enable us to grow regardless of the operating environment. We are not reliant on system growth. We are not reliant on macro conditions as we think about calendar 2023. I'll come back to those later. Our strategy has been consistent from when we first architected the bank in 2016, and we remain absolutely committed to it.
We are running our own carefully planned and timed race. Not too fast, not too slow, just the Judo Bank planned pace. We are a young business in a continually challenging landscape. I want to take a moment to recap on our purpose and vision and reiterate our belief that a significant mark-market opportunity exists for Judo. A market opportunity that goes way beyond our metric to scale targets. As mentioned, Judo is a pure-play specialist SME bank. The business is unique, and we cannot find a like-for-like comparable anywhere in the world. In so many ways, Judo is a great Australian success story. Our business was conceived by belief that there was a market failure, with SMEs being poorly served by an industry that, post the GFC, had consolidated and industrialized its approach to SME banking.
Competitive forces in SME banking were weak. When we built Judo Bank, our goal was to bring back the craft of SME banking, where relationships trump product. Where each SME is seen as unique and requiring a bespoke solution, not an industrialized take it or leave it option. Being a specialist means SME banking is all we think about and all we talk about. We see this as a huge advantage when combined with speed, agility, and the ability to provide a more individualized service, which cannot be matched by generalist competitors who can suffer from diseconomies of scale in providing the service SMEs deserve and want. This slide shows the progress we have made since being just a PowerPoint only six years ago. Our history is short, but our progress has been unique, compelling, and sustainable.
Since receiving our banking license in 2019, we have grown our loan book to AUD 7.5 billion. AUD 7.7 billion, including undrawn lines of credit. We've established 18 locations nationally. We are now a credible alternative to other banks with a clearly differentiated story and value proposition. Six years ago, we had a clear vision on how the bank would evolve over three broad horizons. Horizon one was to build a bank and prove the CVP and EBP, and that we could get to profitability within three years without compromising on sound risk reward economics, ensuring that our lending was cognizant of our cost of capital. Horizon two was to scale the bank, setting it up for a sustainable path to becoming a world-class. Horizon three was to demonstrate world-class quantitative and qualitative metrics.
We are now firmly in horizon two, executing a clear plan to realize the scale benefits that are inherent in our model. This includes investments in technology that will better enable our bankers and improve our customer experience. It also requires developing a culture and embedding our risk management frameworks. We have come a long way quickly, in a very volatile period that included the pandemic. While we still have a lot to do, we have a strong team, and I've never been more confident in our ability to execute on our strategic agenda and achieve our vision. Turning to the key operating metrics. As you can see, we have delivered strong performance in all measures. Gross loans and advances reached AUD 7.5 billion on 31 December. Our underlying net interest margin for the half was 3.56%, well above our guidance.
Our CTI of 54% is well below the CPI of 71% in the last half and puts us on track to deliver a full-year CTI of below 60%. Credit quality was strong. Our profit before tax of AUD 53 million equates to an annualized ROE of 5%. We are on track to our aspiration of delivering an ROE in the low to mid-teens at scale. This slide highlights some dimensions of our progress in scaling. The demand for our relationship-based customer value proposition has continued to drive lending growth and pull out into new regions and markets. Over the last six months, we've established a presence in four new locations Bunbury, Rockhampton, Orange, and Albury. This is consistent with our belief that to have a genuine relationship with our customers, we must have a physical presence in the region.
We have seen our banking numbers continue to increase, albeit as signaled in our full-year results last August, at a consciously slower pace, following a significant increase in banking numbers last calendar year. We have sufficient latent capacity in the existing workforce to continue growing our loan book, as well as stay close to our existing customers in the challenging environment we see for 2023. Underscoring the demand for lending is a growth in our AAA pipeline, which at 31 December was AUD 1.3 billion, up from AUD 1.1 billion in June. We continue to see great opportunity for growth, notwithstanding macro conditions. Importantly, our net promoter score at +66 is by a country mile the very best in the banking market. There is much debate about the economic outlook. I'd like to reiterate that this is not our first rodeo.
Our management team and our board have seen many cycles and have built Judo from a blank piece of paper with risk management at its core. Commercial banking is in the business of risk management. It must be a core competency. Our high-touch business model with a comparatively lower ratio of customers to bankers means we remain in close contact with our customer base and can proactively manage any emerging issues. The benefit of our model is demonstrated by our continued strong credit quality. We have just 15 customers that are in 90 days arrears or impaired out of our approximately 3,300 customers. Andrew will discuss credit quality in more detail. The appendix to this deck provides considerable detail on our portfolio. Before passing to Andrew, let me just summarize the headlines on these results.
First, we are on track to meet our guidance for financial year 2023 and to deliver our key business metrics to scale. Secondly, we are more confident than ever in our CVP and the market opportunity available. Thirdly, risk management is a core competency within our business. We have seen no deterioration in credit quality and have prudently bolstered our provisions. Fourthly, our approach to growth is measured and sustainable. We are running our own race. Growth for growth's sake is not our strategy. The economics of growth are important to an owner mindset management team. We have moved beyond the first phase of starting a bank to the next phase of scaling our bank, and we're delighted with the progress we are making. I'll come back later to talk about the operating environment and our outlook, but in the meantime, over to Andrew.
Thank you, Joseph. For those who don't know me, my name is Andrew Leslie, and I recently took over the CFO role in November 2022, having joined Judo's finance team back in 2019. It's with great pleasure I'm here today to present Judo's 1st half 2023 results. Our headline results for the half is a Profit Before Tax of AUD 53.2 million, significantly up over the half and three times the PBT generated over the entire 2022 financial year. Lending volumes and margins both grew strongly, contributing to a 67% increase in revenue. Expenses increased 27% to support this growth, whilst CTI reduced by 17%, with overall very positive jaws for the half. Pleasingly, asset quality has continued to remain benign.
With the increase in impairment expense over the half, largely reflecting provisioning from growth in the loan book. With strong lending growth and low write-offs for the half, we maintain a prudent provisioning coverage level now at 104 basis points. The fact that we are generating strong PBT means we're now also generating organic capital at a meaningful rate. As Joseph highlighted earlier, we remain on track for all of our 2023 guidance and our key business metrics at scale. We've seen another half a strong growth across all lending product lines. GLAs were AUD 7.5 billion at the end of December, and momentum has continued throughout January and February, with the pipeline now over AUD 1.3 billion. Clearly putting our June 2023 target of AUD 9 billion-plus well within sight.
As a reminder, we typically expect about 90% of our AAA pipeline to convert to GLAs. On top of the GLA balance, we have around AUD 200 million of undrawn lines of credit on which we hold liquidity and provisions, but also earn fee income. Portfolio mix in the 1st half has remained relatively stable. SMEs still prefer that flexibility of floating rates, with 10% of our book on fixed rates. Security levels have also remained broadly unchanged, with 86% of our portfolio fully or partially secured by real property. We've included some further detail on our sector concentrations versus the broader SME market in the appendix. In terms of channel split, we've seen a slight increase in the portion of flows directly originated, consistent with our longer-term objective. We remain focused on balancing the split of originations with a greater portion of direct over time.
Turning now to margins. On this slide, we show the key drivers of underlying NIM since June through to December 2022. A reminder that underlying NIM is a measure of NIM excluding the impact of our TFF preservation strategy. This is where we preserved an amount of TFF funding using treasury securities as collateral to subsequently utilize as we grew the loan book. Underlying NIM for the 1st half was 3.56%. That's above the top end of our guidance range, with a strong 72 bits expansion, predominantly from funding. As you can see from the slide, there were several key components driving this increase, which is just worth unpacking. Firstly, our lower cost of deposits on a hedged basis, which continued to improve over the half. Secondly, the benefit of our structural leverage to rising rates from fixed TFF funding and equity funding.
Partly offsetting these tailwinds was the lower lending margin, which I'll touch on shortly. Finally, the impact of rate rises on fixed rate bonds and the drag from holding higher liquidity as we took advantage of favorable TD pricing. I'll run through each of these elements in more detail over the next few slides. Before we leave this slide, I want to give some guidance for the 2nd half NIM. As many of you know, our expectation is to deliver a NIM of over 3% at scale. Consistent with this, we expect our underlying NIM to moderate in the 2nd half to between 3.1%-3.3% as some of the current tailwinds abate. Next, the funding mix.
Term deposits remain our primary source of funding for loan growth and now sit at AUD 5.3 billion, having grown AUD 1.2 billion over the half. While a significant amount of our term deposit growth came through the retail channel, growth was also supported by the recent launch into the direct SMSF channel, which we expect to grow into a material new channel over time. We continue to execute on our TFF funding strategy with an additional AUD 740 million in low-cost TFF funding deployed to support SME loan growth over the half. Funding from warehouses increased slightly as our optimization program progresses.
We also executed our inaugural public senior unsecured benchmark deal in September 2022, which was well supported by fixed income investors and an important milestone as we progressively build our presence in debt capital markets. You can see, we have proven our ability to access a wide range of different funding sources and channels, which we think positions us well to continue to fund growth and repay TFF funding. Let's now turn to the TFF. At the end of December, we have self-securitized AUD 2.3 billion or 80% of our total AUD 2.9 billion TFF allowance. We expect peak self-sec TFF utilization during the 2nd half of 2023, with repayments to be progressively made ahead of June 2024 to ensure an orderly and efficient transition.
Over the long term, we expect our funding stack to consist roughly 70%-75% term deposits, 15%-20% wholesale funding, and 10% core equity, which will continue to be supplemented with organic capital generation. Based on this mix, we expect our overall through the cycle funding costs to settle at roughly 100 basis points over BBSW. Our committed warehouse capacity was AUD 1.75 billion at December 31, on which we currently pay market-based line fees. We're in advanced discussions with several banks and are well progressed towards our AUD 2.5 billion target by June 30, 2023. Now, most of our committed warehouse lines remain largely undrawn, and these will provide a significant amount of funding flexibility ahead of the TFF repayment window. As I mentioned earlier, term deposits are a core part of our funding strategy.
Our at scale NIM of above 3% assumes term deposit funding margins of 80-90 bps over swap through the cycle. The cost of our new TDs for the 1st half was only 47 bps, down from 66 bps in the prior half, well below our at scale assumption. Looking forward, we do expect repayment of the TFF to drive additional competition for TDs. As we've shown on the slide, we have in fact already entered the major bank's TFF refinance window. We are seeing the majors compete more aggressively in certain segments. Notwithstanding some recent pricing increases in the market, pricing in our key markets remain at or below historical averages.
As a result, this means we continue to have headroom in our assumed margins to work through this period of funding transition and also flexibility across tenors and channels to optimize the margin. In addition, we are uniquely positioned to price competitively for our TDs, given our lending margins are higher than the sector, who are primarily mortgage lenders with NIMs below 2%. In terms of outlook, we have assumed that TD pricing reversed to 85 basis points over BBSW for the rest of FY 2023, which is the main driver of our underlying NIM while running back close to 3%. I'd now like to turn to lending margins. As noted earlier in the NIM waterfall, we saw some pressure on lending margins this half, which is worth unpacking. The most material driver on margins was fixed rate loans.
As a reminder, 10% of our GLAs had fixed rates, predominantly the asset finance book, which do not reprice as rates rise. The impact of fixed rate loans was a 12 basis points drag on underlying NIM over the half. Refinances for existing customers and lower margins on new lending also had an impact, in total, a seven basis points drag on underlying margin. We attribute lower lending margins in part to the recent lower funding costs across the system, with the sector using favorable deposit costs to fund lower lending margins while managing overall NIM. As sector funding costs increase, we expect this will be reflected in asset pricing. We remain focused on our disciplined approach to pricing credit risk.
We continue to see our long-run lending margin assumption of 450 bps over one-month BBSW as achievable, given the premium customers are willing to pay for our high touch service. Turning now to operating expenses. 1st half CTI reduced by 13 percentage points to 54%, demonstrating improved leverage as the business continues to scale and the strong NIM we delivered this half. The increase in expenses over the half predominantly reflect growth from new recruitment, including additional specialist staff, some new office openings, and a normalization of travel activity. After a successful period attracting new bankers to Judo, we have a very strong team with ample capacity, and we expect banker numbers to stay relatively steady over the remainder of this year. In terms of guidance, we remain on track to deliver a full year 2023 CTI of under 60%.
Our December 2022 run rate Opex was AUD 15 million, which we expect to increase in the order of about 10% from continued investments in growth and some lingering inflation. We expect 2nd half 2023 CTI to rise by 2%-3% off the 1st half, largely due to an assumed normalization of NIM. Turning now to credit quality, which remains sound. Impairment expense for the half was AUD 22.3 million. As a reminder, as a high growth bank, most of our impairment expense is provision build in accordance with accounting standards, which require us to take our provisions up front for new loans.
We've previously provided cost of risk guidance for full year 2023 at AUD 50 million-AUD 60 million, which we expect to meet. There were no write-offs over the 1st half. In the absence of write-offs over the 2nd half, our bias is to continue to build provisions. Our days past due and impaired remain at low levels. Whilst we saw a slight uptick over the half, this was due to a small number of customers across various industries with no discernible trends, which we'll continue to monitor. Note, we've included an industry breakdown of credit quality in the appendix. Clearly, the 16 bits of 90 days past due in impaired assets that we reported in the 2nd half 2022 was abnormally low, with some normalization expected, which we're now starting to see come through.
Given the continued build and collective provisions over the 1st half and no write-offs, total provision coverage has increased to 104 basis points of GLAs. Specific provisions also increased over the period, which was driven by a small number of impaired loans. I do want to spend a moment now on our collective provision overlays. This half, we raised a new overlay of AUD 3.7 million for vulnerable sectors. This reflects the heightened uncertainty in industries more adversely impacted by reduced discretionary spending, namely accommodation and food services, discretionary retail, and arts and recreation services. The overlay reflects a one-notch downgrade to customer risk ratings in the relevant industries. In addition, we continue to hold a large customer overlay, which was first raised in September of 2020.
Overall, we believe our current level of provisioning is prudent for the risk in our book and the current economic outlook. Let's turn to capital. Our very high capital ratio continues to support our growth. Pleasingly, and as noted earlier, we are now beginning to generate organic capital at a meaningful rate. This half, contributing 70 bits to CET1. This trend will continue as we grow and see the full benefits of scale and investments made. I also want to provide some comments on the revised APS 112 capital standard, which took effect on the 1st of January. For us, this provides a pro forma benefit of about 9% reduction in credit risk-weighted assets, resulting in a pro forma CET1 of 19.2% on December 2022 numbers. This is a very strong capital ratio to support our future growth.
I'd like to close with a summary of key considerations for the 2nd half to give you all a good sense of where we expect to land at 30 June. On revenue, we expect net interest income to be higher in 2nd half 2023, reflecting higher volumes and benefits of scale, as well as the ongoing benefit we receive from rising rates as an ADI. The NII tailwinds will be partly offset by lower 2nd half underlying NIM due to the normalization of TD margins, line fees on new warehouses, and the drag from temporarily carrying high liquid assets as part of the TFF refi strategy. Other operating income, which is largely fees charged on bank guarantees and undrawn lines of credit, will be broadly flat half on half.
On expenses, we expect an increase of around 10% off the December 2022 run rate of AUD 15 million, with a corresponding increase in 2nd half CTI of around 2%-3%. Holding prior guidance, cost of risk is expected to be between AUD 50 million and AUD 60 million FY 2023. Lastly, as discussed on my previous slide, our CET1 ratio will benefit from APRA's revised APS 112 standard, which results in a 9% reduction in credit risk-weighted assets and a pro forma CET1 of 19.2%. Thank you once again, and I'll now pass back to Joseph.
Thank you, Andrew, for that excellent update. I'm going to spend some time discussing the operating environment and outlook together with some organizational priorities. While speculation about the economy remains a hot topic, we are optimistic about the outlook for our business. We're cautious about how the economy might evolve in 2023. We are in uncharted waters, but we do not see a severe downtime. We still appear to be on a narrow path to achieving a soft landing. High interest rates and the potential for consumer distress is clearly a key risk to the economy, and we continue to see the household sector as an area of concern. Accordingly as Andrew discussed, we have raised an economic overlay for sectors we consider to be vulnerable, predominantly those sectors relying on discretionary consumer expenditure. context is important.
While the official cash rate has been increasing quickly, the consensus for the medium-term peak cash rate of between 3.5% and 4% is consistent with the long-term average. We are returning to normal settings, albeit at an extraordinary pace, the transition will undoubtedly prove challenging for some households and businesses who are also grappling with broader inflationary pressures. It is well understood that household leverage is high, a concern for the economy that I've been voicing for some time. In contrast to the growth in household debt over the last decade, which has been both eye-watering and concerning, SMEs have de-leveraged, as you can see from the slide, and are generally well-placed to withstand an economic slowdown. Coming next to our organizational priorities. We have four clear areas of focus in building a world-class SME bank.
First, maintaining our unique culture, which is founded on an owner's mindset. The importance of this cannot be overstated. I know that culture as a source of competitive advantage doesn't lend itself to our financial model input, but it is real and it can be defining. The enduring truth is that great businesses have great cultures. Second, keeping our customers front and center in everything that we do. Our reasons for being is to erect a market failure. This is more important and relevant today in times of potential economic stress. Third, maintain a challenging mindset, and consistent with that, avoiding the many risks of sleepwalking into becoming a smaller version of the big players. Again, culture matters. Fourth, continuing our journey in building a world-class bank through a strong commitment to investing in technology.
We have a lot more to say about this at our next investor meeting scheduled for May 2023. All businesses face challenges. We believe in transparency, and that extends to being candid about our assessment of the top challenges facing our business. Our primary challenges are unchanged from what we discussed six months ago at the full year 2022 results. Over and above credit portfolio management, which is critical in the context of the economic outlook I've just mentioned, we see four top challenges. First, a shortage of specialist talent in certain key functions such as information technology. Secondly, the increasing burden of regulation. Thirdly, the real risk of entrenched inflation. Fourthly, preserving our unique culture as we grow. We spend a significant amount of our time on our people, their well-being, and our cultural agenda.
Our organization will either fail to achieve its potential or achieve success based on these factors. We are developing a strong culture. As a young company, the cultural concrete is still wet. We must work hard to ingrain the culture we want before the concrete sets. Once it sets, as it has in most mature organizations, it's very difficult to change absent a life-threatening crisis. Our unique culture is underpinned by a strong sense of purpose and our core values of accountability, performance, teamwork, and trust. We undertake weekly engagement tracking, which provides real-time feedback on employee morale and enables rapid resolutions of any issues. We believe that this is unique in our industry. In terms of talent, our focus continues to be on hiring top talent who are passionate about Judo's purpose and aligned to our core values.
Our credit test remains an essential step in hiring new bankers, and the pass rate on the test remains stubbornly below 50%. We celebrated 90 internal promotions and career moves as part of our investment in developing and growing our people in calendar year 2022, including, of course, Andrew's promotion to CFO. Promoting from within I see is central to our culture and future success, as is maintaining an ownership mindset. Importantly, knowing that incentives influence behavior, our reward structures are based on the core principle of driving long-term shareholder mindset via equity ownership for our employees. Over 8% of the equity in the company is owned by employees and directors. We are fortunate to have a management team with deep domain banking expertise and significant equity ownership, as I've just mentioned.
Several of the management team have held senior risk management roles through their careers, not to mention our chairman, who was group chief risk officer at one of the major banks. I've said before that this is the best management team that I've worked with. The recent changes to the team have augmented the skills and capabilities we need to optimize our pathway to scale and strengthen our succession planning. We plan to make the management team available to meet with investors more frequently through the year to provide more insight into their respective areas. To guidance. We are reiterating our FY 2023 targets. This includes a loan book exceeding AUD 9 billion. Importantly, though, and as can be seen from our rate of growth, we are not looking to grow the loan book much beyond this target.
Our current rate of growth balances the lending opportunities we see with the current operational bandwidth and capital requirements of the business. We do not want growth for growth's sake. We want to manage and protect the sustainable economics of the business. We have no appetite for pricing credit risk below our cost of capital. That's what an ownership mindset means. Our guidance on underlying net interest margin, CTI, and cost of risk remains unchanged. Andrew stepped through the considerations for each of these lines in detail already. In delivering on our FY 2023 guidance for lending growth, we will be halfway to our key business metrics of scale. We believe any questions regarding the validity of our CVP have been emphatically answered. It becomes a matter of execution to achieve the remaining metrics.
Throughout this year, we will provide strategy deep dives on our CTI, including the role that technology plays and on credit quality and our culture. These will fill in some of the blanks in terms of our pathway to scale. We anticipate our CTI update will be in early May, and we will hold a credit quality and culture update later in the 2nd half of the year. In conclusion, our business model is on plan. We are doing what we said we would do. We are growing profitability with a structural bias to rising rates and continue to execute against our commitments.
We have strong funding optionality that gives us confidence that we can fund growth and manage our TFF repayment. Whilst the environment is uncertain, we do not see ourselves as a macro play. We have a strategic edge inherent in our relationship-based model that position us to continue growing regardless of the operating environment. Our group opportunity is not correlated to system growth per se, but to the poorly served customers sitting on the books of other banks. The stock of SME loans sitting in the banking system is approximately $450 billion that churns at approximately $125 billion per annum.
As a specialist pure-play bank, our team of experienced bankers and risk executives gives us a significant competitive advantage as we can exercise speed and judgment for larger banks with the industrialized approaches, often involving contact centers or bankers managing hundreds of customers simply can't match. As I mentioned, we are not directly leveraged to the housing market, which will undoubtedly be challenged in 2023, but we are very cautious of contagion risk and the risk of spillover into the broader economy. We believe we have a compelling Customer Value Proposition, and we've established ourselves as a viable alternative to other banks.
We remain confident we can continue to grow and support the SME economy and build a world-class SME bank. We are hugely excited about the future of Judo Bank as a genuine, incredible challenger bank. Thank you. We will now move to Q&A, and I'm looking forward to your observations and questions on another black belt performance by Judo.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you're on a speakerphone, please pick up your handset to ask your question. Your first question comes from Andrew Lyons with Goldman Sachs.
Thanks, good morning. Just two questions, firstly, on capital. At the FY 2022 result, you explicitly said that you had sufficient core equity available to achieve metrics at scale. While you have reiterated your at-scale metrics today, that very explicit comment around capital sufficiency does appear to have been removed from the various 1H releases today, at the same time as you've consumed 320 basis points of CET1 in the half. I can see you'll enjoy a 1.9% tailwind from the adoption of the new capital standards from Jan. Just in light of all of this, can you just comment on your comfort around your capital position and its ability to fund the business as it reaches self-sufficiency? I've got a second question on margins. Thanks.
Okay. No. Thank you, Andrew, appreciate the question. Look, there's no change to our position on capital. We're still very confident that we have sufficient organic capital to achieve those key business metrics at scale. The APS 112 benefit is obviously a component to that. I think the other kind of key thing that we're, you know, very excited about is really the organic capital generation we're now starting to see come through. As we think about capital consumption going forward, I think the rebase under the APS 112, you know, is helpful in that regard. You know, whilst you've noted what we've used in the 1st half, we expect that net kind of capital consumption on an absolute basis will be smaller going forward. There's no change to that position at all, and, you know, we stand behind those comments.
Great. Appreciate that. Just a second question on your NIM. You're expecting your underlying NIM to be in the range of 3.1%-3.3% in the 2nd half. I just note that the gap between your reported and underlying NIM shrunk from 61 bips last half to 33 bips in the current half. Can you maybe just help us to understand the extent to which that gap will continue to shrink in the 2nd half of 2023? Therefore, just the extent to which your underlying guidance implies a flattish trajectory for NIMs or Sorry, reported NIMs or will reported NIMs also be down in the 2nd half? Just also confirm that that gap between reported and underlying should be zero by the June 2023 run rate.
Yes. Look, Andrew, you're right. Those, the NIM and underlying NIM will ultimately converge just as we continue to use the TFF. The underlying NIM is, you know, our way of, I guess, providing some visibility or like for like on that. They will converge. At the point where we have peaked our TFF draw or utilization rather, that will ultimately see those margins kind of come together. That's really the impact that you're seeing in comparing those two numbers for the 1st half.
Will you be any more explicit just in relation to that gap? As I said, the underlying versus NIM, sorry, versus reported was 33 bips in the current half, down from 61. Any sort of quantitative guidance as to the extent to which that'll shrink in the 2nd half.
Look, ultimately, they will all converge together. It's just as we start to use the preserve component of the TFF. We obviously used kind of AUD 740 million of that. There's a bit more to go. You know, they will ultimately converge as we, you know, as we get to that point of peak utilization.
Thanks. Appreciate the answers.
Your next question comes from Jonathan Mott with Barrenjoey.
Thank you. Just another question on margin, if I could, and on that guidance on TD pricing. Are you assuming that it widens materially through the rest of the 2nd half back to through the cycle 80- 90? Question on that, where you get that number, is that a gut feel that it'll revert to the average? Why you think it just is a automatically revert to mean situation? How do you get that number? Can you give us a feel for that then after the second question?
No, thanks, Jonathan. I mean, ultimately, I guess we look at what the dynamics that we're kind of seeing in the TD market. we're quite open that we have seen an increase in competition there. that's come in selective channels. it's really an extrapolation, I guess, of where we see that competition. I think the other element here is we're not kind of linear in terms of how we do that origination, where we can be a bit nimble. We took some larger volumes in the back end of the 1st half. as we run into June, they're always kind of big origination months for us.
Naturally, there's some increase in the deposit activity. You know, it is an extrapolation ultimately, John, in terms of kind of what we're seeing in the market and also I guess, you know, as we play around with that price elasticity to take the volumes that we're that we're looking at for the rest of the half. It is in line then with, I guess, what we have always seen as a, as a long run, origination assumption for us, for TDs. That's based on, you know, ultimately being at a bit of a premium to where we see the long-run average for the, for the branchless banks. We think that's appropriate, given the normalization, as Joseph talked about in terms of the interest rate environment. We'll expect to ultimately see that come through on the funding costs as well.
Thank you. Just a follow-up question, just sort of what's the backup plan? Let's just say competition gets very intense, which is, you know, some people thinking about is the major banks have to roll over the TFF if funding becomes a challenge. If you had to prioritize it, would you prefer to draw down the warehouse facilities? Do you just pay up for TDs to make sure that you maintain that funding mix? Would you slow down loan growth? How would you prioritize it as a backup if competition gets very intense?
Look, I mean, ultimately, we have a view that, you know, there has been this very favorable funding environment for TDs. Ultimately, over time, as that normalizes, you know, I think we'll see normalization in asset pricing. There is an element of normalization here. Specifically to kind of your question, you know, tactically, as we look at that on a more day-to-day basis, one of the real benefits that we've been and our treasury team have been working very hard at is the warehouse optimization program that we've got. We've got committed warehouse lines of AUD 1.75 billion today.
We've got a target to take that to 2.5 by June. We're very well progressed with a number of banks that will take us towards that target. We pay line fees on those undrawn committed warehouses, so the marginal cost of then drawing them versus our long run TD assumed cost is actually not that different. So I think if we see a, you know, for some reason, there's a massive blowout in TD pricing, we've got that flexibility of looking at warehouses. You know, it was really interesting in the middle of the early days of COVID, we actually did see the marginal cost of some of our warehouses cheaper than deposits for a couple of weeks. So we have that flexibility. We've used that before, and it's something certainly that we have in our arsenal in terms of funding over time.
Andrew, I just might add a footnote to your comments. Certainly, slowing down, lending growth is not something that we're contemplating. I mean, one of the benefits of being an SME bank is the pricing flexibility that we have in coping with higher than planned, deposit costs or funding costs. So we do have the ability, if we do see a significant systemic shift in funding costs in the deposit market, to ensure that that's passed on through the repricing, of our lending. That's, that's a big strength of the company versus a, you know, a mortgage-based lender.
Thank you.
Your next question comes from Richard Wiles with Morgan Stanley.
Good morning. I've got a question on capital and also a question on the lending margin. I'll start with capital. Andrew, you say you've got 70 basis points of capital generation, but you also used more than 350 basis points of capital to support your RWA growth. Even with the benefit from the new framework, that common equity ratio is gonna keep coming down. Can you give us some guidance on what sort of level of capital you might need in a couple of years' time? Should we be thinking it's 11%-12% common equity tier one ratio, or does it need to be meaningfully higher than that, given that you remain in a high growth phase?
No, thanks, Richard. I mean, we've, we do believe that, you know, at the point where we, I guess, get to scale, that we will have a, have a CET1 of, you know, between the regionals and the majors, and I guess a premium, you know, to the regionals given, you know, given the potential for future growth. I mean, we'll always calibrate that, I think, based on the opportunity that's ahead of us. That's always been our at scale assumption. You're right that, you've seen us consume, you know, capital for growth over the, over the half and, you know, the 300 odd basis point assumption is correct.
I think what I would say on that, though, Richard, is that with that, with that reset under the new APS 112, you know, all other things being equal because of that rebase, that kind of capital consumption, certainly that we expect, going forward now under the new rules will be less. Then continuing to offset that will be, you know, growing profitability as the business continues to scale. You can kind of look at that, I guess, for some guidance around the near term, but that will kind of start to converge as we continue to grow and scale kind of beyond the next six months.
Okay.
Lending margins.
Yeah, on the lending margins. You express this confidence that you can do 4.5% in the medium term. You know, they must be generating pretty low margins now, given how quickly the funding costs have gone up. There's also a lot of competition. Every single major bank wants to do better in this space. Maybe they don't have the customer service, but they do have the price lever. When can we realistically expect to achieve a 4.5% lending margin? How much longer will that drag from the fixed rate book be there for your, for your lending margins?
Richard, it's Chris. I might take that, if that's okay. I mean, yeah, I mean, look, as I think we've disclosed in the past, the fixed rate book, predominantly our fixed rate book is asset finance, right? The nature of that product is it amortizes relatively quickly. That's not a concern, especially given the, you know, the proportion of the overall book that is represented by that. As you know, our overall fixed rate loans are less than 10% of our entire portfolio. The underlying 7 basis points drop in the, in the 1st half, I think as we've already said, you know, yes, absolutely. That a high degree of competition using the price lever that they've always used.
SME was also a factor during that half. Also, we talked about, you know, the tailwinds from the funding cost benefits that the major banks have been using, particularly as two banks in particular, who have become, you know, been very public about their aspirations for growth in that sector. The reality is that we believe there's still a significant loyalty tax being paid by a significant number of customers out there. It's interesting to note that the PEXA refinance index is at an all-time high in terms of the likelihood of customers looking for refinance opportunities, matched with the fact that the NPS scores of the major banks has not moved at all either. We're very confident in our underlying assumption around that 4.5.
I would expect that by the time we report, sort of our exit NIM, in the full year results, you'll be seeing starting to see the benefit of that sum to come through. Of course, it largely depends, as Joseph said, in terms of where the economy goes as well. We do believe that the banks will start to pass on increased funding costs to their customers. The exact timing of that, of course, is in front of us. The long-term thesis of 4.5 is still an assumption that we're very confident in.
Thank you.
Your next question comes from Nick Dalton with JP Morgan.
Hi, everyone. A couple of quick questions from me. Firstly, just in terms of your guidance. Working through your 2nd half guidance, would seem to imply revenues of a bit under AUD 170 million and pre-provision profit of AUD 75 million. Is that in the ballpark correct?
Yes. I assume, Nick, that you've been triangulating off the CTI and some of the other guidance that we've given. Yes, look, that's broadly in the ballpark.
Okay. Perfect. Just on terms of your medium-term targets, do you place any greater importance on any single metric? So for instance, would you forego growth to achieve your target ROE? Or do you all kind of view them as equally important?
Well, I. Joseph here. The question broke up a little bit, but, as I what I heard was will you grow and sacrifice.
Oh, no, definitely. No. No, it's, s orry about that. It's potentially the headset. It's in terms of your at scale metrics, do you place any greater importance on any single metric? Would you, for instance, foregrow one metric to sustain another one? Would you reduce your growth to achieve your ROE target?
Well, we're committed to those metrics at scale that we've outlined, we don't see the need. We don't see. Right now, we don't see trade-offs. We're not going to. As I mentioned in my remarks, we're not gonna engage in lending that does not achieve the economics that we've set for the business. We don't think we need to do that. That's why it's important that as we think about growth, that we're running our own race, you know, that we can be selective in where we're lending and not get involved in lending at sub cost of capital, not get involved in taking on excessive risk. I mean, the aspirations of getting to AUD 9 billion, which, you know, we're on track for.
Then if you think through metrics at scale, AUD 15 billion-AUD 20 billion in a market that is over AUD 600 billion, AUD 450 billion of current stock and then mortgage and other opportunities. Our aspirations actually at scale are not blue sky aspirations. We believe that by running our own race, and managing the economics of the business, that we can achieve what we said we would do without compromising on risk or on ROE. Certainly, you know. We could say to the market that we're gonna set our metrics to scale at AUD 25 billion, right? We don't, we don't want to do that.
We wanna say that we can demonstrate over the next number of years that we can get to what we promised back in November of 2021, and do it in a way that's sustainable and protects the economics of the business. I mean, I've been in this business so long, and I do not ever see price or credit compromise as a sustainable strategy. The campaigns, it give you some market share, but they destroy the economics of the business and that's not what we would do.
Thank you.
Your next question comes from Josh Freiman with Macquarie.
Hey, all. Thanks for the opportunity. Just two quick questions from me. Just the first on that fixed lending margin compression. I mean, this really sort of appears due to a balance sheet mismatch. I'm conscious you guys may partly naturally hedge that using deposits over 12 months or even part of the TFF that you guys have been allocated. For the delta of mismatched loans, how should we sort of consider that moving forward? Are you guys sort of considering that to be something that you guys will hedge moving forward? Should we consider that to be perpetually mismatched?
Thanks, Josh, for the question. You're right. We've kind of called out, I guess, that impact on the 1st half of those fixed rate loans. Look, that is an element that we have been, I guess, naturally hedging against, you know, against kind of what else we have across the, you know, across the liability side of the balance sheet to date. You know, our hedging program has been very much focused on, you know, I guess the, you know, in part the TFF, but also the lending side using deposits. That's been really the priority for us in terms of the hedging program to date.
I think going forward, you know, we will look at more actively managing that component of the lending book, so those fixed rate loans. We've got a little bit against that today, but we'll probably look more actively at kinda matching those specific parcel of assets just going forward. From an outlook perspective, I think as you kind of look at the NIM waterfalls and think about, well, what might the impact of that portfolio be on the book going forward, you know, it was in the 1st half effectively a, you know, a nine basis point drag, and I think we'll see something. Sorry, in the 1st half, it's a, you know, a drag of the order of, you know, about 12 basis points. I think we'll see that a little bit lower in the 2nd half and going forward.
Perfect. Thank you. I guess just to sort of follow up with my second question, you know, still on hedging, I guess no surprise from me. You know, I'm conscious, you know, in that you sort of mentioned you have been focused on the TFF with hedging, and in slide 36 you sort of note 35% of that is swapped back to BBSW one month. I'm not sure if any of the remaining balance was naturally sort of matched with any of your lending. Given it's sort of not entirely clear what proportion of the TFF was in total matched or swapped back, what do you kinda see as that overarching longer term headwind out into FY 2025 as the TFF fully rolls off?
I mean, we'll keep hedging on the TFF pretty stable. It has been fairly stable following the initial hedging activity that we've got. You know, we've got AUD 1 billion of hedges sitting against the TFF, and we expect that to be continued, I guess, going forward. That's just all around, I guess, then managing, you know, Josh, how, you know, the repayment profile of that TFF will ultimately come through. We're quite kind of comfortable, I think, with the level of hedging we've got there. We think kind of where we are in the rate cycle and also given the repayment profile of that that's kind of where we wanna be. There's no intention to kind of, you know, change that materially, you know, as we approach peak utilization and then ultimately repayment.
Thanks. I guess just sort of touching on that, I mean, if you could sort of provide a quantum in how you guys think of that, like the AUD 1 billion hedge. What's the quantum then of the margin drag for the unhedged portion?
Look, we're not kinda giving detailed guidance on that at this point, Josh. I mean, in terms of, I guess, as we think about the impact, I guess, of having, you know, this fixed portion of funding and the kind of net of, I guess, the hedging that we've got against it in terms of the kind of 2nd half outlook, for example, you know, we'll still continue to get a benefit from that in the rising rate environment. It'll probably be in the order of about, you know, 15 basis point benefit in the 2nd half, net of the hedging that we've got against that funding line.
That's it. Thank you.
Your next question comes from Brendan Sproules of Citi.
Good morning. I just have a couple of questions on asset quality. Could you give us a little bit of information around what you're showing on slide 21 for the 90 days past due, the pickup there. Is there certain sort of industries that are overrepresented, I guess, there? I guess, have you got any statistics on the 30-day past due and whether that's higher than the 90? Then I have a second question.
Thanks, thanks, Brendan. I mean, in terms of, I guess, what we're seeing, in that, in that, you know, for the 1st half. There's no, there's no kind of particular trends, I guess, or particular sectors of stress necessarily. I mean, we have as we talk through, we have taken an overlay kind of proactively, I guess, based on the outlook in terms of what we see for discretionary or sectors that are impacted by discretionary spending. But, you know, that level of days past due and impaired, I mean, it's 18 customers or 15 customer groups, in a, in a pool of, you know, 3,300. It is a very small number. In the appendix, we have a little bit more detail about where they sit in terms of particular sectors. You know, it's one or two customers across most of the different segments.
There's fi-
And-
There's five customers in manufacturing, but that largely reflects, supply chain problems that were kind of building up. Actually are now starting to ease. We expect to see some of those accounts, remedy themselves in the coming weeks.
Brendan on the 30-day, nothing material to report. I mean, still, roughly around about 70 basis points in total. That includes the 90. Obviously, it's over 30 days. I think in total, we've got about 60 customers which are over 30 days. You can subtract from that the 90-day numbers as well. You can see, you know, nothing of any materiality coming through at all. As already commented, no sector concentrations there at all. It is the law of small numbers.
You know, even if you look at our, you know, discretionary retail, for instance, you know, the GLA balance is only AUD 200 million. Even at 1.26% of over 90 days is AUD 3 million spread across three customers. In arts and recreation, again, it's diversified. You know, it's a gym, it's tourism. There's no concentration issues at all, and there are no discernible trends coming out of, any of the, arrears data.
Thank you. That's very helpful. My second question is on slide 23, where you show in the capital waterfall that there was a deterioration in the average risk weight on lending across the whole portfolio. I imagine that's across your whole 3,000 clients, despite the fact that leverage, as you point out in the sector, has actually been declining. What sort of drove this? Is this because you're riding slightly lower credit grade business in the current period and the average is pulled down? Or are you seeing a broad-based deterioration across, I guess, the pre-geared profit of these businesses that's leading to a lower risk weight on the lending book?
Oh, look, Brendan, I mean, it's, it is a factor that we've got there, but there's nothing particular kind of driving that, in terms of any material change to the portfolio. You know, I don't think there's anything, you know, that we feel we kind of need to call out on that. It's, it's a very small delta, overall.
There's been no shift in our risk appetite.
No, no.
We've been very disciplined on, in terms of, executing against the board-approved risk appetite. No deterioration. We monitor our average credit rating and average and security classification every month on the lending that we're doing and in the pipeline. We pull lever. We're not seeing any deterioration.
No, no. I mean, it's. Look, it's a point-in-time metric on a rapidly growing book. If you look at our new segments in health and agri, in particular, you know, we are seeing a skew the other way. Very, very high quality credits coming out from both of those two new segments that we've entered in the last 12 months. As Andrew said, it's just 0.3%. It's not something that we're concerned about at all, particularly with the pivot to APS 112, where the different security mix will have a bigger impact as well in H2.
Okay, thank you.
Your next question comes from Azib Khan with E& P.
Thanks very much. A couple of questions from me. First one on capital. The pro forma CET1 ratio, that's got a 1.9 percentage point benefit from APS 112. Have you changed your internal CET1 ratio target range at all? Has that been shifted upwards under the new framework?
Sorry, has there been any change to th, y ou just cut out.
To your internal CET1 ratio target range. Obviously under the new framework.
Oh
Yo u've got a 1.9 percentage point benefit. Are you changing your targets at all?
No. Look, no change at all. I mean, we, you know, there's been no change to how we look at the book and the consequence in terms of how the risk weights come through. There's no change at all there.
All of that 1.9 percentage point converts to excess capital.
That's right. I mean, it's really just, w hat it reflects, I guess, is just how some of the different parts of the portfolio and under the new 112 standard change in terms of the credit risk weights. The biggest impact is really, I guess, in the corporate counterparties bucket, which is the largest kind of component to our in terms of our gross credit exposure. That really benefits because, you know, that portfolio effectively under the old standards was, you know, close to 100% risk weighted.
What we do is we get the benefit then, I guess, of when under the new, the new category mappings that we get under APS 112, in terms of in particular, I guess kind of, you know, SME retail and SME corporate, where those risk weights kind of come down. That's really where the bulk of it, that benefit comes through. It is then just a, an overall, you know, a step up in terms of the CET1 that we get under the new standard.
Zib, it's Chris. I mean, this wasn't a surprise. I mean, we've seen APS 112 coming for the last two years. In the guidance that we've always given the earlier comment around that we have enough capital to execute on the metrics of scale. This has always been part of our equation, if you like. There's no, there's no internal pivot. We knew it was coming. We're pleased that the standard is finally in. And it, and it's part of the part of one of the levers that we've been using in terms of the previous guidance that we've given.
Thank you. just got another question on margins. You've obviously called out, you know, lower new lending margins in the half. Is it fair to say those new lending margins are about 50 basis points below the long-term assumption of 450 over swap?
No, no. They're not that, n o. They're not as low as that, Zib.
Sure. On the TD margin, so you're guiding to 85 basis points over swap on that front. You've recently been paying about 40 basis points, a 40 basis points premium to major TD pricing. Is that 85 predicated on roughly a 40 basis points premium to the majors or something lower?
No, no. I mean, we, our, you know, we've always had the view, Zib, that, you know, when we look at where the branchless banks originate at around either the long term, through the cycle at about, you know, 75 basis points. We've always made the assumption that, you know, to be the price leader, you know, in the order of kinda 10 basis points above that. You know, it's very much kind of predicated, I guess, on where we see those long run TD, you know, costs for branchless banks, which is kind of our, I guess, our closest peer set, and a 10 basis point premium above that, which is the 85 basis point through the cycle assumption.
There has been a lot of movement in terms of, you know, some competition as we referred to earlier, from major banks in certain segments. You know, we're kind of more focused on, you know, where are we with the branchless banks and where, you know, where we need to price for our tenors and our channels.
Yeah. I mean, we would be on average about 50 points above on 6 months money or a 6-month TD.
Mm.
Above the average of the major bank. That's a very defendable position in the market. I mean, the, there's gotta be a limit to how aggressive major banks can be on TD pricing, just given what it would do to the economics of their business.
I think this is earlier to John's earlier question around the 85 basis point assumption.
Yeah.
The branchless banks that Andrew referred to are retail banks, and they're lending, you know, home loan lending at a maximum of 2% over swap. That assumption of 85 basis points, which is a 10-20 year through the cycle, when we're, you might see some short-term spikes, but you're not gonna see that average fundamentally change.
Thanks for that.
Okay.
Thank you. Can I just push my luck with one more question? I just want confirmation. On the 12 basis points drag from the fixed rate equipment finance book. Can I confirm that that's just a timing issue? I mean, Chris Bayliss has said that that book amortizes pretty quickly. As it rolls over, do you have scope to reprice those rates in line with the interest rate increases and make up for the drag?
Yes, completely. I mean, today, the equipment finance that we're writing today is based off today's swap rate, so it will amortize very, very quickly. We pulled it out. As Andrew said, you know, we do have a natural hedge with the TD book. We could have just netted them off in terms of the way that we showed it in the waterfall, but we chose to break the two components down. It is naturally hedged against equipment, against the TD book. It will amortize quickly and absolutely. We can't reprice midway through a contract, but, you know, the loans we've been writing for the last six months have been reflective of the swap curve that's prevalent at the time.
Thank you.
Okay. Thanks for that. I think we've kinda come to the end. I just want to thank everybody for their participation on this call and for the questions. We look forward to continuing the dialogue in the next days and weeks. We mentioned at the beginning that this is a set of results that we're absolutely thrilled with. Demonstrates the quality of the business and the potential in the business. I hope all of you feel that the level of disclosure and transparency that we provided in these and in this half set results is reflective of our approach to keeping the market well informed on how we are thinking and how we are planning and performing. On that note, again, just thanks everybody for your participation in the call. Bye.
That does conclude our conference for today. Thank you for participating. You may now disconnect.