Review of Operations

A second quarter profit of $666 million lifted the National's half year profit after tax to $1,390 million. The March 1999 half result is 25.3% higher than the previous corresponding period (18.2% higher excluding the effect of exchange rate movements) but 0.9% lower than the profit before abnormal items for the September 1998 half (0.9% higher excluding the effect of exchange rate movements).

Cash earnings (earnings before goodwill and abnormal items) for the March 1999 half of $1,490 million are 25.2% higher than previous corresponding period. Cash earnings per share (earnings attributable to ordinary shareholders before goodwill and abnormal items) increased from 83.6 cents for March 1998 half to 99.9 cents for March 1999 half, an increase of 16.3 cents or 19.5%.

The Group's return (before abnormal items) on average ordinary shareholders' funds increased to 17.5% for the March 1999 half from 16.6% recorded for the March 1998 half. On a cash earnings basis the return increased to 23.4% for the March 1999 half from 21.2% for the March 1998 half.

For the quarter, a higher average Australian dollar combined with the absence of a number of one-off income items, lower income from trading activities and a higher doubtful debt charge led to an 8.0% decline in profit compared with the December 1998 quarter. The decline was 6.8% excluding the effect of exchange rate movements. Importantly, the Group continued to show good cost restraint with costs declining 3.3% during the March quarter. Cash earnings for the March 1999 quarter are $715 million, a decline of 7.7% on the December quarter (6.6% lower excluding the effect of exchange rates).

Net Interest Income
During the March 1999 half net interest income rose $220 million, or 7.8%, compared with March 1998 half (4.3% higher excluding the effect of exchange rate movements).

Loans and advances have increased by 11.2% since March 1998 but fell marginally by 0.4% since December. The decline in lending over December can be attributed to a strengthening of the Australian dollar against the US Dollar and Sterling combined with customers switching between funded lending and bill acceptances in Australia. Key areas where growth continues to be strong include housing loans up 1.7% and lease finance up 4.6% since September 1998.

In local currency, total lending increased by 5.5% since September 1998.

Net interest margins have declined from 3.14% for the March 1998 half to 3.01% for the March 1999 half. The decline is evident in both Australia and offshore. In Australia, the decline is due principally to a reduction in interest spread on loans and advances. Outside Australia, lower interest earned on loans and advances combined with a reduction in official rates in the United Kingdom were the main contributors.

Net interest income for the March quarter declined marginally from the December quarter, however, when exchange rate movements are excluded, net interest income grew 1.4%.

Other Operating Income
Other operating income continues to increase and for the March 1999 half was $510 million, or 29.2%, higher than the previous corresponding period. Excluding the impact of the acquisition of HomeSide ($225 million) and exchange rate movements ($84 million) the increase was $201 million or 11.9%.

Other operating income represents 42.6% of total income for the March 1999 half, up from 38.2% a year earlier. The change in income mix demonstrates the success of National's strategy of diversifying the income base to provide greater stability in income streams.

The combination of a stronger dollar, the absence of a number of one-off items recorded in the December quarter and a reduction in treasury trading income, caused other operating income to decline by 6.8% between the December and March quarters.

The December quarter included one-off receipts in respect of the sale of National's stake in Data Advantage and dividends from strategic investments.

Excluding the impact of these one-off items, the key changes in other operating income include:

• fees from banking activities which have decreased by 5.7% primarily loan application and service fees in the Australian operations;
• a reduction in market volatility which has reduced the Group's earnings from treasury trading activities;
• fee and commission income which has risen strongly due primarily to profit sharing associated with the sale of personal loan insurance by the United Kingdom banks.

Other Operating Expenses
The National has benefited from the tight control over costs. Other operating expenses (excluding amortisation of goodwill) for the March 1999 half are $261 million or 10.3% higher than the previous corresponding period. Excluding the impact of HomeSide and exchange rate movements, other operating expenses increased by only 0.8% or $21 million. Personnel and general expenses were steady while occupancy costs increased 4.8%. The increase in occupancy costs is due to higher rental expense on properties resulting from the sale and leaseback activities in Australia and Europe.

On a quarterly basis, other operating costs remained steady, excluding the impact of exchange rate movements and an actuarial adjustment to long service leave provisions booked in December.

The Group's efficiency ratios improved over the quarter with the Cost to Income ratio reducing from 53.0% at December 1998 to 52.8% at March 1999. The Cost to Assets ratio remained steady at 2.2%. Cost to Income ratio for the March 1999 half improved to 52.9% from 55.6% for the March 1998 half.

Personnel expenses declined by $37 million over the quarter. Excluding the effect of the one-off December long service leave adjustment and the impact of exchange rate movements, personnel costs declined marginally by $1 million or 0.1%. Since December 1998, staff numbers have increased marginally by 0.4%.

Occupancy costs decreased 3.1% over the quarter, of which 1.6% was due to exchange rate movements.

General expenses declined by $5 million over the quarter which is almost entirely due to exchange rate movements.

Approximately 60% of the restructuring charge recognised during the last financial year has now been utilised. The benefits associated with the restructuring program are now beginning to be reflected in the Group results.

Provisions for Doubtful Debts
The charge for doubtful debts for the March quarter increased by $34 million to $162 million. With the exception of the United States, higher charges were recorded across all regions.

Capital
The Group's total capital position has remained steady at 9.2% of risk weighted assets at March 1999, the same as December 1998. The Tier 1 capital ratio at March 1999 of 6.5% is in line with the Group's preferred range.

On 30 September 1998, the Group issued US$450 million of fully paid preference shares which, initially, have no entitlement to dividends. However, the investors have entitlements to non-cumulative distributions at an annual rate of 8% payable quarterly in arrears, via a holding of Trust Units Exchangeable for Preference Shares. A distribution to the Trust Unit holders of $29 million was made by the Group in the March 1999 half.

Shareholder Value
The National is committed to growing value for its shareholders. Value for shareholders is created by generating returns which are greater than the cost of capital employed in the business. The National measures its success in generating value in terms of economic profit, which is measured by cash earnings in excess of the cost of capital for the period, plus the value of any franking benefits generated.

Economic profit for the March 1999 half was $862 million, an increase of 36.6% from the economic profit of $631 million generated during the previous corresponding period. This increase was due to the higher level of cash earnings and imputed franking credits (generated by higher Australian earnings), partially offset by a higher level of capital employed from growth in business volumes.

Asset Quality
Asset quality remains steady with gross non-accrual loans declining marginally by $31 million from December 1998 to $1,428 million.

The Group's impaired asset portfolio remains modest, with the ratio of gross non-accrual loans to risk weighted assets at March 1999 remaining at 0.7%.

Asian Exposures
The Group continued to actively manage its Asian portfolio, reducing its total exposure by 6.6% from December 1998 to $10.4 billion. Gross impaired assets in Asia represent less than 0.3% of the Group's total shareholders equity.