Review of Operations

Group operating profit for the year increased 19.8% to a record $3,377 million. This result was influenced by the acquisition of the MLC Group on June 30, 2000, and the adoption of Australian Accounting Standard AASB 1038 as from July 1, 2000.

MLC, for the three months to September 30, 2000, contributed $140 million before funding costs, abnormal items and outside equity interests in profit, including $54 million from margin on services and $86 million after tax from the revaluation of MLC and its subsidiaries. Eliminating the impact of MLC and AASB 1038, total income increased 7.5%. Net interest income grew by 6.5% on the back of a 17.8% (14.2% in local currency) increase in lending assets. Excluding the impact of HomeSide and MLC funding, net interest margin was maintained. Other operating income grew by 8.8% driven by an 11% increase in total banking non-interest income. Expenses growth was contained to 2.6%, which, in real terms, represents a reduction from the previous year. Underlying profit grew 13.1% to $5,574 million. Bad and doubtful debt provisioning was flat largely due to continued tight credit control in all regions and adjustments to provisioning levels in Michigan National following its adoption of the Group's statistical provisioning methodology.

Group EVA¹, which is a measure of profitability in excess of the Group's cost of capital, increased by 6.3% to $1,477 million using a cost of capital of 11.4%. The Group uses a three year rolling average cost of capital and for the financial year 2001 this has been set at 11.5%. Total shareholder return (TSR) for the year to September 30, 2000 was 19.1%, which was above the 14.9% achieved in the year to 30 September 1999.

Capital Position

The acquisition of MLC for $4.6 billion on June 30, impacted the capital position of the Group but all key ratios remain sound.

Tier 1 Capital represents 6.6% of Risk Weighted Assets (5.5% excluding Hybrid Equity) and Total Capital represents 9.3% of risk weighted assets. Our tangible common ratio was 4.08%.

Operating Environment

The Group encountered strong economic growth in all major operating regions except New Zealand where GDP grew only 2 3/4% for the year. Credit conditions remained sound and the interest rate environment was favourable to all operations except HomeSide. Increases in US interest rates saw mortgage production volumes drop dramatically, which caused irrational pricing in an industry characterised by over capacity. Mortgage pricing in the UK and Ireland also encountered heavy discounting.

Abnormal Items

The Group has created provisions for abnormal expenses totalling $204 million before tax ($136 million after tax) relating to three major initiatives:

1. A provision for integration costs related to the merging of MLC and NAFM to create a Wealth Management Division ($108 million). The integration charge covers the estimated total costs for the integration of asset management and administration systems; establishment of common information technology infrastructure and distribution systems; separation of services provided to MLC by its former owner; the write off of capitalised software and systems which will not form part of the integrated Wealth Management business going forward; and other integration costs.

2. Costs of the recently announced metropolitan network transformation ($84 million). This provision relates to a significant transformation of the Australian retail distribution network to meet the rapidly changing customer preferences for accessing financial services and includes the costs associated with closures, relocation, and reconfiguration and enhancement of the metropolitan branch network.
   
   
3. A consolidation of the wholesale network to deliver globally consistent customer offerings and the centralisation of processes where scale efficiencies can be realised for Global Wholesale Financial Services. This will be achieved through streamlining the Group's technology and processing capabilities for foreign exchange, money market and derivatives activities across Australia and Europe using a common technology platform. A provision of $12 million has been taken in respect of this restructure.

Progress on Key Strategies

1. Driving performance and growth in businesses that rely on relationship management

• Over the past 12 months we have continued to strengthen our position in the customer segments that underpin our first core strategy. In Australia, we are the leading small and medium business bank with market shares of 32% and 35% respectively. Our superior relationship banking model, underpinned by our world class customer relationship management (CRM) and National Leads system, has enabled us to continue growing the share of financial services that we supply to our customers. We have over 75% of our small business customers' share of services and nearly 55% of our medium business customers. In the Premium or high net worth segment, we have a 48% share of services. We lead our competitors in each of these critical measures and will continue to do so with new e-commerce, enterprise support and superannuation offerings.

• In the United Kingdom, we opened new banking centres for our business and premium customers as well as launching a range of new products targeted at these segments. In June, we launched the Rapid Repay product in Yorkshire Bank which received widespread publicity as an innovative product. To date the product, which was originally developed in New Zealand, has achieved sales of GBP 40m. The product is also being launched in Clydesdale Bank making it the first line of credit mortgage in Scotland.

• We have continued to develop and enhance our customer relationship management capabilities that will lead to improved "organisation memory", customer insight and contact management which are expected to generate benefits through increased customer retention and sales. During the last 12 months, our "National Leads" system generated almost $7 billion of new lending and deposits which resulted in over $135m in additional income to the Group.

2. Accelerating the growth of selected global businesses

• We established a new global business during the year with the acquisition of MLC in June. This acquisition transforms our capability in the wealth management area and forms the basis for our Wealth Management division. The combined National/MLC group has achieved strong growth in Retail Funds Under Management with an average annual compound growth rate of 28% compared to an industry rate of 19%. Retail Funds Under Management are now $28 billion. We have achieved a top tier position in the areas of Total Funds Under Management and Protection In Force and, based on the latest ASSIRT industry figures, the National has the No 1 position in Retail Funds Inflows. A provision of $108 million has been taken for the costs of integrating the MLC business into the National Group.

• The announcement by our HomeSide business in June that they had entered a partnership with the world's largest mortgage lender - Fannie Mae - to deliver a new on-line mortgage channel in the US called HomeSide Solutions, was a major initiative. The new process is truly revolutionary against existing offerings and is a clear demonstration of the National's ability to be an innovator in the world's most competitive market. In addition to the Fannie Mae joint venture, HomeSide also completed the conversion of almost 370,000 Australian mortgages onto the HomeSide platform during the year.

• Our Wholesale Financial Services division improved its structured finance capabilities in the UK and US. As a result, our reputation as an innovative and capable provider of structured finance services continued to grow. Wholesale Financial Services took key roles in some of the world's largest financing deals including the Euro 30 billion financing of Vodafone Airtouch's acquisition of Mannesmann. Our improved capability and positioning will produce increased, low risk, revenues for the Group in the future. The Group will be restructured along product lines this year and this major transformation should see greater cross border leverage of our significant relationships. A provision of $12 million has been taken in respect of this restructure.

• Our Global Securities Services business experienced further rapid growth in Assets Under Custody over the past 12 months. In Australia we have a 38% share of the Master Custody market which is growing at approximately 30% per annum. In the UK, we have a 15% market share which has increased from just 10.5% 3 years ago. Recently we announced the winning of 2 major mandates in the UK which will double our business in the UK to over $200 billion and our total Assets Under Custody to $380 billion in the next 12 months.

3. Staking out positions in areas key to the evolution of financial services

• The establishment of our new subsidiary O₂-e Ltd was another major milestone in the year. O₂-e is largely responsible for achieving the Group's third core strategy and has a charter to build new and separate businesses as well as playing a key role in the implementation of the National's existing business strategies. One of the first moves of O₂-e was an investment in, and strategic distribution affiliation with, Peakhour. Peakhour will provide the platform for the National to deliver a comprehensive range of offerings to our business customers including on-line business banking, accounting systems, customer relationship management, internet access, web site hosting, and e-procurement. The National is the first Australian bank, and one of the first in the world, to develop a complete suite of digital services under the one business banking relationship.

• Our foundation membership of the Concert alliance late last year is providing the infrastructure that will support the Group's e-business activities in the future. We have now linked our operations on a digital "backbone" which is allowing us to share masses of data around the world and begin realising the vision of global systems and processing.

4. Managing our businesses to create maximum value

• A major milestone in this area was the implementation of Stern Stewart's EVA model and principles throughout the Group as the basis for decision making, reporting and rewarding performance. Our objective is to get every one of our people thinking and acting like owners. We will use the EVA methodology in all parts of our business to ensure that resources are efficiently allocated and paid for. Our initial focus has been on using EVA to determine the compensation and incentives of our senior management group and their direct reports. EVA for the year ending September 2000 was $1,477 million, up 6.3% on the previous year.

• We have refined our operating model during the year to ensure we gain maximum advantage from our international operations. We also took this opportunity to bring a new, younger group of managers into the National's leadership ranks. The average age of the direct reports to the top team is now 40 years, which is well down from the previous structure. Nearly 35% of the top two levels have been with the Group for 5 years or less. This is a significant change aimed at bringing new energy and vision into the Group's leadership and building a solid succession plan for the Group.

• The new operating model has made it easier to extract the benefits of having major businesses around the world. We are leveraging the enormous scale advantage that our HomeSide business has in the US to service the mortgages of our Australian customers. These mortgages are serviced directly from HomeSide's San Antonio Texas computer centre. In addition we recently announced the outsourcing of the entire back office processing for our credit card businesses across the globe to the Equifax organisation in the US. Our global scale enabled us to negotiate a global contract that will provide real benefits to our customers and shareholders.

• We have also begun to leverage our products globally. The Rapid Repay Mortgage, which is an enhanced revolving mortgage, was recently launched in the UK with only 90 days development time as all the documentation and processes had already been developed in New Zealand. It is now our fastest growing product in the United Kingdom.

5. Diversifying income streams

• Our 5th core strategy ensures we continue striving to diversify our income streams. As interest margins continue to contract, it is imperative that we develop sustainable, reliable revenues.

• The acquisition of MLC has significantly improved our non interest income streams with over half the Group's income now coming from non-interest sources. In addition to MLC, increasing contributions from retail banking operations as well as Global Wholesale Financial Services and Global Securities Services were particularly pleasing.

(1) EVA® is a registered trademark of Stern Stewart & Co.