Review of Operations

The National continued to expand its operations in the first quarter of the 1997/98 financial year with robust lending and deposit growth and a further improvement in underlying profit. Underlying profit (profit before tax and bad and doubtful debts charge) increased by 4.4% over the September 1997 quarter to $932 million.

Despite the improved underlying result, net profit after tax for the December 1997 quarter declined by 10.0% over the September 1997 quarter. The decline can be directly traced back to higher income tax expense following the recognition of previously unrecognised tax losses in one of the Group's subsidiaries in the September quarter. There was also a higher general provision charge in the current quarter in line with the strong growth in risk weighted assets.

The composition of the result was also pleasing with a further increase in the contribution from the Group's offshore operations, assisted by movements in exchange rates, and increases in non interest income which have maintained the ratio of non interest income to total income at just above 40%.

Net Interest Income

Net interest income increased by 2.4% over the September 1997 quarter, and by 5.2% over the corresponding December 1996 quarter. Interest margins for the December quarter were slightly lower with competitive pressures in Australia accounting for the majority of the decline. Despite an easing in margins, volume growth led to higher net interest income. Loans and advances increased by 10.6% over September 1997 with strong lending growth in:

• housing lending, up by 6.8% over September 1997;
• lease financing, up by 12.9% over September 1997;
• credit cards, up by 12.6% over September 1997.

Other Operating Income

Total other operating income increased a further 2.4% over the September 1997 quarter and by 14.1% over the December 1996 quarter. The proportion of other operating income to total net income remained the same as that reported for the September 1997 quarter at 40.1%, up from 38.2% for the December 1996 quarter.

The increase in other operating income over the September 1997 quarter was primarily due to:

• money transfer fees which increased by 10.1% reflecting changes in fee and account structures in Australia;
• increased trading income from treasury operations up 16.7%;
• fees and commissions which increased by 4.3%.

Other Operating Expenses

Total other operating expenses increased marginally by 1.1% over the September 1997 quarter and by 18.1% over the December 1996 quarter.

Personnel costs rose by 3.9% over the September 1997 quarter reflecting salary increases being recorded across the Group and the $16 million cost of acquiring shares under the new staff share scheme. Staff numbers declined by 3.0% since September 1997. On-costs were little changed from the previous quarter while restructuring costs were incurred in Australia and Europe to cover redundancies over the quarter.

Occupancy costs fell by 6.0% from the September 1997 quarter reflecting the partial completion of branch refurbishment programs undertaken in Australia and Europe involving significant expenditure in the 1996/97 financial year.

General expenses remained relatively steady with a decrease of 1.4% from the September 1997 quarter. The main contributor to this reduction was reduced computer equipment and software expenditure, down 29.3% predominantly due to decreased expenditure on software. Largely offsetting this decrease was an increase in fees and commissions, up 13.5% which is a direct result of increased credit card and EFTPOS usage.

Provisions for Doubtful Debts

The charge for doubtful debts was up by $15 million or 14.3% over the September 1997 quarter and up by $81 million over the December 1996 quarter. The December 1996 quarter charge was largely offset by high specific provision recoveries in Australia and New Zealand. Compared to the September 1997 quarter, a 9.8% decrease in the specific provision charge has been offset by an increase in the general provision charge reflecting the rise in risk weighted assets (up 11.1%).

Specific provision coverage of non-accrual loans grew to 49.2%, as gross non-accrual loans fell 1.0% to $1,268 million ($1,281 million at September 1997).

Capital

The Tier 1 capital ratio declined to 6.6% from 6.8% at September 1997 predominantly due to large growth in risk weighted assets over the quarter. Tier 2 capital rose to 3.2% from 2.2% at September 1997 due to the raising of an additional $2.0 billion term subordinated debt in the Australian and US markets.

Asset Quality

Asset quality further improved over the period with gross non-accrual loans declining by 1.0%. As a result of the decline in non-accrual loans and the increase in risk weighted assets, the ratio of gross non-accrual loans to risk weighted assets is now 0.7% compared to 0.8% as at September 1997.