At a glance...5. Executive summary...6. Net Interest Income Asset Quality Non-interest income Capital Costs...

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3 At a glance...5 Executive summary...6 Net Interest Income Asset Quality Non-interest income Capital Costs Return on Equity... 21

4 Major Australian Banks: Half Year 2018 Results Analysis Half Year 2018 Results Snapshot

5 5 Major Australian Banks: Half Year 2018 Results Analysis At a glance ANZ CBA 1 NAB WBC 1H18 PCP 2 1H18 PCP 2 1H18 PCP 2 1H18s PCP 2 Ranking By profit before tax By total assets By total equity By market capitalisation By CET 1 capital ratio Financial Performance P/L Profit before tax ($ million) statutory basis 5,356 4,389 6,975 6,770 4,058 3,984 6,035 5,643 Profit after tax ($ million) statutory basis 3,323 2,911 4,906 4,895 2,583 2,545 4,198 3,907 Cash profit after tax ($ million) 3,493 3,355 4,735 4,828 2,759 3,294 4,251 4,017 Performance Measures P/L Net interest margin cash basis (basis points) Cost to income ratio cash basis (%) Basic earnings per share 3 statutory basis (cents) Basic earnings per share 3 cash basis (cents) Return on average equity 3 (%) cash basis Credit Quality Measures Impairment charge ($ million) (statutory basis) Impaired loans to loans and advances to customers (%) B/S Collective provision to credit RWA (%) B/S Financial Position B/S Total assets ($ million) 935, , , , , , , ,875 Total equity ($ million) 59,500 59,075 66,091 63,660 52,401 51,317 62,665 61,342 Capital Measures B/S Capital Adequacy Ratios (%) - Total 14.9% 14.8% 14.8% 14.2% 14.4% 14.6% 14.8% 14.8% - Tier % 12.6% 12.4% 12.1% 12.4% 12.4% 12.8% 12.7% - Common Equity Tier % 10.6% 10.4% 10.1% 10.2% 10.1% 10.5% 10.6% Market capitalisation 4 ($ billion) CBA as reported as at 31 December Prior comparable period (PCP) data comprises of 1H17 for profit and loss (P/L) metrics and 2H17 for balance sheet (B/S) metrics, unless otherwise stated. 3 Comparative amount reported as of 2H17 4 Market capitalisation sourced from statutory accounts or ASX.

6 6 Major Australian Banks: Half Year 2018 Results Analysis Executive summary The first half year 2018 (1H18) results of the Australian major banks (the majors) shows that growth continues to be challenging in a new era of industry transformation. Whilst reporting continued improvements in loan impairments and margins, the results indicate a difficult regulatory and operating environment facing the majors, with slowing revenue growth, rising capital levels and increasing legal and remediation costs, as the industry works to restore trust. The half year results begin to reflect the transformation of the industry that is underway, as the majors re-shape their business models for the future to reflect the societal, regulatory and technology agenda. The majors reported a combined cash profit of $15.2 billion for the half year, down 2% compared to the previous corresponding period (1H17 or PCP). This decrease is primarily driven by lower non-interest income and higher restructuring and regulatory costs. Aggregated net interest income (cash basis) increased by 4.8% to $31.7 billion for the half year, while aggregated non-interest income (cash basis) decreased by 5.8% to $11.5 billion mainly due to one-off asset disposals, the removal of ATM fees and regulatory changes (e.g. interchange rates). Diagram 1. Cash profit after tax by segment (1H18)

7 7 Major Australian Banks: Half Year 2018 Results Analysis Diagram 2. Average net interest margin Aggregated average net interest margin of 203 basis points (cash basis) increased by 3 basis points compared to 1H17 primarily due to mortgage and deposit re-pricing offsetting lower earnings on capital market s income and the impact of the Major Bank Levy. Loan impairment charges continue to fall across the majors. The implementation of AASB 9 Financial Instruments (AASB 9) is expected to increase the collective loan impairment provisions across the banks as it introduces a forward looking methodology for provisioning. The average cost-to-income ratio increased by 265 basis points across the majors to 45.7%, attributed to meeting rising regulatory compliance, legal and remediation requirements, as well as restructuring costs and increased investment in technology.

8 8 Major Australian Banks: Half Year 2018 Results Analysis Diagram 3. Profit before tax and provisions vs operating profit before tax (statutory basis) Diagram 4. Total capital vs return on equity The majors capital position continued to rise, with their average Common Equity Tier 1 (CET1) capital ratio rising by 20 basis points over the half year to an average of 10.5% of risk-weighted assets (RWAs), reflecting the impact of increased regulatory capital requirements (as the industry works towards APRA s unquestionably strong benchmark). As a consequence of these requirements, the increase in banks capital levels has continued to compress industry returns. The majors returns on equity (ROE) decreased by 78 basis points to an average ROE of 12.9% for the half year.

9 9 Major Australian Banks: Half Year 2018 Results Analysis Despite slowing demand for credit and increasing regulatory and capital costs, the majors are accelerating their efforts to transform their business portfolios, invest in digitial capabilities and simplify their operating models. Outlook Looking ahead, economic conditions in Australia are expected to remain relatively mixed, with a cooling property market and subdued wage growth continuing to be offset by relatively strong employment growth and rising business investment. The medium term outlook - which has many economists predicting a rise in interest rates some time in 2019, coupled with persistently high household debt levels - will require constant vigilance from the majors to ensure they maintain disciplined lending practices. Furthermore, the uncertainty of the future operating and regulatory environment will present substantial challenges for the majors Boards and management teams, as they execute on a range of measures to restore public trust, respond to the Royal Commission and manage the introduction of policy changes, such as mandatory Comprehensive Credit Reporting (this year) and Open Banking (in the middle of 2019). These changes, both individually and collectively, will play a critical role in the transformation of the banking industry in the future. While the majors pursue different strategic initiatives and investments, they are each seeking to simplify, digitise and reorientate their business models balancing the needs of all stakeholders in order to deliver enhanced customer outcomes and at the same time decent returns to shareholders.

10 10 Major Australian Banks: Half Year 2018 Results Analysis Net Interest Income Net interest income increased 5.0% to $31.6 billion on aggregate compared to 1H17. This is driven by mortgage and deposit repricing, an increase across interest earning assets and a decrease in wholesale funding costs, partially offset by the Major Bank Levy and weaker markets and treasury performance. Accordingly, net interest margin has increased by 3 basis points to an average of 2.03% compared to 1H17. Cash basis NET INTEREST INCOME 1H18 1H17 HY17 Movement % ANZ 7,350 7,419 (0.9%) CBA 9,253 8, % WBC 8,278 7, % NAB 6,750 6, % Aggregate 31,631 30, % NET INTEREST MARGIN 1H18 1H17 ANZ (7 bps) CBA bps WBC bps NAB bps Average bps Net interest margin Although the low interest rate environment put downward pressure on the net interest margin, the majors have reported an increase in net interest margin compared to 1H17 due mainly to the favourable movements in house lending and re-pricing of interest only and investment loans in response to more stringent regulatory requirements. However, the interest rate environment continued to affect markets interest income in particular, with all four majors posting a decrease in markets and treasury earnings. Other factors such as the Major Bank Levy and lower earning rates on capital also constrained increases in the average net interest margin.

11 11 Major Australian Banks: Half Year 2018 Results Analysis Diagram 5. Interest margins Lending asset growth Housing credit recorded growth in the half year of 1.8% compared to non-housing credit which only grew 0.9%. Housing credit has been impacted by the slowing Australian housing market and the introduction of APRA s prudential cap on interest-only lending. Regulators have been scrutinising property lending and borrower serviceability as an area of heightened risk, particularly given high levels of household debt where movements in interest rates have the potential to impact the serviceability of loans. Despite APRA capping the new interest-only lending at 30% of the total new residential mortgages and limiting the generation of such loans at loan-to-value ratio above 80%, the majors recorded an increase in average interest earning assets across their portfolios of 1% to 777,195 whilst also decreasing gross impaired assets, demonstrating balance sheet resilience. We note that APRA has now removed the interest only cap as it considers it has had the desired impact. However, the increase in average interest earning assets for the past six months of 1%, compared to the 2% increase in second half 2017 (2H17), shows that interest earning assets growth continues albeit at a slower pace. This is in line with the cooling off of the Australian housing market, as well as low economic growth, interest rates and increasing competition.

12 12 Major Australian Banks: Half Year 2018 Results Analysis Diagram 6. Loans to households and market share of household loans Funding mix The major banks continue to change their funding mix towards longer term wholesale funding to build and stabilise a comfortable buffer above the new Net Stable Funding Ratio (NSFR) minimum requirement of 100%. The Basel III NSFR requirement became effective from 1 January 2018, with the majors all reporting their compliance at an average of 113%. This has been achieved with a decrease in deposits and wholesale funding costs. Diagram 7. Customer deposits proportionate to total gross loans

13 13 Major Australian Banks: Half Year 2018 Results Analysis Asset Quality A benign economic environment and APRA s regulatory focus on lending standards has seen this half continue the trend of decreasing impairment charges with the majors recording a decrease of 19.5% to $1.8 billion. These prudential measures have strengthened lending standards resulting in lower levels of impaired assets observed in the past year which continued into the current half, demonstrating an improvement in the risk profile of the majors lending portfolios. Key asset quality metrics indicate that prudential measures put in place in the past, in particular around limits on investor loans and interest-only lending, have flowed onto the majors, with gross impaired assets across the majors decreasing from $8,837 million to $8,545 million. Despite the recent slowdown of housing loan growth and eventual rise of interest rates creating possible future headwinds, the current credit impairment charge compared to gross loans and advances has fallen by 4 basis points, indicating that these vulnerabilities have not yet impacted the financial results of the majors. Diagram 8. Loan impairment charge

14 14 Major Australian Banks: Half Year 2018 Results Analysis In line with the lower level of impaired assets, the provision for credit impairment has fallen across the majors with the exception of NAB which recorded an increase of 9% compared to 1H17. NAB s results included a higher collective provision for additional forward looking adjustments for targeted sectors experiencing elevated levels of risk. With the exception of NAB which has already adopted AASB 9, the implementation of AASB 9 is expected to increase the collective provision as it introduces a forward-looking methodology for provisioning as opposed to using historical incurred losses. CBA announced the implementation of AASB 9 in FY2019 will increase its collective provisions by $850 million with a 25 basis point impact on capital. ANZ noted the new standard is expected to increase its collective provisions in the range of $240-to-$540 million, with a 3 to 6 basis point impact on capital. Looking ahead, the Australian banking industry will face challenges in sustaining asset quality, as the current record low levels of interest rates eventually increase, placing stress on households with high debt levels. Whilst recent measures have increased the resilience of the majors balance sheets, both regulators and banks will need to actively monitor the macroeconomic environment for emerging signs of stress in their lending books.

15 15 Major Australian Banks: Half Year 2018 Results Analysis Non-interest income The majors reported a combined non-interest income of $11.5 billion, down 5.8% from 1H17, as they continue to face competitive pressure and regulatory scrutiny on fees and commission structures. The decrease also reflects challenging trading conditions, partially offset by one-off asset sales as the majors continue to divest non-core businesses and focus on meeting capital requirements. CBA s non-interest income of $3,869 million decreased by 6% compared to 1H17. Excluding prior period s one-off revenue from the sale of Visa Inc., non-interest income movement was flat, reflecting an increase in commission income, offset by lower trading income. NAB s trading income of $610 million decreased by 15% compared to 1H17. This primarily reflects $241million favourable movements in economic hedges in the prior period, compared to $41 million in the current half. ANZ s non-interest income of $2,458 million decreased by 4% compared to 1H17. This primarily reflects lower markets revenues including the lower impact of derivative valuation adjustments compared with 1H17. WBC's non-interest income decreased by $218 million (7%) from 1H17 primarily due to a large decrease in trading income of $206 million from lower risk income and customer activity. They also recorded a lower credit card fee income due to the full impact of the regulatory changes to Australian interchange rates from 1 July Diagram 9. Breakdown of non-interest income (statutory basis)

16 16 Major Australian Banks: Half Year 2018 Results Analysis Asset sales As the majors continue to restructure their wealth management businesses, the following divestments were announced during the period: On 21 September 2017, CBA announced the $3.8 billion sale of its life insurance business including CommInsure Life and Sovereign to AIA, which is expected to be completed in A partnership with AIA will be in place to continue distributing life insurance products to CBA customers in Australia and New Zealand. NAB announced in their 1H18 results that they intend to target an end of calendar year 2019 to exit their Advice, Platform and Superannuation and Asset Management businesses which are currently under their MLC and other brands. ANZ announced the sale of OnePath pensions and investments and aligned dealer groups to IOOF on 17 October 2017 and the sale of its life insurance business to Zurich Financial Services Australia on 12 December Both sales are expected to close in 1H19. Wealth management and insurance Profits in the wealth and insurance businesses increased by 8.3% to $2.6 billion as the majors benefited from more focused wealth management offerings, and an increase in funds under management compared to 2H17. Diagram 10. Net funds management and insurance income

17 17 Major Australian Banks: Half Year 2018 Results Analysis Capital Australian regulatory conditions remain challenging in the midst of rising APRA capital requirements and the implementation of new accounting standards for annual financial reporting periods commencing on or after 1 January Despite this, the Australian major banks continued to perform favourably in key capital metrics on the back of prior steps taken to enhance balance sheet strength. At the end of 1H18, organic growth from cash earnings continued to drive a modest increase in the Basel III Common Equity Tier 1 (CET1) ratio to an average of 10.5% across the major banks. This will continue to be an area of focus for the majors going forward to meet APRA s unquestionably strong target of 10.5% by 1 January The adoption of AASB 9 and the resulting expected increase in loan impairment provisions will place further downwards pressure on the CET1 ratio, ensuring that the majors will need to continue to strengthen their balance sheet. Dividends, which are a key variable in sustainable capital metrics, are largely flat compared to 1H17. Dividend payout ratios have increased to an average of 77.6% across the majors. ANZ reported a flat dividend of 80 cents and a decrease in the payout ratio from 1H17 to 66%, moving them towards their stated target payout ratio of 60 to 65%. ANZ s higher capital position from announced and completed asset sales provides flexible capital management options going forward, including dividends. Capital adequacy metrics ANZ CBA NAB WBC 1H18 2H17 1H18 2H17 1H18 2H17 1H18 2H17 Common Equity tier 1 ratio Tier 1 capital (total) Tier Total regulatory capital ratio Tier 1 capital ($ million) 51,125 49,324 54,465 52,684 48,048 47,417 53,246 42,670 Total capital ($ million) 59,165 57,993 65,087 62,076 55,899 55,707 61,653 59,910 Risk weighted assets ($ million) 395, , , , , , , ,235 Credit risk weighted assets ($ million) 342, , , , , , , ,258

18 18 Major Australian Banks: Half Year 2018 Results Analysis The majors reported continued compliance with minimum capital adequacy requirements throughout the period, including the new Net Stable Funding Ratio requirements that came into effect on 1 January In addition: The Liquidity Coverage Ratio (the amount of high quality liquid assets held that can be used to meet the bank s liquidity needs for a 30 day calendar liquidity stress scenario) is at an average of 131.5% versus the stipulated 100% minimum; and The Leverage Ratio (the amount of Tier 1 capital held divided by average total consolidated assets of the bank) for the majors is running at an average of 5.5% which is also in excess of the currently agreed minimum Basel requirement of 3%.

19 19 Major Australian Banks: Half Year 2018 Results Analysis Costs The majors continue to intensify their efforts to improve their business efficiency. However, combined operating expenses has increased mainly attributable to restructuring costs, increasing regulatory and legal expenditure (e.g. Royal Commission) and CBA s AUSTRAC provision. The majors continue to invest in technology and have reported productivity efficiencies which have led to reduced personnel costs. Cost management continues to be a strategic imperative and will rely on further efforts to simplify product offerings, streamline processes and investment in technology to realise a step-change in their cost bases in the future. Operating expenses have increased in aggregate by 7.3% to $19,573 million across the majors. The half s results include NAB restructuring costs of $755 million with CBA s provision for the AUSTRAC proceedings of $375 million and additional regulatory, compliance and remediation programs of $200 million. The average cost to income ratio has also increased by 265 basis points to 45.7%, mainly due to the above costs and the Major Banks Levy. Diagram 11. Average cost to income ratio Technology Technology spend continues to increase, rising by 5.3% to $2.0 billion across the majors. The rise in technology investment provides the majors with an opportunity to strengthen and streamline their product offerings and operating environments, allowing them to provide an enhanced customer experience and at the same time addressing growing areas of concern, such as cyber and information security. CBA has increased their investment in technology by 6% to $503 million when excluding the lower amortisation due to the one-off acceleration of specific software assets in 1H17.

20 20 Major Australian Banks: Half Year 2018 Results Analysis Diagram 12. Capitalised software Personnel Overall personnel numbers across the majors continue to decline as the majors are reporting benefits from productivity initiatives. Full Time Equivalents (FTE) reduced by 6,326 to 152,702. Most notably, ANZ reported a reduction of 3,316 FTE to 41,580 during the half, attributed to the divestment of their Asia Retail and Wealth businesses. Looking ahead, the majors will continue to focus on operational improvements through the implementation of emerging technologies such as robotic process automation and artificial intelligence. As a result, the demand for jobs that require unique skillsets and technical capabilities will continue to increase, as evidenced by NAB s announcement to hire 2,000 people with digital skills and competencies. Diagram 13. Average personnel costs per FTE

21 21 Major Australian Banks: Half Year 2018 Results Analysis Return on Equity The majors will face increased pressure to manage shareholder expectations as industry Returns on Equity continue to trend downwards owing to slowing revenue and rising capital, regulatory and operating expenses. The prospect of increasing and sustaining ROE has proved challenging for the majors as they report a decline in cash profits and return on equity. This is evident during the period, where ROE has decreased in aggregate across the majors by 78 basis points to an average ROE of 12.9%, primarily due to both internal and external costs such as the Major Bank Levy, in a slowing revenue environment. In particular, this result was driven by NAB and CBA who recognised decreases of 250 basis points to 11.4% and 110 basis points to 14.5% respectively, owing to a large increase in operating expenses from costs associated with NAB s restructuring program and CBA s recognition of a provision for the ongoing AUSTRAC proceedings. Meanwhile, ANZ s ROE increased by 20 basis points to 11.9% on the back of their $1.5 billion share buyback plan currently underway and dividends paid. Diagram 14. Profit before tax against return on equity

22 22 Major Australian Banks: Half Year 2018 Results Analysis Dividends Despite combined cash profit being down across the majors, dividends remained largely flat with only CBA recording an increase on PCP of 1% share. The dividend payout ratio increased across the majors on average by 3%. Individually, the payout ratio varied across the majors. Both NAB and ANZ held their dividend flat, with NAB s ratio increasing from 79.9% in 1H17 to 96.9% with lower cash profit during the half, whilst ANZ s ratio decreasing from 70% to 66.2% with higher cash earnings. Looking ahead, in particular over the short-to-medium term, sustaining the historical high levels of payout ratios will become an increasingly challenging task with rising regulatory pressures and capital costs, in a low growth environment. Diagram 15. Dividend yield vs payout ratio

23 ACKNOWLEDGEMENTS The following KPMG staff have made a significant contribution to the development of this publication. Ashley Trang Michele Cappai Daphne Lam Dejia Li Jessica Tse Daniel Valeri

24 Contact us Ian Pollari National Sector Leader, Banking ipollari@kpmg.com.au Adrian Fisk National Industry Leader, Financial Services adrianfisk@kpmg.com.au kpmg.com/au/majorbanks The information contained in this document is of a general nature and is not intended to address the objectives, financial situation or needs of any particular individual or entity. It is provided for information purposes only and does not constitute, nor should it be regarded in any manner whatsoever, as advice and is not intended to influence a person in making a decision, including, if applicable, in relation to any financial product or an interest in a financial product. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. To the extent permissible by law, KPMG and its associated entities shall not be liable for any errors, omissions, defects or misrepresentations in the information or for any loss or damage suffered by persons who use or rely on such information (including for reasons of negligence, negligent misstatement or otherwise). ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo and are registered trademarks or trademarks of KPMG International. ACS January 2016