Australian Banks. The CEO Cycle AUSTRALIA. Event. Impact. Outlook

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1 AUSTRALIA Consensus vs Macquarie Estimates Source: FactSet, Macquarie Research, April 2015 EPS Growth relates to CEO tenure 30% 20% 10% 0% -10% -20% -30% Rebase Forecasts Years as CEO Mike Smith Andrew Thorburn Ian Narev Brian Hartzer Markets income has been a point of difference in recent results HoH % Change 200% 150% 100% 50% 0% -50% -100% -150% Score some runs ANZ CBA WBC Maintain Coefficient of variation ANZ: 0.72 CBA: 0.27 WBC: H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 28 April 2015 Macquarie Securities (Australia) Limited The CEO Cycle Event WBC kicks off reporting season this year on 4 May, followed by ANZ (5 May), CBA (Quarterly on 6 May) and NAB (7 May). The CEO cycle is likely to be the dominant theme this reporting season with the market getting its first look at new WBC CEO Brian Hartzer, a health check with relatively new CEO Andrew Thorburn and an assessment of ANZ s strategy with old hand CEO Mike Smith. We believe, given nose bleed valuations, it is possible the market could be surprised by the WBC rebasing, a slower recovery in earnings at NAB and an admission of the need to change strategy at ANZ. Given this, we continue to prefer the stability of CBA. Impact Rebasing risk around WBC this reporting season WBC kicks off reporting season on 4 May where we are expecting cash earnings of $3.87b, cash EPS of 121cps (0% HoH) and dividend of 93cps. ANZ is next where we are expecting cash earnings of $3.58b, cash EPS of 124cps (0% HoH) and dividend of 84cps. NAB rounds out 1H15 reporting where we are expecting cash earnings of $3.21b, cash EPS of 131cps (54% HoH) and dividend of 99cps. Out of the banks, we believe there is most risk (upside and downside) around the WBC result given the new CEO and lack of quarterly reporting. CEO cycle likely to take centre stage this result season Each of the major banks are at a different stage of the CEO cycle. This will become apparent with the new WBC CEO (Brian Hartzer) delivering his first result on 4 May. The rebasing path is a well known one and we d be astounded if the new WBC CEO doesn t take the opportunity to start to shape WBC as he sees fit. Likewise, Andrew Thorburn over at NAB is likely to update the market on the state of the turnaround at the bank. We think there maybe some encouraging signs although turnarounds take time. Finally, we believe ANZ s result is likely to be the most interesting of the three banks particularly given the co-incidence of three negative cycles (commodities downturn, Asian economic downturn, US interest rate upturn) that are battering the bank s earnings at present. Regulation/competitive responses also in focus There still remains substantial regulatory uncertainty across the sector. This is the first public platform (outside of the recent CBA result) that the banks have had since the release of the Murray review/basel 4 discussion paper. We expect the banks to report will discuss their emerging views on regulatory change and the logical consequences/competitive responses they may have at their disposal. Outlook This reporting period is unlikely to throw up any sector wide surprises, with surprise likely to be stock specific (New CEO for WBC, pace of recovery at NAB, cyclical headwinds for ANZ). Given this and a slowing backdrop, we believe declining rates will continue to support the sector. Here CBA is best placed given its replicating portfolio and longer-dated hedges. Please refer to page 12 for important disclosures and analyst certification, or on our website

2 Analysis WBC kicks off reporting season this year on 4 May, followed by ANZ (5 May), CBA (Quarterly on 6 May) and NAB (7 May). Our key numbers are contained in the table below. Fig 1 Key numbers for the upcoming results 1H15 (A$ m) WBC ANZ NAB Net Interest Income 7,009 7,142 6,998 Non-NII 3,156 2,827 2,438 Total Revenue 10,165 9,969 9,436 Operating Expenses 4,279 4,536 4,406 PPOP 5,886 5,433 5,030 Impairment Charge Cash NPAT 3,867 3,578 3,213 EPS DPS NIM 2.05% 2.06% 1.91% Source: Macquarie Research, April 2015 For WBC, we are expecting cash earnings of $3.87b, cash EPS of 121cps (0% HoH) and dividend of 93cps. ANZ is next where we are expecting cash earnings of $3.58b, cash EPS of 124cps (0% HoH) and dividend of 84cps. NAB rounds out 1H15 reporting where we are expecting cash earnings of $3.21b, cash EPS of 131cps (54% HoH) and dividend of 99cps. Out of the banks, we believe there is most risk (upside and downside) around the WBC result given the new CEO and lack of quarterly reporting. We detail the key themes of reporting season below. Fig 2 Consensus vs Macquarie estimates for 1H15 reporting period (A$ m) Consensus Macquarie 1H15 Cash Profit EPS DPS Cash Profit EPS DPS ANZ 3, , NAB 3, , WBC 3, , Source: FactSet, Macquarie Research, April 2015 CEO cycle likely to take centre stage this result season Each of the major banks are at a different stage of the CEO cycle. This will become apparent with the new WBC CEO (Brian Hartzer) delivering his first result on 4 May. The rebasing path is a well known one and we d be astounded if the new WBC CEO doesn t take the opportunity to start to shape WBC as he sees fit. Fig 3 EPS Growth The CEO Cycle works like clockwork 30% Rebase Score some runs Maintain 20% Forecasts 10% 0% -10% -20% -30% Years as CEO Mike Smith Andrew Thorburn Ian Narev Brian Hartzer 28 April

3 Likewise, Andrew Thorburn over at NAB is likely to update the market on the state of the turnaround at the bank. We think there maybe some encouraging signs although turnarounds take time. For more detail please refer to our note National Australia Bank - Back in Business, 14 Jan Fig 4 NAB could reinstate over $400m pa of revenue from FY17 $m 1H15 2H15 1H16 2H16 1H17 2H17 Total Costs Salary expense from hiring new staff Investment spend from reinvestment Foregone revenue from lost mkt share Benefits Revenue generated from new staff Benefit from growth capex Retail fee income recovered Net PPOP generated from initiatives Net Cash profit Cumulative Cash Profit % of forecast earnings -0.5% 0.2% 1.5% 2.6% 3.8% 4.4% Source: Macquarie Research, April 2015 Finally, we believe ANZ s result is likely to be the most interesting of the three banks particularly given the co-incidence of three negative cycles (commodities downturn, Asian economic downturn, US interest rate upturn) that are battering the bank s earnings at present. Fig 5 Shift in cash profit growth from APEA and NZ to Australia in 2H14 is Asia no longer the focus? % HoH Growth 28% Fig 6 Contribution from Australia grew in 2H14 100% 90% 18% 80% 8% 70% -2% 60% -12% 50% -22% 2H13 1H14 2H14 Australia APEA New Zealand 40% 1H12 2H12 1H13 2H13 1H14 2H14 Australia APEA New Zealand Regulation/competitive responses also in focus There still remains substantial regulatory uncertainty across the sector. This is the first public platform (outside of the recent CBA result) that the banks have had since the release of the Murray review/basel 4 discussion paper. 28 April

4 Fig 7 Regulation timetable for Regulation Date Summary Confirmed Liquidity Coverage Ratio / Combined 1-Jan-15 15bp charge for use of the facility (WBC estimates 1bp margin impact on $66b) Liquidity Facility DSIB Buffer 1-Jan-16 +1% capital buffer for DSIB banks Net Stable Funding Ratio 1-Jan-18 The amount of available stable funding relative to the amount of required stable funding is required to be equal to at least 100% on an on-going basis. Available stable funding is defined as the portion of capital and liabilities expected to be reliable over the time horizon considered by the NSFR, which extends to one year. The amount of such stable funding required of a specific institution is a function of the liquidity characteristics and residual maturities of the various assets held by that institution as well as those of its off-balance sheet (OBS) exposures. Revised Securitisation Framework 1-Jan-18 Implementation of a more risk sensitive, prudent and more consistent with the underlying framework for credit risk Proposed Bank Deposit Levy 1-Jan-16 5bp levy on deposits up to $250k, with banks likely passing this on to customers FSI - Increased Mortgage Risk Weights Unconfirmed Average mortgage risk weights proposed to increase to 25-30% (25-30%) and long dated FSI - Top quartile capital requirement Unconfirmed and long dated recommendation to be "unquestionably strong" and in the top quartile of globally active banks Basel 4 - Increased Capital under Standardised Methodology Unconfirmed and long dated Potential methodology change from the net income surplus (NIS) to the debt serviceability coverage ratio (DSC) under Basel 4 Basel 4 - Capital floor for advanced banks (% of Standardised) Unconfirmed and long dated Possible capital floor for advanced banks which would be a % of the standardised banks capital requirements Source: APRA, Macquarie Research, April 2015 We expect the banks to report will discuss their emerging views on regulatory change and the logical consequences/competitive responses they may have at their disposal. 28 April

5 WBC 4 th May WBC kicks off reporting season on 4 May, where we are expecting cash earnings of $3.87b, cash EPS of 121cps (0% HoH) and dividend of 93cps. We discuss the potential sources of upside and downside surprise for the WBC result below. Sources of upside surprise Capital could surprise on the upside In the most recent Pillar 3 statement, capital was a little soft (down 60bps for the quarter, following the payment of the 2H14 dividend and other one-off impacts) driven by one-off adjustments. (WBC hedge offshore capital but not offshore risk weighted assets so there was a bit of a drop due to the A$ devaluation (-9bps). APRA has also required the bank to hold more capital against its mortgages, with a change to the bank's risk modelling (-21bps)). Pleasingly, WBC's underlying capital generation for 1Q15 came in at ~34bps, which was quite strong (ANZ ~20bps, NAB ~25bps, CBA ~ 15bps). If this were to continue it is possible that capital could surprise for WBC. Fig 8 WBC CET1 - Capital a little soft at the quarter could this turnaround? Sources of downside surprise Management may finally take the plunge on catching up on the IT front to CBA As we ve discussed in the past, CBA appears to be well ahead on the capabilities required in the new world. While NAB is making headway, really the installation of NextGen will be key in providing the necessary capabilities to go toe-to-toe with CBA. The other banks are behind CBA as well, with WBC taking a more measured approach, while ANZ appears to not acknowledge the risks of a lack of back end system flexibility. Clearly it is our view that there is more spending to come for all the majors. In particular we believe: ANZ and WBC will need to upgrade their core systems primarily due to Celeriti not being fit for purpose, in our view. While NAB has started the process of upgrading both the front and back end systems, the project is running materially over time and budget. CBA has more work to do as well, although this should be able to be subsumed into the current investment agenda. 28 April

6 Fig 9 New World Spending Requirements Activities Required Announced Spend Spend on these Required initiatives New Spending Required ANZ CBA NAB WBC Core system replacement, Refresh of legacy Customer Relationship Management System (incl. single cust. view), Enhanced customer analytics function, Invest in lean methods and automated technology, Investment in in-house app development (eg. cust. facing apps), Branch network reconfiguration Modernisation of retail lending products, Refresh of legacy Customer Relationship Management System, Additional development and rollout of frontline sales tools/applications to enable cross-sell and lead generation, Branch network reconfiguration, Core system refresh, Front-end system refresh, Enhanced customer analytics function, Invest in lean methods and automated technology, Additional security investment (incl. biometrics), Branch network reconfiguration Core system replacement, Complete upgrade/refresh of selected product and channel platforms, Enhanced customer and data analytics function (Phase 2), Invest in lean methods and automated technology, Additional security investment (incl. biometrics), Branch network reconfiguration A$3.7b A$1b A$2.7b A$1.4b A$1b A$0.4b A$3.3b A$1.2b A$2.1b A$3.7b A$2b A$1.7b Management may allude to other rebasing initiatives As we have discussed before, revenue pressures are likely to surface given pending property measures which appear to affect WBC more. Likewise, WBC s retail franchise lags CBA, who has a higher quality customer base. We believe the new CEO to be a man of action and understanding that the market will provide him a narrow window of opportunity to invest/make the necessary changes that will set the franchise up for the coming 3-5 years. A few things management might consider on the rebasing front (other than the IT initiatives we ve listed above) include: Further normalisation of the SVR to drive proprietary channel mortgage flow Further focus on (initially margin dilutive) broker channel Further rationalisation of brands and branch footprint A refocusing of the business banking growth strategy on the high value small end of the market as opposed to low margin commercial real estate 28 April

7 Fig 10 WBC Financial Summary Westpac Bank Year Ending 30 September 2017 Neutral PER SHARE DATA Cash EPS (AUD) - Macquarie Basis (diluted) Current Price Target Price Cash EPS Growth (%) 7% 6% 2% 7% 0% 4% 3% 1% 2% A$38.39 $39.68 DPS (AUD) Total Shareholder Return 8.2% BVPS (AUD) NTA PS (AUD) Bloomberg: WBC AU Shares on issue (m) 3,109 3,109 3,109 3,109 3,120 3,156 3,156 3,226 3,280 Reuters: WBC.AX VALUATION METRICS Macquarie Equities P/E (Cash) Analyst(s) Contact(s) P/B (Stated) Michael Wiblin P/NTA Anita Stanley RoE (%) 15.3% 16.1% 16.1% 16.1% 15.6% 15.8% 15.7% 15.0% 14.5% Brendan Carrig RoA (%) 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% 1.0% Dividend Yield (%) 5.1% 2.3% 2.4% 4.7% 2.4% 2.4% 4.9% 5.0% 5.1% Dividend Payout (%) 86.7% 75.6% 76.0% 75.8% 77.0% 74.9% 76.0% 76.5% 76.6% Margins & Volumes Net Interest Margin (RHS) GLAA Growth (LHS) Sustainable RoE used in Valuation (%) 14.9% 14.9% 14.9% 14.9% 14.9% 14.9% 14.9% 14.9% 14.9% 9.0% 2.20% Cost of Equity (%) 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 42.4% 42.2% 42.0% 41.8% 41.6% 41.4% 41.2% 41.0% 40.8% 40.6% 40.4% 40.2% 160% 140% 120% 100% 80% 60% 40% 20% 0% Efficiency Cost to Income % (RHS) Asset Quality Impairment Charge (RHS) Cost Growth (LHS) Coverage (LHS) 2.15% 2.10% 2.05% 2.00% 1.95% 1.90% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% PROFIT & LOSS (AUDm) Net Interest Income 12,912 6,677 6,819 13,496 7,009 7,176 14,185 14,728 15,467 Non-Interest Income 5,921 3,182 3,142 6,324 3,156 3,409 6,565 7,031 7,289 Fees & Commissions 2,723 1,458 1,468 2,926 1,516 1,577 3,093 3,253 3,404 Financial Markets 1, , ,105 1,155 Life and Funds 1, ,003 2,002 1,046 1,083 2,129 2,195 2,236 Other Revenue Total Operating Income 18,833 9,859 9,961 19,820 10,165 10,586 20,751 21,759 22,756 Total Operating Costs 7,710 4,065 4,181 8,246 4,279 4,401 8,680 9,168 9,584 Employee Costs 4,287 2,344 2,294 4,638 2,340 2,387 4,727 4,918 5,116 Other Costs 3,423 1,721 1,887 3,608 1,939 2,015 3,954 4,251 4,467 Pre-Provision Operating Profit 11,123 5,794 5,780 11,574 5,886 6,184 12,070 12,591 13,172 Impairment Charge ,010 Pre-Tax Profit 10,276 5,453 5,471 10,924 5,491 5,749 11,239 11,634 12,163 Tax Expense 3,103 1,643 1,587 3,230 1,597 1,673 3,269 3,386 3,543 Minority Shareholders Other Post Tax Items Stated Net Profit 6,815 3,622 3,939 7,560 3,867 4,049 7,915 8,193 8,565 Extraordinary & Other Items Hybrid Distributions Derivatives & Hedging Revaluation Macquarie Cash Profit 7,097 3,773 3,856 7,628 3,867 4,049 7,915 8,193 8,565 BALANCE SHEET & CAP AD (AUDm) Risk Weighted Assets* 307, , , , , , , , ,840 Interest Earning Assets 599, , , , , , , , ,451 Gross Loans, Advances & Acceptances 539, , , , , , , , ,571 Total Deposits & Other Borrowings 577, , , , , , , , ,748 Total Assets 696, , , , , , , , ,108 Shareholders Equity 47,481 48,031 49,337 49,337 50,027 52,316 52,316 56,872 60,976 Tier 1 Capital* 32,738 33,304 34,997 34,997 36,213 38,375 38,375 42,673 46,513 Tier 1 Ratio (%)* 10.7% 10.3% 10.6% 10.6% 10.6% 10.9% 10.9% 11.6% 10.4% Core Tier 1 Ratio (%) -Basel 2.5 na na na na na na na na na Core Tier 1 Ratio (%) -Basel % 8.82% 8.97% 8.97% 9.05% 9.36% 9.36% 10.14% 9.25% ASSET QUALITY Impairment Charge / GLAA (bp) Coverage (%) 101% 121% 136% 136% 129% 122% 122% 110% 96% Total Stage 1 DDM Valuation 7.75 Total Fade Period Total Perpetuity 1.14 Total Surplus Capital Per Share KEY RATIOS & GROWTH Net Interest Income growth (%) 2.8% 3.2% 2.1% 4.5% 2.8% 2.4% 5.1% 3.8% 5.0% Non-Interest Income growth (%) 7.4% 5.7% -1.3% 6.8% 0.4% 8.0% 3.8% 7.1% 3.7% Total Revenue growth (%) 4.2% 4.0% 1.0% 5.2% 2.0% 4.1% 4.7% 4.9% 4.6% Cost growth (%) 4.5% 4.0% 2.9% 7.0% 2.3% 2.9% 5.3% 5.6% 4.5% Pre-Provision Profit growth (%) 4.0% 4.1% -0.2% 4.1% 1.8% 5.1% 4.3% 4.3% 4.6% RWA growth (%) 3.2% 4.9% 2.8% 7.8% 3.1% 3.4% 6.7% 4.4% 20.9% GLAA growth (%) 4.2% 5.2% 2.7% 8.1% 3.6% 3.7% 7.4% 5.1% 5.6% Deposit growth (%) 7.5% 3.0% 5.4% 8.6% 3.6% 3.7% 7.4% 5.1% 5.6% Net Interest Margin (%) 2.15% 2.10% 2.07% 2.08% 2.05% 2.03% 2.04% 2.00% 2.00% Cost / Income Ratio (%) 40.9% 41.2% 42.0% 41.6% 42.1% 41.6% 41.8% 42.1% 42.1% *B , B onward 28 April

8 ANZ 5 th May ANZ is next to report on 5 May, where we are expecting cash earnings of $3.58b, cash EPS of 124cps (0% HoH) and dividend of 84cps. We discuss the potential sources of upside and downside surprise for the ANZ result below. Sources of upside surprise Markets income could rebound Markets income at the tail end of last year was softer than expected. While the recent quarterly suggested a continuation of that trend, there is a chance that given ongoing volatility in both rates, currencies and commodities prices, that there may have been some turnaround in markets income in the 2 nd quarter. Fig 11 Markets income was softer in 1Q15 will it rebound? HoH % Change 200% 150% 100% 50% 0% -50% -100% -150% ANZ CBA WBC Coefficient of variation ANZ: 0.72 CBA: 0.27 WBC: H11 2H11 1H12 2H12 1H13 2H13 1H14 2H14 1H15 Note: We have excluded NAB from our analysis due to differences in their disclosure of trading income. Sources of downside surprise Asian impairment could start to rise To date, the ANZ impairment charge has remained reasonably well contained and not out of line with peers. Going forward, the key issue remains whether the banks overweight position in commodities and Asia will see some differentiated performance on this line item. Fig 12 ANZ s Impairment experience hasn t differed that much recently from peers bps ANZ CBA NAB WBC Majors Source: Bank Data, Macquarie Research, April April

9 The outlook could be gloomy from a commodities standpoint Whilst impairment from commodities/asian exposure remains a risk, there are also revenue risks from a slowdown across the region. As recently highlighted in the ANZ quarterly, Trade volumes have been consistent; however, significant reductions in commodity prices are impacting the value of shipments and providing a revenue headwind. If this was to continue, the market could become spooked at the downside risk and ANZ s Underperformance could become entrenched. Fig 13 ANZ Financial Summary ANZ Bank Year Ending 30 September 2017 Underperform PER SHARE DATA Cash EPS (AUD) - Macquarie Basis Current Price Target Price Cash EPS Growth (%) 6% 6% -1% 7% 0% 2% 1% 3% 5% $35.41 $34.24 DPS (AUD) Total Shareholder Return 1.8% BVPS (AUD) NTA PS (AUD) Bloomberg: ANZ AU Shares on issue (m) 2,744 2,744 2,757 2,757 2,773 2,801 2,801 2,880 2,947 Reuters: ANZ.AX VALUATION METRICS Macquarie Equities P/E (Cash) Analyst(s) Contact(s) P/B (Stated) Michael Wiblin P/NTA Anita Stanley RoE (%) 15.1% 15.2% 14.8% 15.0% 14.2% 13.9% 14.1% 13.5% 13.3% Brendan Carrig RoA (%) 1.0% 1.0% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% 0.9% Dividend Yield (%) 4.6% 4.7% 5.4% 5.0% 4.7% 5.4% 5.1% 5.1% 5.2% Margins & Volumes Dividend Payout (%) 71.0% 66.7% 76.9% 71.8% 67.7% 75.2% 71.5% % Net Interest Margin (%) GLAA growth (%) Sustainable RoE used in Valuation (%) 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.0% 2.40% Cost of Equity (%) 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 9.8% 1 8.0% 6.0% 4.0% 2.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% Efficiency Income Ratio (%) Cost / Cost growth (%) 2H H15 2H H % 2.20% 2.10% 2.00% 46.0% 44.0% 42.0% PROFIT & LOSS (AUDm) Net Interest Income 12,772 6,764 7,033 13,797 7,142 7,356 14,497 15,167 16,024 Non-Interest Income 5,606 2,904 2,752 5,656 2,827 2,860 5,687 5,915 6,189 Fees & Commissions 2,459 1,255 1,260 2,515 1,287 1,322 2,610 2,730 2,884 Financial Markets 1, , ,718 1,783 1,851 Life and Funds 1, , ,623 1,671 1,723 Other Revenue Total Operating Income 18,378 9,668 9,785 19,453 9,969 10,215 20,184 21,082 22,214 Total Operating Costs 8,236 4,286 4,474 8,760 4,536 4,621 9,157 9,403 9,717 Employee Costs 4,757 2,493 2,558 5,051 2,609 2,661 5,271 5,483 5,705 Other Costs 3,479 1,793 1,916 3,709 1,927 1,960 3,886 3,919 4,012 Pre-Provision Operating Profit 10,142 5,382 5,311 10,693 5,433 5,594 11,027 11,680 12,496 Impairment Charge 1, ,078 1,115 Pre-Tax Profit 8,945 4,854 4,850 9,704 4,953 5,083 10,036 10,601 11,382 Tax Expense 2,437 1,333 1,333 2,666 1,369 1,401 2,771 2,913 3,109 Minority Shareholders Other Post Tax Items Stated Net Profit 6,272 3,381 3,789 7,170 3,578 3,676 7,254 7,676 8,261 Extraordinary & Other Items Hybrid Distributions Derivatives & Hedging Revaluation Macquarie Cash Profit 6,498 3,515 3,512 7,027 3,578 3,676 7,254 7,676 8, % 140% 120% 100% 80% 60% Asset Quality Impairment Charge / GLAA (bp) Coverage (%) BALANCE SHEET & CAP AD (AUDm) Risk Weighted Assets* 339, , , , , , , , ,624 Interest Earning Assets 575, , , , , , , , ,513 Gross Loans, Advances & Acceptances 473, , , , , , , , ,519 Total Deposits 522, , , , , , , , ,037 Total Assets 702, , , , , , , , ,704 Shareholders Equity 45,615 47,038 49,284 49,284 51,642 53,924 53,924 59,222 64,643 Tier 1 Capital* 35,192 37,315 38,601 38,601 40,107 42,003 42,003 46,938 52,397 Tier 1 Ratio (%)* 10.4% 10.3% 10.7% 10.7% 10.5% 10.6% 10.6% 11.3% 10.7% Core Tier 1 Ratio (%) - Basel III 8.49% 8.3% 8.8% 8.8% 8.7% 8.9% 8.9% 9.7% 9.3% 40% 19 20% 0% ASSET QUALITY Impairment Charge / GLAA (bp) Coverage (%) 102% 119% 136% 136% 104% 85% 85% 62% 50% Total Stage 1 DDM Valuation 6.82 Total Fade Period Total Perpetuity 1.16 Total Surplus Capital Per Share KEY RATIOS & GROWTH Net Interest Income growth (%) 5.5% 3.5% 4.0% 8.0% 1.5% 3.0% 5.1% 4.6% 5.7% Non-Interest Income growth (%) 2.5% 5.4% -5.2% 0.9% 2.7% 1.1% 0.5% 4.0% 4.6% Total Revenue growth (%) 4.5% 4.0% 1.2% 5.8% 1.9% 2.5% 3.8% 4.5% 5.4% Cost growth (%) 2.7% 2.0% 4.4% 6.4% 1.4% 1.9% 4.5% 2.7% 3.3% Pre-Provision Profit growth (%) 6.1% 5.7% -1.3% 5.4% 2.3% 3.0% 3.1% 5.9% 7.0% RWA growth (%) 13.0% 6.3% 0.2% 6.6% 5.4% 4.1% 9.7% 4.6% 17.8% GLAA growth (%) 9.2% 8.4% 2.3% 10.9% 4.6% 3.9% 8.7% 4.4% 7.5% Deposit growth (%) 11.0% 4.4% 2.4% 6.9% 4.6% 3.9% 8.7% 4.4% 7.5% Net Interest Margin (%) 2.22% 2.14% 2.13% 2.13% 2.06% 2.05% 2.05% 2.04% 2.02% Cost / Income Ratio (%) 44.8% 44.3% 45.7% 45.0% 45.5% 45.2% 45.4% 44.6% 43.7% *B , B onward 28 April

10 NAB 7 th May NAB reports on 7 May, where we are expecting cash earnings of $3.21b, cash EPS of 131cps (54% HoH) and dividend of 99cps. We discuss the potential sources of upside and downside surprise for the ANZ result below. Sources of upside surprise MLC earnings could rebound strongly MLC and the NAB wealth business more broadly has been a source of underperformance for NAB as shown below. Given an improving Life Insurance environment, there remains a risk that Life earnings in particular are much stronger at the upcoming result. Fig 14 MLC cash earnings the clear laggard is it about to turn around? Sources of downside surprise Business banking turnaround doesn t show momentum Outside of the asset sale agenda that Andrew Thorburn has been pushing, the market has been watching the business banking turnaround closely. As we had highlighted in our note National Australia Bank - Back in Business, 14 Jan 2015, we believe NAB had generated a business banking revenue hole of A$ m due to its actions. Fig 15 We estimate NAB s business bank has lost A$0.4b-0.5b of revenue each year Method Foregone Revenue Revenue Imperative Cost Imperative Investment Imperative Source: Macquarie Research, April 2015 $440m p.a. $490m p.a. $390m p.a. While we suspect that the business bank is likely to show some improvement, as we had highlighted in the 2 nd half result Q&A, we believe that the business banks cost profile might well blow out a little given that NAB business bankers are paid below market rates. Customer conduct rears its head in a material way The recent report presented to the House of Commons Treasury Committee highlighted a number of issues with the way the various remediation programmes around interest rate hedging products in the UK had been handled by various banks including NAB. The risk here remains that this report crystallizes in to an earnings headwind for the bank at the upcoming result. 28 April

11 Fig 16 NAB Financial Summary National Australia Bank Year Ending 30 September 2017 Outperform PER SHARE DATA Cash EPS (AUD) - Macquarie Basis Current Price Target Price Cash EPS Growth (%) 5% 3% -35% -14% 54% 0% 22% 8% 7% A$38.38 $40.58 DPS (AUD) Total Shareholder Return 10.9% BVPS (AUD) NTA PS (AUD) Bloomberg: NAB AU Shares on issue (m) 2,349 2,354 2,366 2,366 2,416 2,432 2,432 2,471 2,509 Reuters: NAB.AX VALUATION METRICS Macquarie Equities P/E (Cash) Analyst(s) Contact(s) P/B (Stated) Michael Wiblin P/NTA Anita Stanley RoE (%) 12.2% 13.6% 8.6% 11.1% 13.1% 12.8% 12.9% 13.3% 13.4% Brendan Carrig RoA (%) 0.7% 0.7% 0.5% 0.6% 0.7% 0.7% 0.7% 0.8% 0.8% Dividend Yield (%) 5.0% 2.6% 2.6% 5.2% 2.6% 2.6% 5.2% 5.2% 5.4% Margins & Volumes Dividend Payout (%) 75.8% 75.4% 116.3% 91.5% 75.3% 75.8% 75.5% 69.7% 67.7% Net Interest Margin (%) GLAA growth (%) Sustainable RoE used in Valuation (%) 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 12.5% 7.0% Cost of Equity (%) 9.3% 9.3% 9.3% 9.3% 9.3% 9.3% 9.3% 9.3% 9.3% 2.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% Efficiency Cost / Income Ratio (%) Cost growth (%) 1.5% 1.0% 0.5% PROFIT & LOSS (AUDm) Net Interest Income 13,407 6,843 6,932 13,775 6,998 7,159 14,157 15,097 15,964 Non-Interest Income 5,173 2,644 2,494 5,138 2,438 2,508 4,947 5,192 5,407 Fees & Commissions 3,561 1,804 1,848 3,652 1,912 1,968 3,880 4,138 4,349 Financial Markets ,545 1,608 1,673 Life and Funds 1, , ,453 1,478 1,502 Other Revenue ,932-2,031-2,116 Total Operating Income 18,580 9,487 9,426 18,913 9,436 9,668 19,104 20,290 21,371 Total Operating Costs 8,174 4,456 5,724 10,180 4,406 4,534 8,941 9,260 9,436 Employee Costs 4,362 2,292 2,240 4,532 2,285 2,330 4,615 4,802 4,996 Other Costs 3,812 2,164 3,484 5,648 2,121 2,204 4,325 4,458 4,440 Pre-Provision Operating Profit 10,406 5,031 3,702 8,733 5,030 5,133 10,163 11,030 11,936 Impairment Charge 1, Pre-Tax Profit 8,472 4,503 3,353 7,856 4,593 4,675 9,269 10,209 11,067 Tax Expense 2,337 1,263 1,229 2,492 1,290 1,313 2,603 2,867 3,109 Minority Shareholders Other Post Tax Items Stated Net Profit 5,452 2,856 2,439 5,295 3,303 3,362 6,665 7,342 7,958 Extraordinary & Other Items Hybrid Distributions IoRE/Non Controlling Interest Derivatives & Hedging Revaluation Macquarie Cash Profit 5,936 3,150 2,034 5,184 3,213 3,272 6,485 7,162 7,778 78% 76% 74% 72% 70% 68% 66% Asset Quality Impairment Charge / GLAA (bp) Coverage (%) BALANCE SHEET & CAP AD (AUDm) Risk Weighted Assets * 362, , , , , , , , ,191 Interest Earning Assets 662, , , , , , , , ,342 Gross Loans, Advances & Acceptances 521, , , , , , , , ,294 Total Deposits 559, , , , , , , , ,043 Total Assets 808, , , , , , , ,036 1,021,510 Shareholders Equity 46,620 47,478 47,908 47,908 50,484 51,965 51,965 55,858 60,250 Tier 1 Capital 37,480 39,774 39,758 39,758 41,968 42,810 42,810 46,612 50,509 Tier 1 Ratio (%) * 10.4% 10.8% 10.8% 10.8% 11.5% 11.4% 11.4% 11.7% 11.0% Core Tier 1 Ratio (%) - Basel III 8.4% 8.6% 8.6% 8.6% 9.3% 9.3% 9.3% 9.7% 9.3% 64% 20 62% 60% ASSET QUALITY Impairment Charge / GLAA (bp) Coverage (%) 63% 68% 76% 76% 76% 77% 77% 77% 78% Total Stage 1 DDM Valuation 7.27 Total Fade Period Total Perpetuity 0.96 Total Surplus Capital Per Share KEY RATIOS & GROWTH Net Interest Income growth (%) 0.8% 0.6% 1.3% 2.7% 0.9% 2.3% 2.8% 6.6% 5.7% Non-Interest Income growth (%) 5.0% 4.5% -5.7% -0.7% -2.2% 2.9% -3.7% 5.0% 4.1% Total Revenue growth (%) 2.0% 1.7% -0.6% 1.8% 0.1% 2.5% 1.0% 6.2% 5.3% Cost growth (%) 4.4% 6.1% 28.5% 24.5% -23.0% 2.9% -12.2% 3.6% 1.9% Pre-Provision Profit growth (%) 0.1% -2.0% -26.4% -16.1% 35.9% 2.1% 16.4% 8.5% 8.2% RWA growth (%) 9.3% 1.4% 0.1% 1.5% -0.4% 2.7% 2.2% 6.1% 14.9% GLAA growth (%) 4.2% 2.4% 2.1% 4.5% 2.1% 2.9% 5.1% 6.1% 4.8% Deposit growth (%) 4.9% 2.8% 4.1% 7.1% 2.1% 2.9% 5.1% 6.1% 4.8% Net Interest Margin (%) 2.03% 1.94% 1.94% 1.94% 1.91% 1.90% 1.91% 1.92% 1.93% Cost / Income Ratio (%) 44.0% 47.0% 60.7% 53.8% 46.7% 46.9% 46.8% 45.6% 44.2% *B , B onward 28 April

12 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down % in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 31 March 2015 AU/NZ Asia RSA USA CA EUR Outperform 48.99% 59.51% 49.30% 43.79% 59.59% 52.20% (for US coverage by MCUSA, 7.42% of stocks followed are investment banking clients) Neutral 34.12% 26.62% 35.21% 50.29% 34.93% 31.32% (for US coverage by MCUSA, 5.68% of stocks followed are investment banking clients) Underperform 16.89% 13.87% 15.49% 5.93% 5.48% 16.48% (for US coverage by MCUSA, 0.87% of stocks followed are investment banking clients) NAB AU vs ASX 100, & rec history WBC AU vs ASX 100, & rec history ANZ AU vs ASX 100, & rec history (all figures in AUD currency unless noted) CBA AU vs ASX 100, & rec history (all figures in AUD currency unless noted) (all figures in AUD currency unless noted) (all figures in AUD currency unless noted) Note: Recommendation timeline if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, April month target price methodology NAB AU: A$40.58 based on a DDM/PE methodology WBC AU: A$39.18 based on a DDM methodology ANZ AU: A$34.24 based on a DDM/PE methodology CBA AU: A$ based on a DDM/PE methodology Company-specific disclosures: NAB AU: Macquarie Capital (Australia) Limited or one of its affiliates may provide National Australia Bank Limited investment advisory services for which it may or may not receive compensation. Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of National Australia Bank's equity securities. MACQUARIE EQUITIES LIMITED or one of its affiliates managed or co-managed a public offering of securities of National Australia Bank Ltd in the past 12 months, for which it received compensation. WBC AU: MACQUARIE CAPITAL (AUSTRALIA) LIMITED or one of its affiliates managed or co-managed a public offering of securities of Westpac Banking Corp in the past 12 months, for which it received compensation. ANZ AU: MACQUARIE CAPITAL (NEW ZEALAND) LIMITED or one of its affiliates managed or co-managed a public offering of securities of Australia and New Zealand Banking Group Ltd in the past 12 months, for which it received compensation. Important disclosure information regarding the subject companies covered in this report is available at Target price risk disclosures: 28 April

13 NAB AU: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures. WBC AU: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures. ANZ AU: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures. CBA AU: Any inability to compete successfully in their markets may harm the business. This could be a result of many factors which may include geographic mix and introduction of improved products or service offerings by competitors. The results of operations may be materially affected by global economic conditions generally, including conditions in financial markets. The company is exposed to market risks, such as changes in interest rates, foreign exchange rates and input prices. From time to time, the company will enter into transactions, including transactions in derivative instruments, to manage certain of these exposures. Analyst certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN , AFSL No ) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN , AFSL No ) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN , AFSL No ) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN , AFSL No ) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. This research is general advice and does not take account of your objectives, financial situation or needs. Before acting on this general advice, you should consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision. This research has been prepared for the use of the clients of the Macquarie Group and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient, you must not use or disclose this research in any way. If you received it in error, please tell us immediately by return and delete the document. We do not guarantee the integrity of any s or attached files and are not responsible for any changes made to them by any other person. Nothing in this research shall be construed as a solicitation to buy or sell any security or product, or to engage in or refrain from engaging in any transaction. This research is based on information obtained from sources believed to be reliable, but the Macquarie Group does not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. The Macquarie Group accepts no liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this research and/or further communication in relation to this research. The Macquarie Group produces a variety of research products, recommendations contained in one type of research product may differ from recommendations contained in other types of research. The Macquarie Group has established and implemented a conflicts policy at group level, which may be revised and updated from time to time, pursuant to regulatory requirements; which sets out how we must seek to identify and manage all material conflicts of interest. The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at 28 April