Review of Operations

The National recorded an improved second quarter result for the 1997/98 financial year with Group profit before abnormals increasing by 8.1% to $576 million. This result brings the National's profit before abnormals for the six months to 31 March 1998 to $1,109 million compared with $1,139 million for the six months to 31 March 1997.

Over the past six months, the Group continued to build on its underlying business with underlying profit (profit before tax, abnormal items and bad and doubtful debts charge) increasing to $1,943 million which represents an 8.4% increase over the September 1997 half and a 4.7% increase over the March 1997 half.

The composition of the result was also pleasing with the acquisitions of County Investment Management and HomeSide Inc. contributing to the momentum in the Group's non-interest income streams. As a result, for the March 1998 quarter, non interest income represents over 43% of total operating income.

During the six months to 31 March 1998, the Group booked restructuring costs of $229 million ($151 million after tax). Over the past year, the Group has focussed on improvements to its branch network distribution system and has identified the need to restructure this system and its workforce. The restructuring charge has been classified as an abnormal item due to its size and effect on the Group's results. Profit after tax and abnormal items was $958 million for the March 1998 half-year.

Net Interest Income

Net interest income for the first six months increased by $173 million or 6.7% over the March 1997 half. Of this increase, $148 million was attributable to exchange rate movements during the period.

Loans and advances increased by 11.4% over September 1997 and by 21.0% over March 1997 with strong lending growth in:

• housing lending, up by 8.9% over September 1997 and by 20.1% over March 1997;
• lease financing, up by 18.2% over September 1997 and by 36.0% over March 1997;
• credit cards, up by 8.7% over September 1997 and by 18.3% over March 1997.

Net interest income was higher through growth in loan volumes which has been partly offset by reduced margins in most of the Group's operations.

Other Operating Income

Other operating income for the March 1998 half increased by $385 million or 23.9% over the previous corresponding period. This increase reflects further efforts to improve the cost recovery of services provided to customers, continued growth in non-banking activities and the acquisition of HomeSide Inc. on 10 February 1998. Of this increase, $151 million was attributable to exchange rate movements during the period.

This diversification of the Group's earnings streams has led to the proportion of other operating income to total income increasing to 43.7% in the March 1998 quarter which compares with 38.8% for the year to September 1997, and 36.6% for the year ended September 1996.

The increase in other operating income over the March 1997 half was primarily due to:

• the inclusion of HomeSide Inc. which contributed $62 million to other operating income;
• loan fees from banking which increased by 18.2% reflecting higher commitment, security and facility fees across the Group;
• money transfer fees which increased by 19.5% largely reflecting changes in fee and account structures in Australia and the introduction of automated charging of certain customers for overdrawn accounts in Clydesdale;
• fees and commissions which increased by 25.4% due to increases in credit card income and income from custodial related activities;
• increased trading income from treasury operations up 6.0%;
• other income which increased by 29.7% reflecting profit on sale of properties in Australia and Europe, and dividends received from strategic investments.

Other Operating Expenses

Total other operating expenses increased by $470 million or 20.0% over the previous corresponding period leading to an increase in the Group's cost to income ratio from 54.2% for the March 1997 half to 57.5% for the current period. The cost to income ratio remained relatively stable from the December 1997 quarter to the March 1998 quarter. Of the increase in other operating expenses, $149 million was attributable to exchange rate movements during the period.

Personnel costs for the March 1998 quarter increased by 1.5% over the December 1997 quarter. However, excluding HomeSide, personnel expenses declined by 0.8%. This reflects the impact of staff reductions in previous quarters and the impact of the staff share scheme costs which were recognised during the December 1997 quarter. Although staff numbers increased by 0.7% since March 1997, when the impact of HomeSide and County is excluded, staff numbers decreased by 5.0%.

Occupancy costs remained relatively steady when compared with the March 1997 half with an increase of $8 million or 3.8% excluding the impact of foreign exchange rate movements with increased depreciation charges resulting from the branch revitalisation program in Australia.

General expenses increased by 13.0% over the quarter or by 10.3% excluding HomeSide. The Group incurred an increased non-lending loss provision charge in the current half while the March 1997 half was positively impacted by a one off writeback in BNZ. Communication, postage and stationery costs increases, predominantly in Europe, and expenditure on information technology including new and upgraded systems software were higher in the period. Fee and commission expenses increased primarily in Australia as a result of increased credit card activity. Depreciation and amortisation was impacted by strong growth in the Group's vehicle leasing operations in Australia and Europe.

Provisions for Doubtful Debts

The doubtful debts charge for the March 1998 quarter was $28 million higher than the December 1997 quarter. The increase relates to higher specific provisions ($18 million) primarily in Clydesdale Bank and Australia and an increase in the Group's Asian provisions, mainly in Thailand. BNZ recorded further recoveries in the period.

The general provision charge of $56 million for the quarter was $10 million higher than the December quarter and partly reflects the strong growth in loan volumes.

Specific provision coverage of non-accrual loans increased from 46.4% at September 1997 to 50.1% with the total provisioning coverage (including both specific and general provisions) now exceeding 100%.

Capital

The Tier 1 capital ratio declined from 6.6% at December 1997 to 5.8% at March 1998. The decline reflects the acquisition of HomeSide and a 5.1% increase in risk weighted assets. The decline also reflects the introduction of the Reserve Bank's capital requirements for market risk which became effective on January 1, 1998.

Tier 2 capital declined modestly over the March quarter following the further amortisation (for capital purposes) of dated subordinated debt and the reduction in the asset revaluation reserve from the sale of properties in Australia and Europe.

Asset Quality

Total gross impaired assets increased by $104 million during the March quarter. Increases were recorded in Australia, Europe and the United States.

The Group's impaired asset portfolio remains modest, with the ratio of gross non-accrual loans to risk weighted assets of 0.8% at March 1998 (0.8% at September 1997).

Asian Exposure

The National's aggregate exposure to Asia amounted to $16.5 billion at March 1998. Gross impaired assets in Asia declined by 13.2% between December 1997 and March 1998 to $33 million representing 0.2% of shareholders equity.