What does growth look like in the “new normal”? · PDF fileWhat does growth look like in the “new normal”? ... • pressure on fee income ... capital requirements under Basel

What does growth look like in the “new normal”?

PerspectivesMajor banks analysis November 2010

pwc.com.au/mba

PwC analysis of the major banks results for full year 2010

What would you like to grow?

2 Perspectives | Major banks analysis

• pressureonfeeincome,partlyduetolesslendingactivity,andpartlyduetoretailfeereductionsinitiatedbythebanks.

Verystronggrowthinwealthmanagementincomeof21.7%–largelybecauseofimprovedequitymarkets–andfurtherrepricingoflendingmarginswerepartialoffsetstotherevenueheadwinds.Inall,totaloperatingincomeroseby4.2%in2010,comparedto16.3%in2009.However,inthesecondhalftotaloperatingincomeremainedflat.

Ofthesetrends,thebiggestsurpriseforusishowweakcreditgrowthhasbeenoverthepastsixmonths.Inourlastreport,basedonMarch2010data,wethoughtthatwehadjustpassedthetroughincreditandthattherewouldbeasteadyincreaseincreditdemandthrough2010.Today,itlooksliketherecoveryincreditgrowthwasverymodest.Businesscreditisstillshrinking,andismuchweakerthanwouldhavebeenexpectedgiventhegeneraleconomicconditionsandthegeneralstrengthofbusinessbalancesheets,suggestingongoingcaution.Housinggrowthinthelastsixmonthshasbeentheweakestsinceanytimesincethede-regulation;infactweneedtogobacktotherecessionoftheearly1980stofindsuchsluggishgrowth.

Themajorbanks’fullyearresultsforthepastyearreinforceoncemorethecollectivestrengthandprofitabilityofourmajorbanks.Underlyingcashearningshaverisenby25.2%to$21.6billion,followingafallof2.4%inthepreviousyear.Averagereturnonequitywas15.0%,comparedwith13.3%in2009.Thelargestsinglecontributortogrowthinprofitwasthereductioninbaddebtexpense(down$5.6bor42%)aseconomicconditionsimproved.

Thepictureonincomegrowthislessrosy,particularlyinthelastsixmonths,andthispointstothedifficultrealitiesforourbanksastheycometogripswiththerealityofthepost-GFC“newnormal”.Thereareatleastfiveseparatesourcesofrevenueheadwindsforthebanksevidentintheseresults:

• remarkablylowgrowthincreditgiventhestrengthofeconomicactivityingeneral

• increasingcostofwholesalefunding,aspre-GFCfundingmaturesandastheAUDrises

• noreprieveonthecostofretailfundingthroughdeposits

• lessmarkettradingincome

Overview

Michael CodlingBankingandCapitalMarketsLeaderTel:+61(2)82663034Email:[email protected]

Hugh HarleyFinancialServicesLeaderTel:+61(2)82665746Email:[email protected]

PwC analysis of the major banks results for full year 2010 3

Theflip-sideofweakcreditgrowthhasbeenstronger-than-expectedgrowthincorebankdeposits,assistedbystillintensecompetitivepricingwhichisshowinglittlesignofeasing.Allowingforreclassifications,corebankdepositsgrewby9.9%intheyeartoSeptember,abovethehistorical7%-9%“centreofgravity”forcoredepositgrowth.Again,giventherapidgrowthindepositsthroughtheGFC,thefactthatdepositgrowthisstillsurprisingontheupsideisapointertoongoingconservatismforbothbusinessesandhouseholds.

Thecompetitionfordepositshashadasignificantimpactonthemajors’combinednetinterestmargin(NIM).There-pricingofloansmeantthattheNIMactuallyincreased3bpsyear-on-yearto2.25%forFY10;butaswedescribelaterinthereport,themarginshavesteadilydeclinedoverthepasttwelvemonths.Wethinkthemarginsqueezewilllikelycontinue,partlyduetothebanks’needtoroll/renewlong-termoffshoredebt.Muchwilldependontheircollectiveappetitetomakeout-of-cycleraterisestohomeloansinapoliticallychargedatmosphere.Atthetimeofwriting,itappearsthereisindeedsomewillingnesstodothis.

Allofthesetrendssuggestthatthepressureonbankrevenueswillcontinue.Expensesontheotherhandroseby7.6%in2010,andinconsequencecoreearnings(i.e.beforebaddebtexpense)rosebyonly1.5%.Infact,coreearningsdeclined3.0%inthesecondhalf.Hencethebanksareturningseriousattentiontocostcontrol.Tightlabourmarketsandotherinflationarypressureswillmakethistoughgoing.Butitisanimperative,andoneofthereasonswhythebanks’technologyplaysaresoimportant.

Atthesametimethebanksarealsohavingtocopewithaperiodofunprecedentedregulatorychange,togetherwithlevelsofpoliticalscrutinynotseensincetheaftermathofthe1990srecession.HigherliquidityandcapitalrequirementsunderBaselIIIwillinevitablyincreasefundingcostsandputpressureonreturnsonequity,whilethecollectiveimpactoftheotherregulatorychanges(fromcreditrulesthroughtowealthmanagement)willrequiresignificantinvestmentsandinsomecasesaddtoongoingexpense.ThereisariskthattheimpactoftherecentlyannouncedSenateinquiryintobankcompetitionwillplacedownwardpressureonmarginsandfees.

Whilethisadjustmenttothenewnormaliscreatingrevenueandearningsheadwindsforthebanks,itisequallysuggestingasmoothadjustmentpathfortheeconomy,assistedbystrongexportdemandforcommodities.Ourbiggestconcernhasbeenthattheneedforthebankstorelylessonwholesalefunding(bothoffshorelong-termfundinganddomesticshort-termfunding,fordifferentreasons)wouldrestricttheirabilitytomeetdemandforcreditasthatrecoveredthrough2011and2012,givenslowergrowthindeposits.Therecentevidencesuggeststhismightbelessofarisk,duetoweakerdemandforcreditandstrongergrowthindeposits,atleastoverthenextyearorso.Indeed,totalgrowthincoredepositbalancesintheyeartoSeptemberwasslightlygreaterthantotalgrowthinbankloans;inotherwords,coredepositgrowthfundedallnewbanklending.

ContinuedsmoothadjustmentfortheeconomywilldependontheongoinggrowthoftheAsianeconomies,particularlyChina.ThelastsixmonthshaveseengreaterconcernabouttheeconomicoutlookfortheUSeconomy(wheretherecoverymayhavestalled)andmanyEurozoneeconomies(whereausteritymeasureswillrestrictgrowth).

The post-GFC “new normal” is now biting on revenue growth

The PwC Banking Gauge predicts underlying cash earnings growth of 9.0% for FY11

Bad debt expense fell by $5.6 billion or 42%

Underlying cash earnings rose 25% to $21.6 billion


IthasalsoseenmorefocusbyoffshoreinvestorsonpossibleimbalancesintheAustralianeconomy,suchashousing.Allthesefactorshaveservedtoreinforceininvestors’mindsAustralia’sdependenceoncommoditydemandfromAsia,andhencetheriskiftheseeconomiesshouldcomeofftheboil.ThegoodnewsisthattheChineseauthoritiesseemkeentoslowtheireconomytomoresustainablelevels,astherecentincreaseinChineseinterestratesdemonstrates.Inamostuncertaininternationalenvironment,retaininginvestorconfidenceintheAustraliangrowthstoryisfundamentaltothebanks’accesstooffshorefundingatcompetitivepricing.

Continuedsmoothadjustment,bothforthebanksandtheeconomyingeneral,willalsodependonthephasedintroductionoftheBaselIIIrequirements.Thisisnowmuchmorecertainthansixmonthsago,especiallygiventherecentannouncementsthattherewillbelongphase-inprovisionsforthenewliquidityrequirements(2015inthecaseoftheliquiditycoverageratioand2018forthenetstablefundingratio).

Whiletherearemanyfactorssupportiveofcontinuedsmoothadjustment,weshouldnotbecomplacentaboutthemagnitudeofthetasksortherisks.TheGFC(i.e.mid-2007tomid-2009)wastheculminationofeventsandtrendswhichoccurredover20or25years(i.e.fromtheearly1980s),andwhichresultedinanunprecedentedbuild-upingloballeverage,inboththefinancialandnon-financialsectors(particularlyhouseholds),andinthepublicsectorofmanyeconomiesaswell.Whattook20or25yearstobuildupwillmostlikelystillbecastingashadowgloballyforadecadeormore.Householdindebtednessbyitsnaturetakesalongwhiletorepair–repayinghouseholddebtisaslowprocess,whilehouseholdincomestendtorisequiteslowlyaswell.Inmanycountries,ageingdemographics,sloweconomicgrowth,highlevelsofbothgovernmentdebtandunfundedpublicliabilitieswillmakethepublicsectorfinancingtaskextremelychallenging.Ofcoursetherearealsobright-spots,suchasthegenerallystrongshapeofcorporatebalancesheetsgloballyanddevelopmentin

emergingeconomies;butequallythereisnoevidentpathfordealingwiththefundamentaltradeandcapitalimbalancesbetweenWesternconsumingnationsandEasternsavingnations.Tothecontrary,TheEconomisthasrecentlyruna“currencywar”edition.Australia,andhencethefundingofAustralianbanks,couldbeparticularlyvulnerableifaprotectionistmoodtookhold.

Whileno-oneknowshowanyofthesefactorswillplayout,weremainconvincedhoweverbythefundamentalthesis–thathistorywillshowthattheGFCusheredinanentirelydifferenteconomicandfinancialeracomparedtotheso-called“greatmoderation”of1990sand2000s.

Wefeelthatthefullextentofthesechangeshasnotbeenfullyappreciated.WehopethattheproposedSenateInquiryintobankcompetitionisavehicleforpublicdiscussionoftheextentandnatureofthesechanges.Historically,banksdependedprettywellexclusivelyonbankdepositstofundlending.Duringthe20yearsorsoupto2007,anumberoffactorstranspiredtobreakthisnexus,butinawaywhichwasclearlynotsustainableglobally.Theessence(notnecessarilythedetail)ofcenturiesofbankingpracticehasnowbeenre-emphasisedinamuchcloserlinkbetweendepositsandlendingforthebanks.TheproposedSenateInquiryprovidesapowerfulwindowforpublicdiscussionoftheseimportanttrends.Availabilityoffundingisthenowmostimportantfactorinrelationtoimpactingcompetitioninlendingmarkets,whileconsumersarealreadytheclearbeneficiariesoftherestoredimportanceofdepositsthroughkeendepositpricing.

Theextentof“erachange”alsocreatesimportantissuesforbankstrategy.Wesummarisethischallengeinthephrase“fromubiquitytoprecision”.Whenstrongeconomicgrowthandincreasingdemandforborrowingprovidedbanksopportunityinvirtuallyallmarkets,therewasclearlygreattemptationforfinancialinstitutionstoadoptstrategieswhichexpandedtheireconomiesofscopeandreach.Successinamoresubduedandcautiouspost-GFCworldwillrequireamuchmorepreciseanddisciplinedapproach.AsSamuelBeckettsaid,

“Inthelandscapeofextinction,precisionisnexttogodliness”.

InAustralia,wewereclearlyfortunatethatourbankslargelyavoidedtheexcessesofscopeandreachundertakenbybankselsewhere.Equally,nowthathouseholdsarelookingtobemorecautiousaboutdebt,thatsteadyofsourceofbothrevenueandprofitgrowthovertwodecadesiscomingtoanend.Increaseddemandforcommercialandcorporateborrowingsmayhelpoffsetthis.

Inadeleveragingworld,andwithcapitalandfundingrestrictions,theAustralianbankswillneedtobemoreselectiveinfindingnewwaystoconnectwithcustomerstodriverevenueandprofitablegrowth.Thelargeinvestmentsintechnologyareclearlyonevehicleforthis,andindeedthedepthofcustomerinformationavailablewillbeanextraordinaryvehicleforprecisioninbothmarketingandcreditassessment.Thebanksarepushingthemobilehandsetrevolutionforthesamepurpose.

Largedomesticacquisitionsappearofftheagendaasapotentialfilliptogrowth.Offshoreexpansionsremainverymuchinplay,whereeachofthebanksaretakingquitedifferentapproaches.Sufficetosay,historyshowsthatthisisthearenawhereprecisionofunderstanding,incontrasttoubiquityofscopeandreach,isfundamentallyimportant.WhilethehighAustraliandollardoesnothelpthebanks’offshorefundingchallenge,itcertainlybenefitsanyoffshoreacquisitionobjectives.

Wealsosensethatthebanks’customers–fromcorporatesthroughtohouseholds–aretakingamuchmorecriticalperspectiveonhowbanksrespondtosustainabilityissues.Thepublic,media,andlegislativefocusontheseissuesisrisingquicklyandthebankswillbeexpectedtobeattheforefrontofbestpractice.

Asfortheimmediatefuture,thePwCBankingGauge–aconsensusviewacrossfiveleadingbankanalysts-predictsthatthefourmajors,willenjoyunderlyingcashearningsgrowthof9.0%inFY11and7.7%inFY12.


After a period of deleveraging, the

“new normal” will involve (by historical standards) soft credit growth, high funding costs and increased regulation.

Revenues in FY10 were up

4.2% over FY09 but were flat in 2H10 versus 1H10. Future revenue growth is the biggest single challenge facing the majors.

Total costs in FY10

were up 7.6%. Productivity improvements and other cost initiatives are a must in the new environment.

The recently proposed Senate Inquiry will provide a valuable platform to articulate and consider the broader challenges facing the industry.


Combined Results Summary

adjustmentsaremadetothestatutoryresults.Thislasthalfwehaveseenafurtherincreaseinthenumberofsuchadjustments.

Theseadjustmentsincludesomerelatedtochangesinbusinesscomposition:

• Acquisitions-thebanksexcludeoneoffmergerandintegrationexpensesandfairvalueadjustmentsrelatingtoacquisitions.Wherepossiblethebanksalsoseektoadjustpriorperiodcomparativestoincludetheunderlyingperformanceofacquiredentitiesfromthebeginningofthecomparativereportingperiod.Whereverpossiblewehaveusedpro-formainformationinpresentingbothindividualbankandcombinedresults.

• Disposalsanddiscontinuedbusinesses–thebanksalsoexcludetheresultsofbusinessessoldduringtheperiodasthoughtheyweresoldatthebeginningofthepriorcomparativeperiod.Theysimilarlyremovefrompriorcorrespondingperiodstheresultsofbusinessthathavebeenstrategicallydiscontinuedduringtheperiod.

ThekeyelementsofthemajorbanksresultsfortheyeartoSeptember2010aresummarisedinthetablebelow.Themaindriversofthe25.2%increaseincombinedunderlyingcashearningsare:

• Moderategrowthinnetinterestincome,primarilydrivenbyvolumegrowthinhousinglendinginthefirsthalf.

• Solidgrowthinwealthmanagementincomeasimprovingequitymarketsleadtobothhigherfundbalancesandagrowthinnetinflows.

• Lowerfeeandcommissionsincome,andreducedfinancialmarketsincomeasmarketvolatilitystabilisedfromthehighlevelsof2009.

• A42%reductioninthebaddebtexpenseastheimprovedeconomicconditionscausedaslowdowninthedeteriorationofassetquality.

• Coreearnings(beforethepositiveimpactofthebaddebtexpense)wereup1.5%onFY09.

Likethebanks,wefocuson“underlyingcashearnings”–whichshouldallowamoreeffectiveassessmentoftheperformanceofthebanks’ongoingactivitiesperiod-on-period.Toarriveatunderlyingcashearnings,anumberof

ThebanksalsocontinuetoeliminatetheimpactoftheconduittaxcasesinNewZealand;andtheyhaveremovedexpensesassociatedwithbusinessrestructuringandchangeinitiativesthatarelargeandone-offinnature.AIFRSaccountingcontinuestogiverisetovolatilitythatthebanksremove.Suchadjustmentsinclude:thereinstatementofthevaluationgains/lossesontheirownshares(treasuryshares)heldwithintheinvestmentportfoliosofthewealthmanagerswhichareeliminatedunderAIFRS;andtheremovaloffairvaluegainsandlossesrelatinghedgecontractswhichdonotmeettherequirementsofAASB139forhedgeaccountingorarenotfullyeffective,theseareremovedonthebasisthattheywillreverseinfutureperiodstobematchedwithprofitsand/orlossesarisingfromthehedgeditems.Andonebankeliminatedalargetaxcreditrelatedtoapriorperiodmergerasitdoesnotreflectongoingoperations.

Four majors’ combined performance – A$ million – underlying cash earnings

2010 2009 10 vs 09 2H10 1H10 2H vs 1H

Netinterestincome 47,062 44,359 6.1% 23,486 23,576 (0.4%)

Otheroperatingincome 23,055 22,927 0.6% 11,573 11,482 0.8%

Totalincome 70,117 67,286 4.2% 35,059 35,058 0.0%

Operatingexpense 32,257 29,977 (7.6%) 16,413 15,844 (3.6%)

Coreearnings 37,860 37,309 1.5% 18,646 19,214 (3.0%)

Baddebtexpense 7,669 13,283 42.3% 3,039 4,630 34.4%

Taxexpense 8,499 6,663 (27.6%) 4,346 4,153 (4.6%)

Outsideequityinterests 89 103 13.6% 45 44 (2.3%)

Underlyingcashearningsaftertaxbeforesignificantitems

21,603 17,260 25.2% 11,216 10,387 8.0%

Statutoryresults 20,735 13,903 49.1% 10,926 9,809 11.4%


Net Interest Income

Net Interest MarginsAsnotedabove,theriseinthebanks’combinednetinterestmarginfrom2.22%forFY09to2.25%forFY10hidesadifferenthalfyearlytrendwhichisperhapsmoreindicativeoftheirfuturedirection.Themarginsforthelastsixconsecutivesix-monthperiodshavebeen:1H08–2.05%;2H08–2.09%;1H09–2.14%;2H09–2.29%;1H10–2.28%;2H10–2.23%.Therecentdeclinereflectsincreasedtotalfundingcostsmorethanoffsettingthecreditre-pricingthattookplacelargelyduring2009.

Thematerialcomponentsofthechangeinthefullyearnetinterestmarginswere:

• MorecompetitivepricingofdepositsthroughoutFY10:-11bps(2H10-6bps).Banksarenowpayingsignificantlymorefordepositsthan12-18monthsago.Theaverageratefordepositsofalltermsiscurrently22bpsbelowofficialcashrates,whereastwoyearsagoitaveraged

morethan200bpsbelowofficialcashrates.Therewasaperiodaroundthemiddleoftheyearwherepricingcompetitionfordepositsseemedtoeasealittle,butitisnowveryevidentagain.

• Rollingthroughofhigherspreadson,andtermingoutof,wholesalefunding:-4bps(2H10-4bps)

– WholesalespreadshavestabilisedatlevelswellabovethoseseenpreGFC.Forexample,5yeardebtiscostingaround140bpsmorethanpre-GFC.FY10isthefirstyeartoseeasignificantproportionoflongertermfundingpricedatthesehigher(post-GFC)spreads,andthiscostwillriseincomingyearsastheremainderofthetermwholesalefundingisrefinanced.

– Extendingthetermofwholesalefunding–inordertoreduceliquidityrisk–attractedhighercreditspreads.ThestrongA$isfurtherexacerbatingthiscost.

Netinterestincomecontinuedtobeasignificantcontributortothemajorbanksoverallprofitability,growingby6.1%to$47,062mforthefullyear.Thisgrowthwasprimarilydrivenbyhousingvolumegrowthinthefirsthalf.Infact,thesecondhalfsawnetinterestincomecontracting$99m,or-0.4%,reflectingthetrailingoffinhousingvolumegrowthandthebuildingpressurefromrisingfundingcosts.Whilstthemajorbanks’combinednetinterestmargininFY10roseby3bpsto2.25%,halfyearlytrendanalysisindicatesthatmarginsarenowdeclining.Thedriversandcomplexitiesofmarginandvolumegrowthareexaminedindetailbelow.

Interest margins and loans & acceptances 1H05 – 2H10

ANZ

051.6%

2.1%

2.6%

3.1%

$100,000m

$200,000m

$300,000m

$400,000m

$500,000m

$600,000m

10

CBA

1005

NAB

1005

WBC

1005

Notes: WBC includes SGB from 1H08. Prior to 1H08, figures are for WBC only.

Gross loans & acceptances (right axis) Interest margin (left axis)

CBAincludesBankwestfrom1H09.Priorto1H09,figuresareCBAonly


• Higherlendingratesresultingfromthere-pricingofcreditrisk:+20bps(2H10+6bps).

• Combinedglobaltreasuryandfinancialmarketsoperations:-2bps(2H10-1bp).However,therewassignificantvariationbetweentheindividualbankswithsomerecordingpositivemarginimpactandothersanegativeimpactfromtheseactivities.

Weanticipatethatthedecliningmarginsevidentinthelastsixmonthswillcontinue,astheimpactofhigherwholesalefundingcostsflowsthrough,togetherwithongoingcompetitionfordeposits.However,muchdependsonassetre-pricing.Giventhebattleforbusinesslending,wedon’tanticipatemuchfurtherupwardrepricingofbusinessloanmargins.Anyhomeloanrepricingwouldbesubjecttomuchmediaandpoliticalscrutiny;butatthetimeofwriting,theout-of-cycleraterisesdeclaredyesterdaysuggestthereissomeappetiteinthisregard.

Deposits & Lending Bankinglending(totalloansandadvances)growthdeclinedfrom5.9%intheyeartoSeptember2009,to5.2%intheyeartoSeptember2010.Bycontrast,totalsystemcredit(whichincludeslendingbynon-banks)grewby3.3%intheyeartoSeptember2010comparedto1.8%intheyeartoSeptember2009,reflectingsomerecoverybynon-banklenders.

Totalcorebankdepositsgrew10.5%oversameperiod,downfrom14.9%intheyeartoSeptember2009.Theresultwasa290bpsimprovementintheaggregatedeposittoloanratiowhichreached64.4%atSeptember2010.

Lending VolumesThemostnoteworthyaspectoflendingvolumesisthattheirgrowthrateshaveremainedsolow,giventhestrengthineconomicactivityandemployment.GiventheemergencefromtheGFCwehadexpectedgrowthinlendingvolumestobestrongerinthesixmonthstoSeptember2010comparedwiththesixmonthstoMarch2010.Infact,acrossmanycategoriesloangrowthhasbeenweakerinthelastsixmonthsthanintheprevioussixmonths.

Interest Spreads (%)

Mar-07

Jun-07

Sep-07

Dec-07

Mar-08

Jun-08

Sep-08

Dec-08

Mar-09

Jun-09

Sep-09

Mar-10

Jun-10

Dec-09

Sep-10-4.00

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

(%)

Small Bus Wgt Avg Rate based on Credit Outstanding Variable Home Loan Spread to 90 BBSW

90 day BBSW spread OIS Avg All Term Deposits Spread to 90 BBSW

Avg All Term Deposit Specials

Source: RBA

Source: RBA data

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

2000 2010200920082007200620052004200320022001

Total Housing Personal Business

Domestic Credit Growth (Annual % growth - 12 month rolling average)

Core bank deposits to bank loans % (monthly)

50%

52%

54%

56%

58%

60%

62%

64%

66%

Sep-2

002

Sep-2

003

Sep-2

004

Sep-2

005

Sep-2

006

Sep-2

007

Sep-2

008

Sep-2

009

Sep-2

010

Source:RBAdata

Source:RBAdata


Housing LoansTotalhousingcreditgrewby8.0%intheyeartoSeptember2010,slightlyhigherthanthegrowthof7.6%inthepreviousyear.Housingloansnowrepresent58%oftotallending,upfrom55%ayearago(andfrom45%adecadeago).

Notwithstandinghistoricallylowgrowthinhousingcredit,themajorbankshavecontinuedtoincreasetheirshareoftotalhousingcredit,from74.33%ayearagoto76.56%inSeptember2010,reflectingtheirfundingandmarketstrength.Importantlythough,nearlyallthesegainscameinthefirsthalfoftheyear;havingincreasedshareby174bpsinfirsthalf,theincreasewasonly48bpsinthesecondhalf.ForthefirsttimesincetheGFCbegan,theAustralianregionalbanksheldsharesteadyinthesecondhalf(8.29%inSeptemberversus8.25%inMarch).PerhapsthemosttellingstatisticthoughisthattheNBFIsincreasedtheirmarketshareintheSeptemberquarterfrom8.24%to8.71%;againthefirsttimesincetheGFCbegan.WebelievethattheNBFIswillbeincreasinglyactivefromnowon,reflectingthefactthatanumberhaveadjustedtheirbusinessmodelstoapost-GFCworld.This,togetherwithcontinuedsupportforthesecuritisationmarketthroughtheAOFM,andotherpredictedreforms,willlikelylimitthemarketsharegainsavailabletothemajorbanksinaggregatefromhere.

Owner Occupied Housing Demandforowner-occupiedhousingloanshasbeenparticularlyweakinthepastsixmonths,havinggrownbyjust3.2%overthistime,thelowestsix-monthlygrowthratesincethedataseriescommencedin1990.Likewise,growthintotalhousing(owneroccupiedandinvestmentloans)hasonlygrownby3.5%inthepasthalf,comparedto4.5%inthesixmonthstoMarch.Infactwehavegobacktoearly1983tofindalowergrowth(series-lowof2.8%inthesixmonthstoJanuary1983),whenunemploymentwas9.3%(5.1%today),homeloaninterestrateswere13.5%(7.5%today),andwhereinaregulatedworldtherewerefewinvestmenthomeloans.Thiscanonlysuggestaverycautiousapproachbyhouseholdsto

takingonadditionalhomeloancommitments,somethingwhichisperhapsnottoosurprisinginlightofthechartabove,whichshowsinterestpaymentspaidonhousingasapercentageofafter-taxincomeoverthelast50years.Thecharthighlightsboththerapidincreaseinthosecommitmentsintheperiod2002-2007,relativetoprevioustrends,andthattheratioisnowapproachingall-timehighsoncemore.

Anotherfactorimpactingconsumersisthemediaattentionaboutwhetherthereisahousepricebubble,withcapitalcityhousepriceshavinggrownby11.5%onaveragebetweenSeptember2009andSeptember2010.Theveryextentofthepublicdebate,coupledwithwidespreadanticipationoffurtherinterestrateincreases,ismakinghouseholdscautious,especiallygiventhemediaattentiononhousepricefallsintheUSandelsewhere.Webelievecurrentlevelsofhousepricescanbesustained,solongasunemploymentremainslow,

assistedbystrongimmigrationandhousingconstructionremainingbelowunderlyingdemand.Thissuggestshoweveralongperiodoflowgrowthindemandforowner-occupiedhousinglendingashouseholdsrelyonrepaymentsand(likelymodest)growthinhouseholdincomestoreducethehighleverageexplicitinchart.

Fromapublicpolicyperspective,thisisclearlyamuchbetteradjustmentpaththanforinstancethatbeingexperiencedbyhouseholdsintheUS,wherehousepriceslooksettofallfurther.Italsosuggestssomecautionintighteningmonetarypolicydramaticallyfromtheselevels.

Fromabankperspective,itsuggeststhattheunderlyingcreditqualityofthehousingbookswillcontinuetoberobust.Butitalsosuggestsaverylongperiodofsluggishgrowthinhousingcredit.

Housing credit growth – % six monthly

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

Housing interest payments as a % of after-tax income

0

2

4

6

8

10(%)

Jun-

1960

Jun-

1965

Jun-

1970

Jun-

1975

Jun-

1980

Jun-

1985

Jun-

1990

Jun-

1995

Jun-

2000

Jun-

2005

Jun-

2010

Source:RBAdata

Source:RBAdata


Investor HousingStrongerdemandforhousinginvestmentloans,reflectingareturnofbroadermarketconfidence,hastosomeextentoffsettheweaknessinowner-occupieddemand.Investmenthousingloanshavegrownby8.7%overthepastyear,comparedtothepreviousyear’sgrowthof2.6%.Indeedinthelastsixmonthsinvestorloanshavegrownby4.1%comparedtoowneroccupiedloangrowthof3.2%.Growthinthiscategoryseemsnowtobeslowingaswell,fromtherecentpeak4.6%recordedinthesixmonthstoJune2010.

Investmenthousingloansaccountfor30%ofallhomeloansandingeneraltendtotaketheircuefromtrendsinowner-occupiedhousing.Inparticular,rentalyieldsarelow(andquitesteady),soexpectationsofpriceappreciationarecriticalininvestmentdecisions.Giventhepicturepaintedabove,wedonotexpectasurgeindemandforinvestmenthousing,althoughtherewillalwaysbeexceptions.Forinstance,agreaterlatitudeforself-managedsuperannuationfundstoinvestinhousinghasseenanincreaseindemandfromthatsegmentinthepastsixmonths.

Insummary,thebanksfacesignificantheadwindsinrelationtodemandformortgages.Wealreadyareseeingthemajorbanksrespondtothiswithgreaterdiscountingofmortgagepricingrelativetoayearago,aswellassomereversalinmorestringentcreditstandardsintroducedduringtheGFC(suchashigherloan-to-valuationratios).

Theincreasedleverageofthehouseholdsectorhasbeenoneofthemostreliablesourcesofvaluecreationforthebankssincederegulation.Fortunatelythatincreasedleveragecanbeserviced,butinaggregateitismostunlikelythathouseholdswanttopushtheenvelopemuchharderandinsteadprefertoadoptacautiousstance.Weexpecthousingcredittogrowintherangeof5%–7%intheyearahead,roughlyinlineinwithgrowthinnominalGDP.Thereissomedownsideriskonthisnumber,shouldinterestratesrisefurther.WealsoseesomeabilityforsmallerbanksandNBFIstograduallyincreasetheirmarketshare,potentiallysupportedbyfuturepublicpolicy.

Other Consumer LendingOtherconsumerlendinggrewby2.8%intheyeartoSeptember,certainlystrongerthanthefallof5.5%recordedinthepreviousyear.Likehousingloans,however,growthwasstrongerinthefirsthalfyeartoMarch(3.5%)thaninthesixmonthstoSeptember(1.4%),impactedbyhigherinterestrates.

Themajorbanks’shareofthecreditcardshasfallen21bpsto67.7%atSeptember2010,asglobalplayerssuchasCitigroupimplementedbusinessstrategiestargetingthismarket.Themajorbanksshareofotherpersonallendingremainedsteady,growingjust8bpsto61.1%atSeptember2010.Macquariegainedmarketshareinthissegmentfromotherplayersasmarginlendingenjoyedarecoveryoffthebackofstrongerequitymarkets.

Business LendingTotalbusinesscredithasdeclinedby3.7%intheyeartoSeptember2010,comparedtoafallof4.8%inthepreviousyear.Giventhestrengthofeconomicactivityandreportedinvestmentintentions,andthatbusinessbalancesheetsaregenerallyingoodcondition,thisisweakerthanwouldbeexpected,particularlyinrecentmonths.Likeothercreditaggregates,therecoveryinbusinesscreditlookedtobeoncourseintheearlymonthsof2010.Inrecentmonths,itseemstohavelostsomemomentum,withbusinesscreditgrowthfallingby2.5%inthesixmonthstoSeptember.Officialcommentariessuggestthattheauthoritiesmayalsohavebeenalittlesurprisedbytheweaknessinthiscategory.

Webelievethatthereareanumberoffactorsbehindthisweakness:

• companiesaremakingprofitsagain,andtheirgeneralriskaversionisleadingthemtouseinternally-generatedfundstopaydebtdown;

• thetighteningofmonetarypolicyinlate2009/10onlyreinforcedthismood,andtherecentstrengthoftheAustraliandollarmaybehavingasimilarimpactincertainsectors;

• whilecommercialpropertyoverallisshowingsomestabilisation,inmanyregionsandsectorsitstillremainsveryweak,dampeningthedemandforthiscategoryofborrowing;

• muchofthestrengthineconomicactivityandinvestmentiscomingfromtheresourcessector,whichtraditionallydoesnotrelyheavilyonbankborrowingforfunding.Forinstance,RBAfigurespointtolendingtominingonlycomprising3%ofbanklending.

Thepointaboutstrongprofitabilityandinternalgenerationoffundsisveryimportant.HavingnotedthatprofitsintheJunequarter2010were18%higherthanayearpreviously,theRBAestimatesthatinternalgenerationoffundsforincorporatedenterpriseshasbeenaround10%ofGDPformuchofthepasttwoyears.Ina$1.3trillioneconomy,thisamountsto$130billionofinternally

0%

10%

20%

30%

40%

50%

60%

19761978

19801982

19841986

19881990

19921994

19961998

20002002

20042006

20082010

Ratio of housing to total credit


generatedfunds;bynomeansinsignificantrelativetothe$700billionstockofoutstandingbusinesscredit.TheRBAalsonotesthatthemediangearingratioisnowarounditslowestlevelinmorethanadecade.

Inevitablytherehasbeensomedebateaboutwhethertheweakgrowthinbusinesscreditreflects“creditrationing”bythebanks.Theunder-estimationandconsequentlowpricingofriskwaswidespreadpriortotheGFCmeantitwasinevitableoncetheGFCcommencedthatcredittermsandpricingwouldtighten,especiallyinthosesegmentswheretheregionalbankshadbeenparticularlyactive.Totheextentthatthependulumswungtoofar,weareseeingsomepartialreversal.Ourassessmentisthatcredit-worthybusinessproposalsaredefinitelybeingsupportedbythebanksonappropriateterms.Consistentwiththis,theReserveBanknotesthatinthefirsteightmonthsof2010credittosmallbusiness(i.e.unincorporatedenterprises)increasedat6%onanannualisedbasis,fasterthantheoverallgrowthinbusinesscredit.

Theweakdemandforcommerciallendingisparticularlyrelevantinlightoftheweakoutlookforhousingcredit.Throughmuchofthepast25yearsthebankshavebeenabletorelyonstrongdemandforhousingfinance–ashouseholdsincreasedfinancialleverage–todrivebalancesheetgrowthinaveryprofitablecategory.Withdemandforhousingfinanceexpectedtobesubduedforanextendedperiod,thiswillinevitablyencouragethebankstofocusfurtheronopportunitiesforgrowthinthebusinessarena.AnumberofbankCEOshaveflaggedthattheyexpectdemandforcommercialandcorporateborrowingtoincreaseoverthenextsixmonths.

Thisinturnwillsetupsomeinterestingdynamics.First,thetopendofthecorporatesectorwillbeveryawareofalternativesourcesoffunding,especiallynowthatwell-ratedcorporatescanraisefundsoncomparable,orsomecasesevenbetter,termstobanksinthewholesalemarket.Second,corporatelendinghasoftenbeenquitechallengingintermsofsecuringanadequatereturnontherisk,andwithcapitalstillinshort

supplyforthebanks,thiswillcreatesomeinterestingtrade-offbetweenbalancesheetgrowthandreturnonequitymetrics.TheabilityofbankstosellcomplimentaryservicesinadditiontothelendingfacilitieswillbefundamentalfromanROEperspective.

Finally,economicuncertaintiescontinuetoloomlargeininvestmentdecisions,bothforlargeandsmallbusiness.Ongoingtalkaboutahousingbubbleisdoingnothingforsmallbusinessconfidence.

Themajorbankshavegrownshareofbusinesslendingby78bpsovertheyearto74.46%.GrowthwasparticularlystrongintheSeptemberquarter,althoughthiswasconcentratedinjustonebank(whichincreasedshareby186bpovertheyear).Theregionalbankscontinuetoloseshareinthismarket,whiletheforeignbankshaveheldsharequitesteady,indeedthemajorforeignbanklendershaveincreasedshare(especiallyHSBCandRBS).


Deposits VolumesJustascreditgrowthhassurprisedonthedownsideinrecentmonths,depositgrowthhassurprisedontheupside.GrowthcoredepositsfortheyeartoSeptemberhasbeen10.5%,abovetheupperendofour“centreofgravity”forcoredepositgrowthduringnormalmarketconditionsof7%-9%pa.Therecordedgrowthratehasbeeninflatedby$5bofcashmanagementtrust(CMT)balancestransferredbalancesheetbyMacquarieBankinAugust2010;withoutthattransfertotalgrowthwouldstillhavebeen9.9%.Afterthe15%+depositgrowthratesexperiencedinthepreviousyear,wethoughtdepositswouldgrowmuchclosertothelowerendofthe7%-9%rangein2010.Thestrongergrowthincoredepositsisanotherpointertotheextentofgeneralriskaversionatpresent.

Theextentofthestrongergrowthofdepositsrelativetolendingiswellillustratedinthechartbelowofcoredepositstobankloans.Havingmarkedtimeformuchofthetimesincethestartof2009,inrecentmonthsthatratiohas

risensharply,indeedincreasingbythreepercentagepointssinceMay2010.AsofSeptember2010,theratiositsat64.4%,alevelnotseensinceearly2002.TotaldollargrowthindepositsactuallyexceededdollargrowthinlendingintheyeartoSeptember,which,otherthanattheheightoftheGFC,waslastseennineyearsagointheanxioustimefollowingtheSeptember11attacks.

Incontrasttolending,themajorbankshavelostshareindepositsoverthepastyear.Theirshareofhouseholddepositswas81.44%inSeptember2010,comparedto82.10%ayearago;forbusinessdepositsthefallwasfrom83.59%to82.21%overthesameperiod.Forhouseholddeposits,Macquarie’sCMTtransferwasakeydriverofthereductions;butevenallowingforthatitisclearthatbothregionalandforeignplayersarebeginningtoslowlypickuptheirshareofhouseholddepositsagain.Thispartlyreflectsverycompetitivepricingfromsomeofthesesmallerplayers,andgiventhisisintegraltotheirstrategiesinsomecasesweexpectthistocontinueandsobealimitonthe

extenttowhichthemajorscanreducetheirowndepositpricing.Italsoreflectssomeincreaseddepositorconfidenceinthesmallerbankspost-GFC.Itwillbeinterestingtoseewhetherpotentialchangestothegovernmentguaranteeofdepositorschangesthis.ThecurrentarrangementsareduetoexpireinOctober2011.

Pricingfordepositshasremainedverycompetitive,andtentativesignsthatpricingcompetitioneasedalittleinthesecondhalfwereshort-lived.Thenegativecontributiontonetinterestmarginfromdepositsforthemajorbankswas6bpinboththefirsthalfandthesecondhalf.Anumberofbankscontinuetoofferratesabovethecashrateforboth“atcall”internetdepositsand90dayplustermdeposits,althoughabsoluteratespaidforlonger-dateddepositratesfellinthesecondhalfastheyieldcurveshifted.Asnotedabove,weexpectthatcompetitivepressurefromsmallerplayerswillcontinuetorestrictreductionsindepositrates.

Four Majors: Market Share as at 30 September 2010

ANZ CBA NAB WBC Major Banks

Sep-10 Sep-10vs

Mar-10bps

Sep-10vs

Sep-09bps

Sep-10 Sep-10vs

Mar-10bps

Sep-10vs

Sep-09bps

Sep-10 Sep-10vs

Mar-10bps

Sep-10vs

Sep-09bps

Sep-10 Sep-10vs

Mar-10bps

Sep-10vs

Sep-09bps

Sep-10 Sep-10vs

Mar-10bps

Sep-10vs

Sep-09bps

HousingLoans(1) 13.0% 40 51 25.9% (4) 36 13.3% 9 49 24.3% 3 86 76.6% 48 222

HouseholdDeposits(2) 14.0% 2 1 30.2% (104) (144) 13.6% 14 47 23.7% 10 30 81.4% (78) (67)

BusinessLoans(2) 18.0% (31) (35) 19.7% (49) 0 22.8% 198 186 13.9% (21) (73) 74.5% 97 78

BusinessDeposits(2) 17.1% 65 (45) 22.2% (36) 146 22.9% (2) (148) 20.1% (95) (91) 82.2% (68) (139)

Source: (1)APRAandRBA,(2)APRANote: CBAincludesBankwestandWBCincludesSGB. CBA1H10,2H09&1H09havebeenchangedtobein-linewiththeotherbanks.


Total system credit growth in the second half was surprisingly weak, at only

2.2%. We expect 5-7% growth in FY11.

The majors will undoubtedly respond on various fronts – new business models, a focus on key clients, improved productivity, new niche or offshore markets, new pricing – to preserve their RoE in the “new normal”.

Risk aversion meant the majors benefited from resilience in the deposit market. Core bank deposits grew

9.9% in FY10.

Margins declined from 2.29% for 2H09 to 2.28% for 1H10 to

2.23% for 2H10. The outlook depends on asset repricing.


Implications of the Basel III rules for Australian banks

Oneofthemajordevelopmentsofthepastfewmonthshasbeenthereleaseofrevisionstotheproposedchangestotheinternationalfinancialregulationofbanks,knownasthe“BaselIII”rules.ItisexpectedthattheserevisionswillbeconfirmedbytheG20LeadersMeetinginSeoulinmid-November.

Whiletheproposedchangeshavemanydimensions,atthecoretheyrequirebankstoholdmoreandbetterqualitycapital,andlargeramountsofliquidassets,thanpriortotheGFC.Therecentlyannouncedrevisionstotheseproposalstendtomakethemsomewhatlessonerousandalsoextendtheirimplementationhorizon.

ThisbriefnotereviewstheimpactofthesenewrulesontheAustralianbanks.Inessence,thechallengefortheAustralianbankswillbemuchmorewiththeliquidityrulesratherthanthecapitalrules.TheconservativeapproachofAustralianbanksinrelationtocapitalhassetthemupwell;conversely,theirdependenceonshort-termwholesalefunding,andthelimitedsupplyofAustraliangovernmentsecurities,willmaketheliquidityrulesmorechallenging.Thislatterchallengeiswellrecognised,totheextentthattheBaselCommitteeisnowdevelopingaseparatestandardforjurisdictionswhichdonothavesufficienthighqualitygovernmentsecuritiesonissue.

FundamentaltotheBaselIIIrulesarerequirementsonthebankstoholdmorecapitalofgreaterquality.Inparticular:

• allbanksmustholdaminimumcommonequity(commonsharesandretainedearningslessdeductions–someofwhichwerepreviouslytakenagainstlowerformsofcapital)of4.5%ofriskweightedassets,andthismaybesupplementedbyPillar2requirements(setbyAPRAbasedonindividualbankriskprofiles);plus

• a“conservationbuffer”of2.5%,abovethe4.5%minimum,toabsorblossesduringperiodsoffinancialandeconomicstress.Drawingonthisbufferduringtimesofstresswillresultinconstraintsonearningsdistributions;and

• a“countercyclicalbuffer”rangingfrom0–2.5%ofcommonequity,determinedbyAPRAasrequired,forinstanceintimesofexcessivecreditgrowth.

Theresultofallthesemeasuresisthatthenewcommonequity(coretier1)ratiowillbeatleast7%.Inaddition,thebankswillwanttoholdtheirowninternalbuffer,

overandabovethisregulatoryminimum,aspartofnormalriskmanagement,particularlyasthesanctionsforgoingunder7%willinvolverestrictionsontheabilitytopaydividends.Wesuspectthatthisbufferwillbeintheorderof1%-1.5%.

Aswellastheserequirementsforcommonequity,thebanksarealsorequiredtoholdtier1capitaltoaminimumof8.5%(i.e.includingtheconservationbuffer,andofwhichatleast7%iscommonequity)andtotalcapital(i.e.tier1andtier2)ofatleast10.5%

Currentandhistoricaldataforthesemeasuresareshownonthenextpage.

Inadditiontoremindingushowmuchcommonequitythebankshaveraisedinrecentyears,thetableshowsthatthebanksareingoodshapeinrelationtotherequirements.Basedonourestimates,collectivelythemajorbanksjustaboutmeetthe7%ratioforcommonequitynow.Equallyhowever,anysensethatthebanksarecurrentlyover-capitalisedisclearlywrong,especiallygiventhattheywillwanttoholdabufferover7%.

TherelativelysolidpositionoftheAustralianbankscontrastswithmanyjurisdictionsoverseas,wherecapitalratiosarelessstrongandwheretheirregulatorshaveadoptedamuchlessstrictapproachtodeductionsthaninAustralia.Oursenseisthatthechangesinthetreatmentofdeductionsingeneralinoverseasjurisdictionsisbeingunderestimatedbymarkets;inotherwordsthattherewillbelargeradverseimpactsonmeasuredcapitalthancurrentlyestimated.

Wealsosuspectthattherewillbesomeupwardpressureonequitylevelsglobally.Forinstance,Switzerlandhasannouncedcapitalrequirementsonitsbanksinthehighteens.WebelievethattheBaselIIIrequirementsrepresentsomewhatofacompromiseonthepartofregulatorsinordertominimiseadverseimpactsoneconomicgrowth.AsLordTurner(ChairmanoftheFSA)isreportedtohavesaid–“Ifwewerephilosopherkingsdesigningabankingsystementirelyanewforagreenfieldeconomy,shouldwehavesetstillhighercapitalratiosthanintheBaselIIIregime?YesIbelieveweshould.”

Do the banks need to hold more equity?

Thenewliquidityrulesaredesignedtoensurebanks’fundingisonamoresustainable,long-termbasis,thusenablingbetterliquidityduringtimesofmarketturbulence,andinvolvetworatios:

• thenetstablefundingrequirement(NSFR)toensurebetterdurationmatchingofassetsandliabilities.Thiswillbeintroducedfrom2018,followinganobservationperiodstarting2012;

• theliquiditycoverageratio(LCR)torequirebankstoholdsufficienthighqualityassetstosurviveperiodsofseveremarketstress.Thiswillbeintroducedfrom2015,followinganobservationperiodstarting2011.

BoththesemeasurescreatechallengesfortheAustralianbanks.Thestablefundingrequirementisachallengebecauseitallowsminimalfundingofassetsthroughshort-termliabilities,whereasthebankshave,intheyearsleadinguptotheGFC,reliedquiteheavilyonshort-termfunding.APRA’sQuantitativeImpactSurvey(QIS)suggestedthatasofJuly2010(andbeforerecentannouncedmodifications),thebankshadanetNSFRof85%,shortofthebenchmarkof100%.Sincethat

timestronggrowthindepositsrelativetoassetshasimprovedthisratio,butshort-termfundinginwholesalemarketsbytheAustralianbanksinaggregatewillstillbeintheorderof20%oftheirassets,orroughly$350billion,comparedtolong-termwholesalefundingintheorderof$470billion.

TheliquiditycoverageratioisachallengeinAustraliabecausetheassetsmostliquidduringperiodsofmarketstressaregovernmentsecurities,andAustralia’sstrongpublicsectorfinancialpositionmeansthereisasmallpoolofgovernmentsecuritiesrelativetothesizeofbankbalancesheets.APRA’sQISindicatedthatthebankshaveacombinedLCRof38%,againwellshortof100%.

ThechallengefortheAustralianbanksinmeetingtheserequirementshasbeenmadesomewhatlessdauntinginthepastfewmonthsbyBaselCommitteeannouncementswhichmaketherequirementslessoneroustomeet.Forinstance,fortheLCR:

• therun-offratesofcertainretailandSMEdepositsduringperiodsofmarketstresshavebeenreduced;

• likewise,assumedoutflowsofcertainfundingfromcentralbanksandgovernmenthavealsobeenreduced;

• anewcategoryof‘level2’liquidassets(e.g.bondsofcertainpublicsectorenterprisesandcoveredbondsofotherbanks)havebeenintroducedandmayaccountforupto40%oftherequirement.

Despitethesechanges,thecoreissuefortheAustralianbanksfortheLCRistheshortageofCommonwealthGovernmentBonds,andtheReserveBankhasrecentlydescribedthecurrentproposalsas“still…unworkable”.TheBaselCommitteeiscurrentlydeterminingitsresponsetothischallengeforjurisdictionssuchasAustralia.

ThepositioninrespectoftheNSFRismuchthesame.RecentannouncementshaveeasedtheimpactoftheproposalsinrespectofjurisdictionssuchasAustralia,forinstanceinhowmortgagesaretreated.Nonethelessthepostponementoftheirapplicationuntil2018(followinganobservationphase)isanindicationoftheextentoftransitionrequired.

Impact of BCBS Capital Strengthening Rules on Australian Banks

Major Banks

Minimum 2H10 1H10 2009 2008 2007

Sharecapital$b 86.3 84.5 82.4 45.1 37.7

NewCommonEquityRatio% 7% 6.6% 6.7% 6.4% 5.4% 5.1%

CurrentCoreTier1Ratio% 11.2% 11.1% 10.7% 9.0% 7.8%

RevisedTier1Ratio% 8.5% 8.7% 8.5% 8.2% 7.2% 6.5%

CurrentTier1Ratio% 4% 9.3% 9.3% 8.9% 7.7% 6.8%

RevisedTotalCapitalRatio% 10.5% 11.4% 11.5% 11.3% 11.0% 10.2%

CurrentTotalCapitalRatio% 8% 11.4% 11.8% 11.5% 11.1% 9.9%


Will the new liquidity rules bite on credit growth?


And so what are the implications for the banks performance?

Offshorewholesaledebtmarketsareunlikelytobetheanswer.WhileinrecentyearsthemajorshaveverysuccessfullyusedtheirAAratingstotaptheinternationalborrowingmarkets,thereisalimit;boardsandmanagementarenowreluctanttobemuchfurtherexposedtooffshoreinvestorsandhencevulnerabletoeventstheycan’tnecessarilycontrol.Atthesametime,therearerelatedquestionsaboutAustralia’sstructuralrelianceonforeignsavingstofundthecurrentaccountdeficit.

Aswenotedsixmonthsago,severalideasarebeingproposedanddebated.AnumberinvolvesomeformofmobilisingAustralia’slargeandever-

increasingpoolofsavingswithinsuperannuationfunds.Forexample,therehasbeenarenewedpushforachangetotheBankingActtoallowcoveredbonds,i.e.allowingbankstoissuebondssecuredbyring-fenced(inevitablyveryhighquality)assetsontheirbalancesheet.Australianinvestorsdemonstratedtheirappetiteforcoveredbondsafewweeksago,snappingupA$denominatedcoveredbondsissuedbyaCanadianbank.Coveredbondscouldprovideourbanksanotheroptiontoaccesslong-durationwholesalefunding,andadditionallythebondscouldpotentiallybetreatedas“eligiblesecurities”forLCRpurposes.

Theworst-casescenariowouldbewheretheNSFRrequirementscanonlybemetthroughthebanksrationingcredit(assets)tolessthan,say,growthinnominalGDP.Oncurrentspecifications,thisriskcannotberuledout,butwebelieveinpracticeitisalowrisk–RBA,TreasuryandAPRAareallacutelyawareofthisriskandgiventhelongleadtimesthetransitioncanbemanaged.Ongoingriskaversionbyborrowerswillmostlikelyhelpinthisregard;conversely,iftheauthoritiesfeelthatcreditgrowthisbecomingexcessive,theseratiosprovideanothermeanstoensurebalanceinthesystem.

Inaglobalcontext,theAustralianmajorshaveperformedverywellduringandsincetheGFC.Onatotalshareholderreturnbasis(capitalappreciationanddividendscomparedtoopeningshareprice)themajorsfaredsignificantlybetterthanalmostalltheirglobalpeersoverthelastthreeyears.

Thereisadiscussionthatwesternbankingsectorsneedtocontractfurther,andthatpotentiallythebestoutcomewecanhopeforislowgrowth.Thereisalsoanexpectationinsomequartersgloballythatthelogicofamoreriskadverseworldandamoreregulatedenvironmentforbankswilltranslateintolowerreturnsoncapitalforbankshareholders.Theextentofregulatoryreformmeansthatno-oneknowswithcertaintytheactualimpactonthebanksortheeconomy,andwiththatthepossibilityofsignificantnegativeunintendedconsequences.

TheimpactoftheBaselIIIreformsontheAustralianmajorscanbesummarisedinthefollowingover-simplifieddiagram:

• Capitalhasincreasedandwilllikelyneedtoincreasefurther

• Ahighleveloflower-yieldingliquidassetswilldepressreturns;andsoakupfunding

• Fundingmaybeconstrainedbybothavailabilityandappetiteandcouldthereforerestrictgrowth,outlastingthecurrentshort-termconcernsofasluggishcreditmarket;andremainsexpensive

• Henceweexpecttheretobepressureonlonger-termreturnsonequity.

Nodoubtthebankswillrespondtothesechallengesonvariousfronts–newbusinessmodels,afocusonkeyclients,improvedproductivity,newnicheoroffshoremarkets,newpricingstrategiesetc.Oneoftheinterestingthingsaboutmoreregulationisthatitactuallyincreasesthebarrierstoentryforpotentialcompetition,andhenceprotectsthemajors.Whichisonereasonwhythecurrentpoliticalshenanigansaresuchcompellingviewing.

Capital increasedcapital

PressureonRoEs

depressedreturns

constrainedgrowth

Liquidity

Funding


PwC analysis of the major banks results for full year 2010 17PwC analysis of the major banks results for full year 2010 17


Wealth Management Thebanks’wealthmanagementbusinesses–whichcomprisefundsmanagementandinsuranceoperationsofthebanks–deliveredastrongperformance.Revenueshavestartedtoreboundwhileatthesametimeincreasesincostswerewellcontained.

Thekeycatalystsforimprovementinfundmanagementperformancehavebeenthepositivenetinflowsoffundsandtheslowlyimprovinginvestmentmarkets.Whileinvestorsarestillcautiousaboutthemarketoutlook,andtheleveloffundinflowsarestillrelativelylow,theyareslowlyrepositioningtheirportfoliostowardslessdefensiveassetsrelativetotheextremelyconservativestanceimmediatelyaftertheGFC.Cashholdingsarestillveryhigh.

Thebank-ownedwealthsectormaintainedretailmarketsharethroughouttheyearatapproximately62%.Thefourmajorbankscontinuetoleveragetheirbrandstrength,customerreach,diversedistributionandscale,whiletheGFCanduncertaintyregardingtheimpactofregulatorychangesonfinancialplanningorganisationshavealsoprovidedselectedopportunitiestogrowthroughacquisition.

Theoveralltoneinrelationtoopportunitiesforacquisitionhashoweverchanged,followingtheAustralianCompetitionandConsumerCommission’s(ACCC)blockingofNAB’sproposedacquisitionoftheAustralianandNewZealandlifeandwealthmanagementoperationsofAXASA,duetoconcernsabouttheimpactoncompetition,particularlyintheretailinvestmentplatformmarket.ThispositioningbytheACCCmayemboldennewentrantstothemarket,especiallywiththeprospectofthesuperannuationguaranteechargebeingliftedto12%.KohlbergKravisRobertssignalledaninterestinbecomingasignificantplayerintheAustralianfundslandscape,throughitstiltforwealthmanagerPerpetual.

Theliferiskinsurancesegmenthascomethroughtheglobalfinancialcrisisingoodshape.Newbusinessovertheprevious12monthshasbeenstrong,asisoftenthecaseduringperiodsofincreasedriskawareness.Atthesametime,concernsoveranincreaseinclaimsresultingfromhigherunemploymenthaveeased.

What’s new in the regulatory space?Postthe2010electionwehaveseenincreasedfocusintheindustryontheFutureofFinancialAdvice(“FOFA”)proposals(formerlytheRipollenquiry),theCooperReview,NationalConsumerCreditProvisions(NCCP)andPrivacyActrecommendations.

TheFOFAproposalsimplysomereshapingoftheadviserindustry,andthereisstillmuchuncertaintyinrelationtothebanningofcommissionsandthepracticalrequirementsforthedutytoactasafiduciarytoaclient.Thebanksarecomparativelywellplacedtomeettheincreasedcompliancerequirementsinanefficientandcost-effectivemannergiventheirscale.

TheCooperReview’srecommendationsalsoimplyasubstantialreshapingofthesuperannuationindustry,butsignificantelementsmaybeimpactedbythedifficultyoftheirpassagethroughafinely-balancedFederalParliament.ThemessagescomingfromtheGovernmentonthisaresomewhatmixed;veryrecentlytheGovernmenthasbeensignallingmoredeterminationonpushingthroughthefullsuiteofchanges.“Superstream”(whicharedesignedtoachieveindustryefficiencies)aremorelikelytoachievebi-partisansupportthanthe“MySuper”proposals(whichaimtoprovide“nofrills”superannuationoptions).

ASIChasalsoforeshadowedchangestotheregulatorycapitalrequirementsforresponsibleentitiesofmanagedinvestmentschemesinvolvingcapitalincreasesofover100%forlargerplayerssuchasbanks.

Other Operating Income

Contribution to other operating income

FY10 FY09 FY08

Bankfees&commissions 47.3% 50.7% 52.9%

Tradingincome 9.8% 16.0% 10.4%

Wealthmanagementincome 37.3% 30.8% 32.1%

Other operating income was up 0.6% on FY09 and now represents 32.9% of total income, down from 34.1% in FY09. Bank fees and commissions fell 6.2% and trading income suffered a significant decline of 38.6%. Both of these adverse trends were offset by growth in wealth management income, up 21.7%.


Thefundsmanagementindustrystillcontinuestoworkthroughtheissuesof“frozenfunds”triggeredbyilliquidityduringtheGFC.Someinvestorsremainunabletoaccesstheirinvestments.MostresponsibleentitieshavenowputinplacehardshipprovisionsinconjunctionwithASICtoallowforreleaseincertaincircumstancesoffundstocertaininvestorsfromcashreserves.

Wealth management – OutlookImprovingtheconsumerconfidenceinsuperannuationcontinuestobeachallenge.IntheFSC/PwC2010CEOSurvey,CEO’sidentifiedthatthemostimportantfactorsinregainingconfidenceinsuperannuationarestabilityoflegislation,betterdisclosureandamoreefficientsystem.

Improvedinvestmentperformancewasalsoidentifiedasimportanttoregainingconfidence.Theindustryhasatoughbalancingacttoundertake.Ononehand,thefragilityininvestmentmarketsentimentimpliestheneedforwealthmanagerstofocusondeliveryoftheircoreofferingstocustomersexceptionallywell.Withexpectationsofaperiodoflowerinvestmentreturns,meetingtheneedsandexpectationsofclientstothehighestpossiblelevelwillbekey.Whileontheotherhand,thecombinationofconsiderableregulatoryuncertaintyandtheongoingneedtoadjustbusinessmodelstoapost-GFCmarketsenvironmentwillmakethisverychallenging.

Theproposedincreaseintheminimumemployersuperannuationguaranteecontributionfrom9%to12%willsupportfurthergrowthintheindustry.However,theimpactofthisgrowthmaybesomewhatoffsetbythecontinueddownwardpressureonfees.

Theremovalofcommissionscouldfavourthebank-owneddistributionmodelovertheindependentdistributionmodel.Theabilityofbankownedadviserstoleveragetechnologyandbackofficeserviceswillbecomeanimportantdifferentiator.Bank-ownedadviserbusinessesaregrowing,witheconomiesofscalebeinganimportantfactorintheadvicemarket.

Improvingthepenetrationofotherbankingproductswithintheirgrowingwealthmanagementclientbasewillcontinuetobeakeyfocus.Technologyisbeingusedtobettersupportcustomersthroughtheprovisionofweb-basedapplicationsthatprovidethecustomerwitha“wholeofbank”viewoftheirrelationshipwiththebank,includingtheirsuperannuation/investmentaccounts.

Thegrowingdemandforcashandfixedinteresttypeproductsmayprovideanimportantsourceoffuturefundingforbanks.Theproportionofsuperannuationfundsassetsheldincashhasrisento15%,wellabovethedecadeaverageof9.2%.Whilethereisstillapost-GFCeffecthere,weexpecttheproportionofnon-equitiessuperannuationallocationstoincreaseasthepopulationcontinuestoageandmoreinvestorsmoveintoretirementandseektoinvestinlowerriskproducts.

Bank Fees and CommissionsIncomefrombankfeesandcommissions(whichcompriselendingfeesof$3,993millionandnon-lendingfeesandcommissionsof$6,919million)decreasedby6%overFY09,andby2%for2H10versusto1H10.

Theoveralldeclinewasdrivenbynon-lendingfeesandcommissions(-9%overFY09).Akeydriverofthiswasthereductionorabolitionofnumerousfees–includingunpopularexceptionfees–whichhasbeenundertakenbythebanksforbothpositioningandcompetitivereasons.Whilethishasbeenwellreceivedbyconsumersandmedia,theimpactoffeerevenueisapparent.

Otherfactorsimpactingthedeclineinfeesandcommissionshavebeenmoresubduedlevelsofsecuritybrokerageandcertainadviceservices,theimpactofchangestoATMinterchangerules,andongoingfeecompetition.

LendingfeesfellslightlycomparedtoFY09,largelyareflectionoftheweakeningcreditdemand.

Trading IncomeTradingincomefell38%to$2,254minFY10,reflectinglessmarketvolatilityandreduceddemandforriskmanagementservicescomparedtoFY09.However,FY09wasanexceptionallyvolatileyear,andinfacttheFY10resultwasmuchthesameasFY08($2,225m)andFY07($2,329m).TheFY10resultwasalsoimpactedbythestrengtheningoftheAussiedollarwhichreducesUSdenominatedincomeinAUDterms,offsetsomewhatbynarrowing(butvolatile)creditspreadsonderivativemark-to-marketassets.

WhileallthebanksrecordedfallsintradingincomeinFY10,therewassomevariabilityintheextent.Weestimatethattheunderlyingdecreaseintradingresultwasdownabout20%,consistentwithsomemarketdiscussionthroughtheyear.Theprovisionofriskmanagementservicesremainsanimportantareaforthebankstodeepencustomerengagementinapost-GFCworld.


Efficiency

lineforcustomerserviceinitiatives(includingexpandeddistributionoffshoreinthecaseofonebank),inriskandcompliancetoaddressongoingregulatorydevelopments,andinprojectdeliveryforthelarge-scaleprojectsthebanksarerunning.

Higherstaffcostsalsoreflectthemarketconditionsandcompetitionfortalent,togetherwiththeimpactofthebanks’improvedfinancialperformanceonincentivesincludingequitybasedcompensation.Plusthereweresomehighercostsrelatingtodefinedbenefitsuperannuationfunds.

Propertyandequipmentcosts(10%oftotalexpenses)wereup4.0%overFY09,whichincludednewandrefurbishedkiosks,branchesandATMs.

Technologycosts(10%oftotalexpenses)werethebiggestriser,up11.8%overFY09.Allofthebankshaveinplacemajorinvestmentstoenhance‘aged’technologyinfrastructureto

supportstrategicpriorities–withamajorfocusbeingimprovingcustomerservice–andtodriveproductivityefficiencies.

Weexpectthisongoinginvestmentintechnologytocontinueforthenextthreetofiveyears,withtheimpactonprofitdependentonexecutionsuccess.Whilethedriversaresimilar,eachbankhasadoptedadifferentapproachtotheirdevelopmentandmigrationpaths,andconsequentriskmanagement.Indeedthisinvestmentintechnologywillhaveapronouncedimpactontherelationshipthatbankscanhavewithcustomersandthechannelmixappropriatetoservicethem.

Atthehelicopterlevel–recognisingtherevenueheadwinds–themajors’abilitytoreduceunitcostsiscritical.Investorsandanalystswillbejudgingbanksontheconfidencetheyhaveinmanagementtoexecuteontheircostsplays;andthereisarealopportunityforthebankstodifferentiatebysubsequentlydeliveringontheirpromises.

Total bank operating expenses increased by 7.6% over FY09. Consequently the banks’ combined expense to income ratio increased to 46.0% compared to 44.6.% for FY09. In fact, this ratio has now increased for four consecutive halves – and is rightly a key area of attention, particularly given the sluggish outlook for revenue growth.

Salariesandrelatedcosts,whichrepresent57%oftotalexpenses,wereup9.2%onFY09.Theincreaseincostsreflectshigheraveragestaffnumbers,upby6.4%onFY09.Thiswasprimarilyattributabletoincreasedstaffinthefront

Reported expense to income ratio

2010 2009 2008

ANZ 45.0% 44.8% 44.0%

CBA 45.7% 46.4% 48.9%

NAB 45.9% 43.9% 46.9%

WBC 41.2% 40.1% 43.3%


Asset Quality

Atasegmentlevel,thecorporateandinstitutionalportfoliosperformedparticularlywellforthesecondhalfyearinarow.Withnonewlarge“badboys”emerging,theremainingportfolioqualityappearsgenerallysound,reflecting“survivorbias”.

ThemiddlemarketandSMEportfolioshavealsoheldupwell,albeitthereisevidenceofmorelossesnowemergingfromthesebooks,whereweakerentitieshavelostthelongbattletosurviveintheaftermathoftheGFC.Thelossesarestilllessthanoriginallyfeared,butenoughforbankmanagementtoremaincautious.Thankfullytheexposurestocorporaterealestate–whichwererearingasapotentialmajorheadache–seemtohaveturnedthecornersomewhat.Ingeneralthedeclineinpricesandrentsacrossmostsectorsappeartohaveslowedsignificantlyandinmanysectorsstabilised.

Thetailoftheeconomicdownturncontinuedtoripplethroughtotheconsumerlendingportfoliosduringtheyear.However,inrecenttimesthearrearshaveremainedrelativelystable.Onhousing,thebigtalkingpointlatelyhasbeenwhetherornotthereisahousingbubble.

WhileAustralianhousepriceshavemorethandoubledinthepastdecade,simplecomparisonstotheUSandUKmarketaretoosimplisticandnotappropriate.Forastart,wedon’thavecitieswhicharemassivelyoverbuilt.Ourbankswerenotlendingtoraftsofpeoplewhoquiteclearlycouldn’taffordtorepay.AndthebankshavenotbeenapplyingLVRssignificantlyinexcessof100%.

Thebanks’resultsforFY10weresignificantlybolsteredbya$5.6billionreductioninbaddebtexpense(BDE).TheaggregateBDEof$7.7billionrepresents42bpsofgrossloansandacceptances,downfrom76bpsforFY09.Thesecondhalfwas34bps,followingafirsthalfof52bps,trendingbacktowardsthelong-termratioof25-30bps.

WhiletheBDEreduced,thequalityofthebanks’loanportfoliosinfactcontinuedtodeteriorateslightlyduringthecourseoftheyear,asexpectedaswemovethroughthetailoftheGFC.Consequentlywe’veseenthattotalloanlossprovisions–thesumoftheindividuallyassessedprovisions(IAPs)pluscollectiveprovisions(CPs)–havecontinuedtoincrease.However,therateofincreasehasslowedconsiderably,withaconsequentreductioninBDE.

Asexpectedatthisstageofthecycle,grossimpairedassetsgrew17%overtheyear,tonowrepresent124bpsofgrossloansandacceptances.IAPscorrespondinglyincreased16%from$6.0billionto$7.0billion.

Ontheotherhand,CPsgrewonly3%from$12.9billionto$13.3billion,andinfactreducedinthesecondhalf.Thisisalsonaturalatthisstageofthecycle:CPsareestablishedforthosebaddebtsalreadyincurredbutnotyetidentified;andastheloanssubsequentlybecomeidentifiedasimpairedassets,theCPsareconvertedintoIAPs.

Likewisewealsobegantoseethereleaseofsomeofthemanagement/economicoverlayscarriedwithintheCPs.Thishasnotbeensignificant–whichisappropriategiventhecontinuinguncertaintywiththeeconomyandothersystemicdriversofportfolioquality–butit’saninterestingpointertothefuture.

Four majors: impaired assets and bad debt expense

Notes:Pre2006AGAAP;post2006AIFRS

1992

0%

1%

2%

3%

4%

5%

6%

7%

0%

0.5%

1%

1.5%

2%

2.5%

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Impaired assets / gross loans & acceptances (left axis)Bad debt charge / gross loans & acceptances (right axis)


Solongasunemploymentlevelscontinuetoholdup,wearenotexpectingasharpfallinhousepricesinAustralia.ThisviewappearstobesupportedbytheReserveBank.TheirmostrecentHouseholdIncomeandLabourDynamicsinAustralia(HILDA)surveyindicatesthatalmosttwo-thirdsofhouseholdswithowner-occupierdebtfacedrepaymentslessthan30%oftheirdisposableincome,andthataroundhalfofallhouseholdswereaheadoftheirscheduledrepayments.Thishelpstoconfirmthatthedebtburdenisgenerallymanageableforhouseholds,althoughtherecanbenounduecomplacencygiventheflip-slideisthatmorethanonethirdofthosehouseholdshaveadebtloadinexcessof30%ofdisposableincome.

OtherpotentialshadowsonthehorizonincludetheimpactofthestrengtheningAussiedollaronoffshoretrade-exposedsectors.Thebanksarealsoholdingalargestockofimpairedassets,andmuchoftherelatedsecuritywillmostlikelycomeontothemarketinduecourse.Weexpectthebankstocontinuetoadoptameasuredapproachtothis.Oneofthepositivefeaturesofthisdownturnhasbeenthepreparedness(andability)ofbankstosupportbusinessesandholdoffforeclosingtoallowtimeforremediation.ThishashelpedcontaintheBDE.However,ifalotofassetsdidhitthemarketatthesametime,itcouldseriouslydepressprices.

Onbalance,weexpectthatbaddebtexpenseswillcontinuetoreducenextyear.Indeedweexpectthatintimetheymaytrendlowerthanthe25-30bpslong-termaverageforthesimplereasonthatsomuchofthebalancesheetisnowheldinlessriskyhomeloans.Butyear-on-yearwearenotgoingtoseearepeatofthisyear’s$5.6billionreductioninBDE.


Key banking statistics – Full Year 2010

AllfiguresinAUDmillionunlessotherwiseindicated

(i) Inarrivingat“underlyingprofit”,incomeandexpensesexcludesignificantitemsandcertainnoncashitems.Noncashitemsincludeprovisionalgainsonacquisitionofcontrolledentities,impactofhedgeaccountingandrevaluationoftreasurysharesandotheritemsreportedbythebanks.Significantitemsincludethegainsondisposalofbusinesses,non-continuingbusinesses,restructuringandtransformationcostsandotheritemsreportedbythebanks.Somecomponentsofincomeandexpenseshavebeenreclassifiedtoimprovecomparabilitybetweenbanks.

(ii) Statutoryresultasreportedbythebanks,unadjusted.

(iii) ANZacquiredtheremaining50%ownershipofINGAustraliaon30November2009.ANZprovided“proforma”resultsfor2009and2010asthoughINGAustraliawasownedfrom1October2009.WehaveusedthisproformainformationinreportingANZ’sresultsabove.ANZalsoprovidedadjustmentseliminatingtheimpactofmovementsinforeignexchangeratesontheircomparativeresults.Inordertomaintainconsistencybetweenbankswehavenotsoughttoremovetheseimpactsinreportingtheirresultsabove.

(iv) CBAacquiredBankweston19December2008.CBAhasprovidedcomparativesfor2009reflectingtheresultsofBankwestasthoughithadbeenacquiredon1July2008(proformainformation).WhereverpossiblewehaveusedtheproformacomparativesinouranalysisandpresentationofCBA’sinformation.CBA’sunderlyingcashearningsaftertaxbeforesignificantitemsareshownbeforeinvestmentearningsonshareholder’sretainedprofitsandcapitalinlifebusiness–Jun10$178millionandJun09($193)million.

(v) NABunderlyingcashearningsaftertaxbeforesignificantitemsareshownbeforedistributionstoholdersofNationalSecuritiesandinvestmentearningsonshareholder’sretainedprofitsandcapitalinlifebusiness–Sep10($154)millionandSep09($219)million.

(vi) WBCacquiredStGeorgeBankon1December2008.WBChasprovidedcomparativeinformationfor2009reflectingtheresultsofSGBasthoughithadbeenacquiredon1October2008(proformainformation).WhereverpossiblewehaveusedtheproformacomparativesinouranalysisandpresentationofWBC’sinformation.

ANZ(iii) CBA (iv) NAB (v) WBC (vi)

12mthsSep-10

12mthsSep-09

12mthsSep08

12mthsJun10

12mthsJun-09

12mthsJun-08

12mthsSep-10

12mthsSep-09

12mthsSep08

12mthsSep-10

12mthsSep-09

12mthsSep08

Balancesheet

Totalassets 531,739 476,987 470,293 646,330 620,372 487,572 685,952 654,120 656,799 618,277 589,587 587,114

Riskweightedassets 264,242 252,069 275,434 290,821 288,836 205,501 344,658 342,522 343,511 279,379 288,739 195,505

Grossloansandacceptances 367,506 352,107 355,347 512,838 488,500 383,502 447,981 436,570 438,303 482,366 467,843 435,875

Assetquality&provisioning

Grossimpairedassets 6,561 5,595 2,673 5,216 4,210 683 6,048 5,500 2,149 4,585 3,770 1,407

Netimpairedassets 4,686 4,069 1,998 3,224 2,481 404 4,524 3,949 1,504 2,963 2,542 806

Grossimpairedassetsasa%ofloansandacceptances

1.79% 1.59% 0.75% 1.02% 0.86% 0.18% 1.35% 1.26% 0.49% 0.97% 0.81% 0.32%

Individuallyassessedprovisions 1,875 1,526 675 1,992 1,729 279 1,524 1,551 645 1,622 1,228 458

Individuallyassessedprovisions%ofimpairedassets

28.6% 27.3% 25.3% 38.2% 41.1% 40.8% 25.2% 28.2% 30.0% 34.8% 32.6% 32.6%

Collectiveprovisions 3,153 3,000 2,821 3,461 3,225 1,466 3,221 3,195 2,539 3,439 3,506 2,131

Collectiveprovisions%ofnonhousingloans&acceptances

1.91% 1.83% 1.57% 1.83% 1.64% 0.87% 1.44% 1.37% 1.06% 2.05% 1.92% 1.13%

Totalprovisions 5,028 4,526 3,496 5,453 4,954 1,745 4,745 4,746 3,184 5,061 4,734 2,589

%ofloans&acceptances 1.37% 1.29% 0.98% 1.06% 1.01% 0.46% 1.06% 1.09% 0.73% 1.05% 1.01% 0.59%

Profit&lossanalysis(i)

Netinterestincome 11,051 10,312 7,855 11,868 10,716 7,907 12,288 12,072 11,142 11,855 11,789 9,652

Otheroperatingincome 5,171 5,216 4,440 6,955 7,013 6,451 5,874 5,778 5,210 5,055 5,034 5,206

Totaloperatingexpenses 7,298 6,948 5,406 8,601 8,222 7,021 9,386 8,524 8,214 6,972 6,740 6,440

Coreearnings 8,924 8,580 6,889 10,222 9,507 7,337 8,776 9,326 8,138 9,938 10,083 8,418

Baddebtexpense 1,875 3,128 2,090 2,075 3,392 930 2,263 3,815 2,489 1,456 3,292 1,205

Profitbeforetax 7,049 5,452 4,799 8,147 6,115 6,407 6,513 5,511 5,649 8,482 6,791 7,213

Incometaxexpense 1,977 1,536 1,365 2,208 1,584 1,630 1,777 1,451 1,408 2,537 2,025 2,061

Minorityinterest 6 2 8 16 30 31 1 0 (1) 66 71 74

Cashearningsaftertaxbeforesignificantitems(underlyingprofit)

5,066 3,914 3,426 5,923 4,501 4,746 4,735 4,060 4,242 5,879 4,675 5,078

Statutoryresults(ii) 4,501 2,943 3,319 5,664 4,723 4,791 4,224 2,589 4,536 6,346 3,446 3,859

Keydata

Otheroperatingincome(%oftotalincome) 31.9% 33.6% 36.1% 36.9% 39.6% 44.9% 32.3% 32.4% 31.9% 29.9% 29.9% 35.0%

Interestspread 2.21% 2.00% 1.59% 1.91% 1.81% 1.68% 1.93% 1.94% 1.69% 1.94% 2.12% 1.71%

Interestmargin 2.47% 2.31% 2.01% 2.13% 2.08% 2.02% 2.24% 2.16% 2.19% 2.22% 2.33% 2.02%

Expense/incomeratio(headlinereportedratio)

45.0% 44.8% 44.0% 45.7% 46.4% 48.9% 45.9% 43.9% 46.9% 41.2% 40.1% 43.3%

Totalnumberoffulltimeequivalentstaff 46,917 37,687 36,925 45,025 44,218 39,621 44,551 38,953 39,729 38,479 36,199 36,690

Operatingcostsperemployee(dollars) 155,551 161,010 146,405 191,027 185,942 177,204 210,680 218,828 206,751 181,190 186,193 175,525

Returnonaverageequity%(asreported) 15.5% 13.3% 15.1% 18.2% 15.6% 20.4% 13.2% 11.8% 14.3% 16.1% 14.0% 23.1%

Capitalratios

Tier1 10.1% 10.6% 7.70% 9.2% 8.1% 8.2% 8.9% 9.0% 7.4% 9.1% 8.1% 7.8%

Tier2(netofdeductions) 1.8% 3.1% 3.40% 2.3% 2.4% 3.4% 2.5% 2.5% 3.6% 1.9% 2.7% 3.0%

Total 11.9% 13.7% 11.1% 11.5% 10.4% 11.6% 11.4% 11.5% 10.9% 11.0% 10.8% 10.8%

pwc.com.au/mba

National

Hugh Harley [email protected]

Sydney

Michael Codling [email protected]

Melbourne

Mark [email protected]

Brisbane

Sandra [email protected]

Adelaide

Kim [email protected]

Perth

Justin [email protected]

New Zealand

Paul [email protected]

For further information or copies of this report, please contact

Michelle Oliver+61(2)[email protected]/mba

Note:thePwCBankingGaugeisaconsensusviewacrossthefourbanksandacrossfiveofAustralia’sleadingbankinganalysts–CraigTurton(Macquarie),JamesEllis(CreditSuisse),JonathanMott(UBS),MatthewDavison(MerrillLynch)andScottManning(JPMorgan).

©2010PwC.Allrightsreserved.“PwC”referstoPwC,apartnershipformedinAustraliaor,asthecontextrequires,thePwCglobalnetworkorothermemberfirmsofthenetwork,eachofwhichisaseparateandindependentlegalentity.

ThisdocumentisprovidedbyPwCasgeneralguidanceonlyanddoesnotconstitutetheprovisionofaccounting,legaladvice,taxservices,investmentadvice,orprofessionalconsultingofanykind.Theinformationisprovided“asis”withnoassuranceorguaranteeofcompleteness,accuracyortimelinessoftheinformationandwithoutwarrantyofanykind,expressorimplied,includingbutnotlimitedtowarrantiesofperformance,merchantabilityandfitnessforaparticularpurpose.InnoeventwillPwCoritsprofessionalsbeliableinanywaytoyouortoanyoneelseforanydecisionmadeoractiontakeninrelianceontheinformationorforanydirect,indirect,consequential,specialorotherdamagesrelatedtoyouoryouruseofinformation,evenifadvisedofthepossibilityofsuchdamages.Beforemakinganydecisionortakinganyaction,youshouldconsultaprofessionaladviserwhohasbeenprovidedwithallthepertinentfactsrelevanttoyourparticularsituation.

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