Edited Transcript of MYS.AX earnings conference call or presentation 20-Feb-20 11:00pm GMT

Turning to Slide 5. The key metrics and performance drivers all show a very strong business. Net interest income rose 9.1% to $48.2 million as a result of a much higher-average balance sheet in the half, disciplined deposit and lending margin management and the benefit of wholesale — falling wholesale funding costs. Net profit after tax increased 5.4% to $15.1 million, and earnings per share grew 4.4% to $0.1657 a share. Return on tangible equity grew 20 basis points to 12.6%, a number which compares very favorably to all of our peers.

We maintained the interim dividend of $0.1425 per share, fully franked, which is payable to shareholders on the register at the 2nd of March 2020, and have increased the discount on the DRP to 2.5%. We’ve got a strong capital position and balance sheet, with total capital adequacy at the 31st of December of 13.2% and a Tier 1 ratio of 11.4%. We’ve managed our capital really well, and we’re looking to use that capital to grow the balance sheet with a lower use of securitization into the future.

Our digital platforms have been well received, and customers have been fast to adjust to the convenience that we now offer our customers, with 89% of all customer transactions now performed online or on a mobile device. The success of our online product has helped to build our customer deposits, which were up $241 million over the calendar year, $3.7 billion at the end of the half.

On Slide 6, you can see how our digital capabilities strengthened our overall offering, helping us to engage customers better. More people are using an app to do their business than any other channel. And we’ve experienced a 62% increase in online customer growth over the last half on top of similar growth in previous periods. Customers are using less paper and electing to receive statements online, enabling them to control their lives better by having faster access to statements and also saving on printing and posting costs.

Online origination and our digital platform have enabled us to build our business. A greater proportion of our loan book has been derived from Australia’s eastern seaboard. 5 years ago, almost 2/3 of our loan book was Tasmania-based. Today, that proportion is almost reversed and nearly 60% is based on the Australian mainland. So we’re now less a Tasmanian bank and now more a national bank based in Tasmania.

We anticipate further benefits as we continue to reengineer the business for growth. We’re preparing to capitalize on our platform and positive reputation of our brand through an investment in marketing, which has already increased 39% in the half. We intend to keep channeling cost savings in the marketing activity in order to continue to grow the customer base of the business rapidly. We are delighted to be selected by the National Housing Finance Investment Corporation to join the initial lending panel for the federal government’s First Home Loan Deposit Scheme. After the first 3 weeks of operations, we’ve already exceeded our total target number of loans. And at current flow rates, we anticipate that we’ll get very close to the government cap of 1,000 loans per bank.

Additionally, we and a number of our staff have been recognized as finest in a number of mortgage industry awards. This is a recognition of the work that we’ve done over a number of years and a number of iterations to improve our service proposition to our broker partners and our customers. It’s fair to say that as a small bank, we punch well above our weight in this area in terms of turnaround times and consistency, which certainly augurs well for us for the future. We’re incredibly busy at the moment helping people achieve their dreams and changing the business to make it better. And it’s a really exciting time, as I said before, to be at MyState.

And I will now turn the microphone over to Gary, who is going to take you through the financials in some more detail.

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Gary Dickson, MyState Limited – Interim CFO [3]

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Thanks, Melos, and I’m pleased to be speaking with many of you for the first time. Moving to the results summary on Slide 8.

Most of the key metrics have moved positively compared to the previous corresponding half, and it’s clear that this is a strong result. That’s despite a challenging environment, with increased competition in the low-risk owner-occupied lending market, with a loan to valuation ratio of less than 80%, which we target. While operating expenses increased 4.8%, income growth exceeded cost growth and we experienced positive jaws. Net profit was up more than 5%, benefiting from a higher-average balance sheet relating to the previous corresponding half.

Net interest margin was up 1 basis point on the first half of 2019 and up 3 basis points on the prior half as we maintained a disciplined focus on margin management and benefited from lower wholesale funding costs. Cost-to-income ratio improved by 116 basis points, with the benefits of process reengineering and automation beginning to flow through. MyState continues to have a strong capital position, with a total capital ratio of 13.21%. As Melos mentioned, earnings per share increased to $0.1657 and the company maintained the interim dividend of $0.1425 a share. This represents a payout ratio of 86% towards the upper end of the dividend policy range.

Moving to Slide 9. You can see that, that highlights that while we continue to operate in a highly competitive market, focused management of deposit rates and lending rates and lower wholesale funding costs have driven an improvement in net interest margin of 3 basis points on the second half of last financial year. The RBA has reduced the cash rate by 75 basis points since June 2019, with flow-on effects to both the earning rate on assets and the cost of funding. While home loan margins remain under pressure, funding markets eased in the second half of last financial year in anticipation of these cash rate changes, and MyState Bank has benefited from the tailwinds of a continued fall in wholesale funding costs and the narrowing of the BBSW-OIS spread during the current half.

Term deposit margins have continued to reduce as the book rolls to lower rates following the RBA cash rate changes. With exit NIM in the month of December at 1.93%, we expect net interest margin to improve slightly in the second half of FY ’20.

Turning to Slide 10. Operating costs continue to be well managed. Headline cost growth of 4.8% reflects ongoing investment in technology to build out our digital capabilities and a significant increase in marketing to build awareness of our brand. Marketing spend during the period has also contributed to customer acquisition, which is focused on building the bank’s franchise on Australia’s eastern seaboard. Digital marketing is enabling us to reach a broader population with new online and mobile products. Underlying cost growth was 3.16% after excluding one-off investment costs relating to the rebrand of our Wealth Management business from Tasmanian Perpetual Trustees to TPT Wealth, the launch of a new managed funds platform in early December and redundancy costs as we continue to reengineer and automate processes. We expect further cost benefits in the second half to flow through from these initiatives.

Operating leverage within the business continues to improve, with personnel, administration, governance and occupancy costs relatively flat since the first half of 2018.

On the next slide, net profit after tax grew by 5.4% from $14.3 million in the previous corresponding period after excluding the contribution of the financial planning business, which was sold in June 2019. Net interest income benefited from balance sheet growth, as I mentioned earlier, and focused management of margin and the reduced funding costs I also spoke about earlier. Wealth Management income was up due to higher funds management and trustee fees, and operating expenditure includes the growth in technology and marketing spend and the one-off investment costs I noted earlier.

We’ve also reported a noncash impairment expense of $0.6 million, reflecting an uptick in total and 90-plus days arrears balances in the home loan portfolio. This uptick is partly driven by a very small number of high-value loans, which have fallen behind on their repayments. Impairments overall remain at historic lows, and arrears remain well below relevant 30-day and 90-day benchmarks. The prior comparative period includes a write-back to provisions of $0.4 million, primarily due to a lower number of restructured loans. Our result does not include any remediation or regulatory noncompliance costs, which have impacted some of our peers.

Turning to Slide 12. We’ve maintained our focus on low-risk owner-occupied lending, with a loan to valuation ratio of less than 80%. Loan book growth was slow in the first quarter, but has been stronger in the second quarter. The chart on the top right-hand side shows that applications and settlements were both slightly below the previous corresponding half. The total lending book grew 1% during the half to $5.1 billion at 31 December 2019.

Lending momentum has pleasingly returned with strong application flows towards the end of the calendar year and very high applications under the federal government’s First Home Loan Deposit Scheme, as Melos mentioned earlier. We anticipate solid bank balance sheet growth in the second half. The geographical distribution of our loan book continued to broaden, with 41% of our loan book in Tasmania and 56% in the eastern states of Queensland, New South Wales and Victoria. As our loan book becomes more nationally representative, it reduces concentration risk and we expect this trend to continue.

On Slide 13, the chart on the top left-hand side illustrates the consistent focus on lower LVR loans, with 82% of the home loan book in the less than 80% LVR category. The average LVR across the portfolio is 57%. This high credit quality contributes to the strength and stability of our business. We support this with strong customer service and fast turnaround times, and the quality of our book demonstrates the success of our channel strategy and service culture. As I noted earlier, impairment levels remain at historic lows with very few mortgages in possession. Credit conditions remain relatively benign, with arrears remaining well below industry benchmarks.

On the next slide, Slide 14, the chart on the top right-hand side highlights that more than 2/3 of our funding continues to be sourced from customer deposits. During the half, the funding mix has been enhanced by lower cost at core customer deposits, primarily through our award-winning Bonus Saver account. This fee-free savings account was awarded a 5-star rating by Canstar and received Mozo’s Experts Choice Award.

Securitization remains an important component of the funding mix, and we completed a $400 million public RMBS transaction in September 2019 under the ConQuest securitization program. And this program continues to attract strong and broad investor support. Moody’s continues to maintain a stable Baa1 investment-grade rating for MyState Bank.

Turning to capital on Slide 15. MyState remains well capitalized with all capital ratios comfortably above regulatory minimums. The group’s total capital ratio at 31 December 2019, was 13.2%. Our common equity Tier 1 ratio and Tier 1 ratio were 11.4%, well positioned to meet the expected changes to APRA’s capital standards. Given the expected level of loan book growth in the second half, we continue to explore a range of alternatives to further improve balance sheet efficiency.

Finally, moving to Wealth Management on Slide 16. Funds under management closed at a decade high of $1.19 billion. Revenue was up 5.1% on a continuing basis, with higher fund management revenue and trustee fees. As Melos has mentioned, the rebranding to TPT Wealth and the new investor portal represent the first step in a multiyear program that positions the business for growth nationally. We have outsourced funds administration and registry portal administration to a leading third-party provider. This will enable efficiency benefits as the business gains scale. Product rationalization is also taking place, and we closed the platform mortgage fund in September 2019, simplifying our portfolio.

I’ll now return you to Melos to talk about our strategy and future outlook.

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [4]

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Thanks very much for that, Gary. So I’ll just now cover strategy and outlook, just beginning on Slide 18.

Back in 2014, the Reserve Bank said that Australian businesses needed to take more risks to drive confidence and motivate people. And the same could certainly be said today. We’re really in a low mojo economy, characterized by low interest rates that could go lower. And in any event, they’re going to be low by historical standards for a period of time to come. We certainly also have low consumer confidence and low business confidence. As people continue to pay down their mortgages ahead of scheduled repayments, this is going to provide some buffer for the economy into the future.

Economists expected the cash float will be lowered by another 25 basis points around the middle of 2020, while financial markets are predicting that this will be later in 2020. Regardless, everyone is predicting that interest rates have still got some time to come down. And it’s really too early to tell at the moment how much or how long a coronavirus-led slowdown in China is going to impact the world or Australian economy.

Much of the Reserve Bank’s 20 — 75 basis point reductions in cash rate in 2019 have been passed through to mortgage rates. And what we’re seeing is people’s house-buying intentions also starting to increase as a result of that, and house price rises — house price increases are starting to flow through. This is likely to increase the wealth effect on consumers and may lead to an increase in confidence and spending in the short term.

The Tasmanian economy continues to perform very well and we expect will continue to grow for some time to come. With both the national and Tasmanian economies being underpinned by solid population growth above OECD averages, this is going to provide support to the economy for a period of time.

So for us, this is a great time to be a small, clean bank with a solid and engaged customer base. We know that customers’ expectations of digital services are increasing, which we anticipated when we began investing in our platform a number of years ago. We’re small, we’re nimble, and we can implement new technology quickly. With banks lost in their branch network, our technology platform enables us to engage customers effectively with digital strategies and benefit from economies of scale.

We have a very small branch network of only 13, which means that we’re now much more a digital bank than a traditional bank. At the same time, larger banks are struggling with complexity and distracted with customer remediation issues. These issues aren’t shared by MyState, which is closer to our customers. Customer service is very deep within our DNA.

Let’s turn to the federal government. We really believe that the most effective way for the federal government to encourage better behavior in financial services is to allow an increase in competition. More needs to be done to promote customer choice and allow smaller banks to provide innovative products and services on a much more equal footing.

The Productivity Commission’s June 2018 reporting the competition in the financial sector said that competition and stability were both important to the Australian financial system. They went on to say that since the global financial crisis, there’s been a focus on requiring prudentially regulated institutions to be unquestionably strong. It’s important to ensure that the essential role of competition in economic growth is not eroded by having stability as a default regulatory position to the exclusion of competition.

Competition can support stability, checking irresponsible behavior of providers and providing outcomes for consumers and must be allowed to flourish. Sadly, the Productivity Commission’s report was a bit overshadowed by the Hayne royal commission, which started soon after Productivity issued their report, but it’s worthwhile going back to that report and read the recommendations of that report because we still believe that they’re relevant.

We think there are 3 key points that the federal government and regulators need to address. The first point is that risk weights set by regulators require smaller banks to hold more than 50% more capital than big banks for each loan. This reduces smaller bank’s ability to lend and receive inadequate return on capital despite individual loans carrying the same risk. The second is to reduce a significant funding advantage enjoyed by the big banks in the government’s implicit “too big to fail” guarantee. This implicit subsidy of those big banks gives significant wholesale funding cost advantage over smaller banks. It’s a margin which smaller banks like MyState will invest in, further improving customer experience and attracting new customers. This has happened in the past, but the current situation doesn’t provide smaller players with that incentive.

The third point is that despite small banks not having the same remediation issues with their customers as the larger banks, smaller banks wear the same regulatory burden, but it falls disproportionately harder on smaller banks. While we acknowledge that APRA has indicated a willingness to apply a principle of proportionality, this really can’t happen soon enough, and we urge them to implement regulations that recognize the size and risk of a bank.

We’re pleased that the government has not accepted the Hayne royal commission’s recommendation regarding mortgage broker remuneration, which will [conjure to] substantial proportion of MyState’s new business. However, we do believe this needs the greater transparency of ownership of mortgage brokers and aggregators and the balance sheet that their loans end up on. We suggest that aggregators and brokers owned by the major banks, and indeed all aggregators, should be required to disclose the proportion of loans they direct to their owners, which will allow customers to make better and more informed decisions.

So turning now to our strategic priorities. We continue to develop our digital banking capability, which allows our customers to make it when they want and where they want. Our digital platform enables us to serve customers faster, reducing our cost to serve, while providing them with intuitive, responsive systems that allow greater control over account management. We’re also able to target the customers we want more effectively. Our strategy has been focused on building a modern, highly scalable digital bank. We continue to transform our business through process reengineering with increasing use of process automation, including robotics. We’re currently investing in data-driven systems and predictive analytics that provide customers with personalized and helpful services, and we’re now in the process of implementing a new digital system that will help our customers manage their money better and engage them in their banking lives. It’s our current intention to roll this out in the next quarter.

We’re focusing on revitalizing our Wealth Management business, rebranding to TPT Wealth and completing the first phase of an ongoing investment with the launch of a new investor portal and fund administration platform and registry business. This will modernize and improve the experience for our existing customers, and it represents an important first step toward providing a national funds management and distribution service with a capacity to serve customers across Australia. This is an incredibly exciting initiative that will provide growth for MyState into the future.

Of course, managing risk is fundamental to our business. We’ve examined the recommendation of the Hayne royal commission very carefully, and where appropriate, we’ve made changes to manage our business. We’ve implemented some new risk-based IT systems in the recent past and investigating — and currently investigating further enhancements in this area.

And finally, on Slide 20. We’re building a highly scalable banking and funds management business and have a very positive outlook for the business. We’re well positioned with excellent asset quality, modern digital platforms and a very strong leadership team. Lending momentum has returned with strong application flows and settlements, and we anticipate strong bank balance sheet growth partly driven by the First Home Loan Deposit Scheme, but also by a very strong brand that we built in the broker network. Our plan is to continue to build both sides of the balance sheet and to generate more economies of scale.

Our technology platform and robust risk management underforms (sic) [underscores] careful margin management. Our ultimate focus is on delivering the best return on equity of the nonmajor banks. We’re generating benefits from process reengineering and lowering the cost of doing business. We expect continued productivity improvement in the second half after having undertaken some restructuring activity in the first half. As we reengineer our cost base, we plan to invest more in marketing, driving customer growth, deposits and profitability.

Our new wealth management platform opens opportunities for funds under management growth. Further fund product rationalization is planned as we develop new products for national distribution. We’re also investing in mortgage fund lending systems and looking at new trust management system to expedite delivery and improve customer service through our products. Our business has evolved significantly and is really now poised for its next stage of development and growth.

As you know, this will be my 12th and last results briefing as I’ll be retiring from the business in early July. So I would just like to thank you for your continued interest in and support of MyState during my tenure.

And I’ll now turn it over to the operator to answer any of your questions, and the operator will now provide instructions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from T.S. Lim from Bell Potter.

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T.S. Lim, Bell Potter Securities Limited, Research Division – Head of Research and Banks & Insurance Analyst [2]

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Well done on the results, and well done, Melos. Just a couple of questions on your long-term view of the cost ratio and also the credit charge. What’s your view short term, medium term?

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [3]

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We’re certainly expecting the cost-to-income ratio to come down further in the next half and into the future. We’ve got pretty strong control over our costs in the business. The business is much more scalable. So as the balance sheet grows and even sort of stabilizes back to more reasonable levels, we’d expect to see the cost-to-income ratio come down into the — in the future.

I think the second part of your question was around delinquencies and bad debts. And as Gary said, we’ve got a very small number of some high-value loans that have moved into, what we call, 90 days. We expect those to queue during the half, and we’re very close to those loans. They will queue during the half, and then that will roll out of the provisioning over the next period of time under the provisioning accounting principles.

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T.S. Lim, Bell Potter Securities Limited, Research Division – Head of Research and Banks & Insurance Analyst [4]

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Okay. And another question on state representation is around 17% of your book from Queensland and 17% from Victoria, are you happy with these numbers? Or are you anticipating them going higher?

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [5]

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There’s more opportunity for us to grow the balance sheet outside of Tasmania just because of the sheer scale, let’s say, outside of Tasmania. Now we continue to focus really hard on being strong in dominating the Tasmanian market, and we’ll continue to focus hard on that. But — and we’ll grow that. We continue to focus on growing that part of our business. But also, I would anticipate that further growth on the mainland. We’ll just keep tilting the percentages towards mainland growth, but in absolute terms, we’ll be growing all up and down the eastern seaboard, including Tasmania. It’s just nice from our point of view to have a reasonably equal spread between Victoria, New South Wales and Queensland.

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Operator [6]

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(Operator Instructions) Your next question comes from Nathan Zaia from Morningstar.

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Nathan Zaia, Morningstar Inc., Research Division – Equity Analyst [7]

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I just had a couple of quick questions. One of them if you can just follow-on on the question about the impairments in these high-value loans. Can you comment if they in Tasmania or outside? And I guess what I’m getting at is as you grow more on the mainland and through the broker network, is there potential for lower credit quality and these larger impairments to become more of a recurring theme or…

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Gary Dickson, MyState Limited – Interim CFO [8]

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Yes. So in terms of your first question, the loans are outside of Tasmania. And then the second part of your question…

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [9]

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Do we expect it to continue? Look, it’s just 2 customers. And the loans are relatively low LVR, in the order of sort of 65%, one of the loans. So look, it’s just — they’re very small number of loans. They just happen to all peak at the same time. They’re not related to anything untoward that we can see. And the rest of the book is performing as it has for a period of time. So we don’t see anything substantial in a little — they will queue themselves. And then the provisions will sort of roll out over a period of time under the accounting standards.

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Nathan Zaia, Morningstar Inc., Research Division – Equity Analyst [10]

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Okay. And it looks like commercial loans went backwards a little bit. Is that deliberate, or is there any comment you can make around that?

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [11]

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They’re mainly Tasmanian-based small business loans. A lot of them are secured by residential housing, less than a bub. It’s not a huge focus of ours because while we are in Tasmania, we get a few of those loans. And they sort of bubble up and down a little bit and they have done for a period of time, sort of around, for a period of years, at around those levels. And I think we should expect them just to continue with that sort of level going forward.

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Nathan Zaia, Morningstar Inc., Research Division – Equity Analyst [12]

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Okay. So no major competitive changes recently to be concerned about or anything?

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [13]

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No. No.

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Nathan Zaia, Morningstar Inc., Research Division – Equity Analyst [14]

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Okay. And just a final one on the increase in customer deposits. Obviously, a very good outcome. Is the customer switching from term deposits to at-call, is that a lot of existing customers? Or is it new customers attracted to the bank? And I guess one small follow-on to that is when you get a new borrower, are they tending to become or start using MyState as their main financial institution in some cases or…

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [15]

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Yes. I think during the recent period, at-call rates for savings accounts have been, for many people, more attractive than term deposit rates. So I think the industry in general has seen a bit of a move from TD rates into some at-call savings rates. A lot of our growth have been driven by some of the marketing that I spoke about in trying to drive customer growth. We’re seeing in parts of our book, in the geographic deposit book, a small move back to TDs. And so we continue to see this movement between those 2 over a period of time. People — because rates are so low, people are really focused on that extra sort of 1 or 2 or 3 or 5 basis points, and so that’s a competitive part of the market. We’re well set. We’ve still got our old TD bankbook rolling down, and that will continue to roll down for a short period of time to come, reducing the average funding costs. And we’re still seeing people look at the Bonus Saver account and opening new accounts. And those customers tend — are tending to come from outside of Tasmania rather than inside Tasmania.

And the second part of your question about, I think, broker-introduced mortgages and whether those customers are then taking on…

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Nathan Zaia, Morningstar Inc., Research Division – Equity Analyst [16]

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Yes, other products here.

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [17]

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Transaction types of accounts, we’ve got a pretty mature and detailed process of onboarding those customers. So once the loan is approved, we contact them, look to open accounts with them, and then over a period of time, look to transfer their banking to us between the loan approval and settlement. And then post-settlement, there’s a number of touch points that we have as part of our process to move the — move their – all their banking to MyState. And that’s been reasonably successful. In fact, it’s been more successful here than my experience elsewhere.

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Operator [18]

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(Operator Instructions) There are no further questions at this time. I’ll now hand back to Mr. Sulicich for closing remarks.

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Melos Anthony Sulicich, MyState Limited – MD, CEO & Director [19]

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Thanks very much, and thanks to everyone for listening into the call today. Thanks very much for your interest in MyState. As I said before, now is a really exciting time for MyState, and I’m really pleased to be giving the baton to Gary and a successor who will be announced as the Board does a search for a new CEO, that will be announced in due course. I’ll be around until July. I will catch up with many of you over the coming weeks as we come around to meet you. But thanks very much for your interest. And thanks very much for your attendance this morning.