Review of Operations

A fourth quarter profit of $734 million lifted the National's full year operating profit after tax to $2,821 million, the seventh consecutive record result.

The National finished the year with an improved cost to income ratio of 54%, a further diversification of its income stream and, due to the success of the National Income Securities issue, a healthy increase in tier one capital.

The Group's return (before abnormal items) on average ordinary shareholders' funds increased during the quarter from 17.6% for the June 1999 quarter to 17.8% reflecting increased earnings which more than offset the impact of a higher equity base.

After abnormal items, the full year result of $2,821 million was $807 million or 40.1% higher than the $2,014 million earned in the year to September 1998. The September 1998 result included abnormal costs of $497 million after tax. There are no abnormal items included in the September 1999 result. Excluding the effect of the abnormal items, the current year's result is 12.3% or $310 million higher than the previous year.

Important factors in the September quarter result included:

• higher net interest income generated from continued volume growth in Australia and Europe and partly from the National Income Securities issued in June 1999;
• steady other operating income - lower treasury income was more than offset by gains on property sales and higher money transfer fees in Europe;
• a lower doubtful debts charge;
• higher expenses driven by adjustments to the carrying value of assets, restructuring costs, projects, marketing costs and other general expenses;
• a lower effective tax rate due to benefits from structured finance transactions in New Zealand and a non-assessable gain on Group hedging activities.

Cash earnings (earnings before goodwill and abnormal items) for the September 1999 quarter are $789 million, an increase of 5.5% on the June quarter. Cash earnings per share (earnings attributable to ordinary shareholders before goodwill and abnormal items) were 51.2 cents for the September quarter, an increase of 3.2% from the June quarter. For the full year to September 1999, cash earnings per share rose 7.1% from 187.3 cents to 200.6 cents.

Return on tangible shareholders' funds on a cash earnings basis was steady for the September quarter and full year. Cash earnings attributable to ordinary shareholders and average tangible ordinary shareholders' funds grew by 10% respectively during the year.

Shareholder Value

Economic profit for the year to September 1999 increased by 16.2% from $1,465 million for 1998 to $1,703 million, a reflection of the growth in cash earnings partially offset by a higher level of capital employed. For the September 1999 quarter, economic profit was $446 million, an increase of 3.2% over the June 1999 quarter of $432 million. Economic profit represents the excess of cash earnings over the cost of capital employed in the business plus the value to shareholders of franking credits generated.

Net Interest Income

Net interest income for the September 1999 quarter increased by 3.2% from $1,490 million for the June 1999 quarter to $1,538 million. Improved margins in Australia and volume growth in Europe was partially offset by the impact of structured finance transactions in New Zealand. Excluding exchange rate movements, the increase was 2.3%. The issue of National Income Securities in June 1999 contributed $25 million to net interest income in the September quarter.

For the full year, net interest income rose by $208 million or 3.6% from $5,858 million in 1998 to $6,066 million for the year to September 1999 (3.9% higher excluding the effect of exchange rate movements).

Since September 1998, loans and advances for the Group have increased by 9.2% in local currency terms.

Key growth areas were:

• In Australia housing loans were up 11.1% and overdraft facilities rose 11.4%.
  
• In Europe, increases were experienced in housing loans (11.3%), credit cards (18.4%), overdrafts facilities (20.4%) and lease finance (33.4%).

For the full year, net interest margins reduced from 3.17% in 1998 to 3.00% for 1999 reflecting a lower interest rate environment impacting retail deposit margins in Europe, Australia and New Zealand and strong competition on lending margins in Australia and New Zealand.

Other Operating Income

The move to diversify the National's income continued during the year to September 1999. Other operating income rose $610 million or 15.4% from $3,953 million to $4,563 million which represents 42.9% of total income, up from 40.3% in the prior year.

Other operating income for the quarter was steady at $1,153 million. The reduction in treasury activities (down $38 million) was offset by gains on disposal of properties in the UK ($24 million) and volume related growth in fees from banking in the European Banks (up $31 million).

The key changes in other operating income for the year include:

• higher mortgage origination and servicing fees of $213 million, reflecting a full year's impact of HomeSide's results. HomeSide was acquired in February 1998;
  
• volume related fee growth from banking activities across the Group (up $139 million);
  
• treasury related income rose by $97 million; and
  
• higher fee and commission income from the Group's wealth creation entities, personal loan insurance income in the UK Banks, higher credit card fees related to increased volumes in Australia and New Zealand and higher fees from structured finance transactions in Australia.

Other Operating Expenses

For the year to September 1999, the National's cost to income ratio was 54.0% down from 54.4% (excluding abnormals) for the previous year.

The Group's cost to income ratio rose during the September quarter from 52.9 percent for June quarter 1999 to 57.3 per cent. The September quarter reflects higher project related expenditure, market based salary increases, restructuring expenditure in Australia and an adjustment to the residual value of operating leased vehicles reflecting the prospective impact of GST.

Other operating expenses (excluding amortisation of goodwill) for the year to September 1999 were $5,742 million or 7.6% higher than the year to September 1998. The increase reflects the first full year results for HomeSide, and a number of one-off factors including the cessation of the superannuation holiday in Australia, restructuring costs (in 1998 restructuring costs were included in abnormal items) and including an adjustment to the residual value of operating leased vehicles reflecting the prospective impact of GST. When these factors are excluded expenses increased by 3.6%.

Personnel costs for the September 1999 quarter increased by $32 million or 4.0% compared with the previous quarter, largely due to restructuring costs in Australia and market based remuneration increases in Australia, effective 1 July, 1999.

For the year to September 1999, the underlying increase in salaries was 0.9%. Total personnel costs are 7.6% higher than the year to September 1998 of which 2.5% is attributable to the full year impact of HomeSide. The 1999 year includes a charge for restructuring in Australia of $30 million. In 1998, restructuring costs were treated as abnormal items. The remaining increase of 4.1% reflects increased long service leave charges and superannuation contributions.

Occupancy costs for the September quarter increased 6.8% compared with the previous quarter, reflecting higher maintenance and general occupancy expenditure. For the year to September 1999, occupancy costs increased 3.8%, of which a full year of HomeSide's costs accounts for 1.6% with the balance attributable to higher rental expense resulting from the sale and leaseback activities in Australia and Europe partly offset by reduced depreciation.

During the September 1999 quarter, general expenses increased by $102 million from $474 million for June 1999 quarter to $576 million. The increase is largely attributable to project related expenditure ($30 million), adjustment to residual values of leased vehicles ($18 million), higher advertising expenditure ($14 million) and software expenditure and amortisation ($15 million). The balance comprises smaller increases across a range of categories and regions.

For the year to September 1999, general expenses rose 8.7% compared with the year to September 1998. Of the increase, HomeSide accounted for 2.7% with the balance attributable to higher teleprocessing and communication costs ($36 million) and including an adjustment to the residual value of leased vehicles ($18 million). These increases were partially offset by the impact of software capitalisation from 1 October, 1999.

Capital

The National's Tier 1 ratio increased from 6.4% to 7.8% during the year. This was largely attributable to the $2 billion issue of National Income Securities in June 1999. The total capital ratio at September 1999 was 10.4% compared with 9.2% at September 1998.

Asset Quality

For the September 1999 quarter, the charge for doubtful debts was $107 million, $36 million lower than the previous quarter. The charge for the year to September 1999 was $540 million, $32 million lower than 1998.

The Group's total provisioning coverage of impaired assets at September 1999 was 158.4% compared with 166.0% at June 1999 and 171.2% at September 1998.

As at 30 September, 1999, the Group's non accrual loans to risk weighted assets was 0.8% compared with 0.7% for 1998. The small increase is primarily a reflection of the continued financial uncertainty in respect of economic conditions, however, there are favourable signs with a slow down in the level of new non accrual loans being identified.