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Share Name | Share Symbol | Market | Type |
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Nabis Holdings Inc | CSE:NAB | CSE | Common Stock |
Price Change | % Change | Share Price | Bid Price | Offer Price | High Price | Low Price | Open Price | Shares Traded | Last Trade | |
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0.00 | 0.00% | 0.305 | 0.275 | 0.30 | 0 | 01:00:00 |
RNS Number:5000S National Australia Bank Ld 26 November 2003 PART 1 Annual Financial Report 2003 Growth through excellent relationships -------------------------------------------------------------------------------- National Australia Bank Limited ABN 12 004 044 937 This annual financial report 2003 is lodged with the Australian Securities and Investments Commission and Australian Stock Exchange Limited. Nothing in this annual financial report 2003 is, or should be taken as, an offer of securities in National Australia Bank Limited for issue or sale, or an invitation to apply for the issue or for the purchase of such securities. All figures in this document are in Australian dollars unless otherwise stated. -------------------------------------------------------------------------------- Table of contents Presentation of information 2 Financial highlights 3 Selected financial data 4 Business overview 8 Introduction 8 Strategy 8 Business operating model 8 Introduction to Financial Services 8 Financial Services Australia 9 Financial Services Europe 10 Financial Services New Zealand 11 Corporate & Institutional Banking 11 Wealth Management 12 Other 13 Competition 13 Regulation of the financial services system 14 Changing regulatory environment 15 Basel II Capital Accord 16 International Financial Reporting Standards 16 Australian tax consolidations regime 16 Payment systems reform in Australia 16 Organisational structure 17 Description of property 17 Certain legal proceedings 17 Financial review 18 Summary 18 Economic outlook 19 Net interest income 20 Net life insurance income 22 Other banking and financial services income 23 Mortgage servicing and origination revenue 24 Movement in the excess of net market value over net assets of life insurance controlled entities 25 Significant revenue 26 Operating expenses 26 Charge to provide for doubtful debts 27 Significant expenses 28 Income tax expense 29 Net profit by segment 30 Employees 35 Assets and equity 37 Return on average equity 37 Earnings and dividends per share 38 Shareholder value 38 Liquidity and funding 39 Capital resources 42 Gross loans and advances 45 Asset quality disclosures, charge to provide and provisions for doubtful debts 46 Deposits and other borrowings 49 Assets under management and administration 50 Risk management 51 Disclosure control and procedures and internal controls over financial reporting 56 Transactions with related and other non-independent parties 56 Risk factors 56 Critical accounting policies 57 Accounting developments 60 Non-GAAP financial measures 60 Corporate governance 62 Report of the directors 70 Financial report 81 Statement of financial performance 82 Statement of financial position 83 Statement of cash flows 84 Notes to the financial statements 85 1 Principal accounting policies 85 2 Supplementary statement of financial position 94 3 Segment information 95 4 Revenue from ordinary activities 98 5 Profit from ordinary activities before income tax expense 99 6 Income tax expense 103 7 Dividends and distributions 104 8 Earnings per share 105 9 Cash assets 105 10 Due from other financial institutions 106 11 Due from customers on acceptances 106 12 Trading securities 106 13 Available for sale securities 107 14 Investment securities 109 15 Investments relating to life insurance business 112 16 Loans and advances 113 17 Provisions for doubtful debts 115 18 Asset quality disclosures 119 19 Mortgage servicing rights 121 20 Shares in controlled entities, joint venture entities and other securities 121 21 Regulatory deposits 122 22 Property, plant and equipment 123 23 Income tax assets 124 24 Goodwill 125 25 Other assets 125 26 Due to other financial institutions 127 27 Deposits and other borrowings 127 28 Life insurance policy liabilities 128 29 Income tax liabilities 129 30 Provisions 129 31 Bonds, notes and subordinated debt 130 32 Other debt issues 132 33 Other liabilities 133 34 Contributed equity 133 35 Reserves 136 36 Retained profits 137 37 Outside equity interest 137 38 Total equity reconciliation 137 39 Employee share, bonus and option plans 138 40 Average balance sheets and related interest 144 41 Maturity analysis 146 42 Interest rate risk 147 43 Notes to the statement of cash flows 152 44 Particulars in relation to controlled entities 154 45 Contingent liabilities and credit commitments 156 46 Derivative financial instruments 159 47 Fair value of financial instruments 165 48 Superannuation commitments 167 49 Operating lease commitments 169 50 Capital expenditure commitments 170 51 Financing arrangements 170 52 Related party disclosures 170 53 Remuneration of directors 173 54 Remuneration of executives 174 55 Remuneration of auditor 175 56 Fiduciary activities 176 57 Life insurance business disclosures 176 58 Reconciliation with US GAAP and other US GAAP disclosures 184 59 Events subsequent to balance date 196 Directors' declaration 197 Independent auditor's report 198 Shareholder information 199 Glossary 215 Principal establishments 217 1 -------------------------------------------------------------------------------- Presentation of information Basis of presentation This annual financial report is prepared in accordance with Australian GAAP, which differs in some respects from US GAAP (as set out in note 58 in the financial report). Comparative amounts have been reclassified to accord with changes in presentation made in 2003, except where otherwise stated. Currency of presentation All currency amounts are expressed in Australian dollars unless otherwise stated. Merely for the convenience of the reader, this annual financial report contains translations of certain Australian dollar amounts into US dollars at specified rates. These translations should not be construed as representations that the Australian dollar amounts actually represent such US dollar amounts or could be converted into US dollars at the rate indicated. Unless otherwise stated, the translations of Australian dollars into US dollars have been made at the rate of US$0.6797 = A$1.00, the noon buying rate in New York City for cable transfers in Australian dollars as certified for customs purposes by the Federal Reserve Bank of New York (noon buying rate) on September 30, 2003. Certain definitions and glossary The Company's fiscal year ends on September 30. As used herein, the fiscal year ended September 30, 2003 is referred to as 2003 and other fiscal years are referred to in a corresponding manner. The abbreviations $m and $bn represent millions and thousands of millions (ie. billions) of Australian dollars respectively. Financial statements means the Company's consolidated financial statements for the year ended September 30, 2003, September 30, 2002 and September 30, 2001 included herein at pages 81 to 197. Any discrepancies between total and sums of components in tables contained in this annual financial report are due to rounding. A glossary of some of the key terms used in this annual financial report is contained at page 215. In addition, non-GAAP financial measures have been defined at page 60. Forward-looking statements This annual financial report contains certain 'forward-looking statements' within the meaning of section 21E of the United States Securities Exchange Act of 1934. The United States Private Securities Litigation Reform Act of 1995 provides a safe harbour for forward-looking information to encourage companies to provide prospective information about themselves without fear of litigation, so long as the information is identified as forward-looking and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those projected in the information. The words anticipate, believe, expect, project, estimate, intend, should, could, may, target, goal, objective, plan and other similar expressions are used in connection with forward-looking statements. In this annual financial report, forward-looking statements may, without limitation, relate to statements regarding: - economic and financial forecasts, including but not limited to statements under the financial review and report of the directors; - anticipated implementation of certain control systems and programs, including, but not limited to those described under the financial review - risk management; and - certain plans, strategies and objectives of management. Such forward-looking statements are not guarantees of future performance and involve known and unknown risks, uncertainties and other factors, many of which are beyond the control of the Group, that may cause actual results to differ materially from those expressed in the statements contained in this annual financial report. For example: - the economic and financial forecasts contained in this annual financial report will be affected by movements in interest and foreign currency exchange rates, which may vary significantly from current levels, as well as by general economic conditions in each of the Group's major markets. Such variations, if adverse, may materially impact the Group's financial condition and results of operations; - the implementation of control systems and programs will be dependent on such factors as the Group's ability to acquire or develop necessary technology or systems, its ability to attract and retain qualified personnel and the co-operation of customers and third party vendors; and - the plans, strategies and objectives of management will be subject to, among other things, government regulation, which may change at any time and over which the Group has no control. In addition, the Group will continue to be affected by general economic conditions in Australia and worldwide, movements and conditions in capital markets, the competitive environment in each of its markets and political and regulatory policies. There can be no assurance that actual outcomes will not differ materially from the forward-looking statements contained in this annual financial report. 2 -------------------------------------------------------------------------------- Financial highlights Profitability - Net profit attributable to members of the Company increased 17.3% to $3,955 million. - Net profit before significant items(1) increased 4.3% to $3,947 million. - The current year's result includes no significant items whilst the 2002 result included the following significant items: - restructuring costs of $412 million (after-tax); and - net profit on sale of SR Investment, Inc. (formerly known as HomeSide International, Inc.) of $6 million. Shareholder returns - Basic earnings per share(1) increased 21.0% to 248.9 cents. Excluding significant items, basic earnings per share increased 7.3% from 231.9 cents. - Basic cash earnings(1) per share increased 20.9% to 268.5 cents. Excluding significant items, basic cash earnings per share increased 8.2% from 248.2 cents. - Return on average ordinary shareholders funds(1) increased from 15.1% (17.0% excluding the impact of significant items) to 18.3%. - Dividends were 163 cents per share compared with 147 cents per share last year. In 2003, the interim dividend of 80 cents per share was fully franked and the final dividend of 83 cents per share will be fully franked. In 2002, the interim dividend of 72 cents per share was fully franked and the final dividend of 75 cents was 90% franked. - Economic Value Added (EVA(R))(1) increased 29.9% to $1,668 million. EVA (R) is a registered trademark of Stern Stewart & Co. EVA (R) measures the economic profit earned in excess of the Group's cost of capital. Growth and diversification - Total assets grew by 12.5% in local currency terms. - Net assets grew by 42.8% in local currency terms. - Movements in exchange rates decreased total assets (in Australian dollar terms) by $24.2 billion. - Gross loans and advances increased 13.4% in local currency terms. - Assets under management and administration grew by 13.2% -------------------- (1) Refer to 'glossary' on page 215, 'non-GAAP financial measures' on page 60 and 'reconciliations of non-GAAP financial measures' on page 6. 3 -------------------------------------------------------------------------------- Selected financial data The information hereunder has been derived from the audited financial report of the Group, or where certain items are not shown in the Group's financial report, it has been prepared for the purpose of this annual financial report. Accordingly, this information should be read in conjunction with and is qualified in its entirety by reference to the financial report. Comparative amounts have been reclassified to accord with changes in presentation made in 2003, except where otherwise stated. Group 2003 2003 (1) 2002 (2) 2001 (3) 2000 (4) 1999 $m US$m $m $m $m $m Summary statement of financial performance Australian GAAP Net interest income 7,419 5,043 7,222 6,960 6,371 6,066 Net life insurance income 444 302 (10 ) 128 332 - Other banking and financial 5,010 3,405 7,006 4,749 4,124 4,027 services income Mortgage servicing and origination - - 378 810 640 536 revenue Movement in the excess of net (160 ) (109 ) (155 ) 510 202 - market value over net assets of life insurance controlled entities Significant revenue - - 2,671 5,314 - - Operating expenses (6,354 ) (4,319 ) (8,707 ) (6,470 ) (5,807 ) (5,701 ) Amortisation of goodwill (98 ) (67 ) (101 ) (167 ) (197 ) (206 ) Charge to provide for doubtful (633 ) (430 ) (697 ) (989 ) (588 ) (581 ) debts Significant expenses - - (3,266 ) (6,866 ) (204 ) - Profit from ordinary activities 5,628 3,825 4,341 3,979 4,873 4,141 before income tax expense Income tax expense relating to (1,681 ) (1,143 ) (962 ) (1,891 ) (1,632 ) (1,321 ) ordinary activities Net profit 3,947 2,682 3,379 2,088 3,241 2,820 Net loss/(profit) attributable to 16 11 (6 ) (5 ) (2 ) 1 outside equity interest - Life insurance business Net (profit) attributable to (8 ) (5 ) - - - - outside equity interest - other Net profit attributable to members 3,955 2,688 3,373 2,083 3,239 2,821 of the Company Dividends paid/payable (5) 2,352 1,599 2,266 2,080 1,858 1,655 Adjusted to accord with US GAAP Net income (6) 3,527 2,397 3,455 1,794 3,004 2,702 Group 2003 2003 (1) 2002 (2) 2001 (3) 2000 (4) 1999 $m US$m $m $m $m $m Summary statement of financial position Australian GAAP Investments relating to life 35,846 24,365 31,012 31,381 31,103 - insurance business Loans and advances (after 247,959 168,538 231,300 207,797 195,492 165,620 provisions for doubtful debts) Total assets 397,471 270,161 377,387 374,720 343,677 254,081 Total risk-weighted assets 252,365 171,532 247,838 257,513 238,589 197,096 Deposits and other borrowings 210,146 142,836 206,864 190,965 185,097 162,468 Life insurance policy liabilities 32,457 22,061 30,425 30,257 29,879 (?c=8212 Bonds, notes and subordinated debt 22,707 15,434 22,192 24,984 21,051 13,437 Perpetual floating rate notes 367 249 460 507 461 383 Exchangeable capital units (7) 1,262 858 1,262 1,262 1,262 1,262 Net assets 27,211 18,495 23,251 23,557 21,407 18,520 Contributed equity 9,728 6,612 9,931 10,725 9,855 9,286 Ordinary shares 6,078 4,131 7,256 8,050 7,180 6,611 Equity instruments (8) 3,650 2,481 2,675 2,675 2,675 2,675 Total equity (excludes outside 24,407 16,589 23,184 23,489 21,361 18,520 equity interest) Adjusted to accord with US GAAP Total assets 398,917 271,144 380,280 377,167 344,227 258,791 Total equity 23,862 16,219 24,005 23,987 21,836 19,226 4 -------------------------------------------------------------------------------- Group 2003 2003 (1) 2002 (2) 2001 (3) 2000 (4) 1999 $ US$ $ $ $ $ Shareholder information Australian GAAP Earnings per share (9) Basic 2.49 1.69 2.06 1.22 2.02 1.87 Diluted 2.44 1.66 2.03 1.23 1.99 1.83 Earnings per share before significant items (9) (10) Basic 2.49 1.69 2.32 2.47 2.11 1.87 Diluted 2.44 1.66 2.27 2.43 2.08 1.83 Cash earnings per share (10) Basic 2.69 1.83 2.22 1.11 2.06 2.01 Diluted 2.62 1.78 2.18 1.12 2.02 1.97 Cash earnings per share before significant items (10) Basic 2.69 1.83 2.48 2.37 2.15 2.01 Diluted 2.62 1.78 2.43 2.33 2.11 1.97 Dividends per share (5) 1.63 1.11 1.47 1.35 1.23 1.12 Total shareholder return (3 year 11.1 11.1 19.2 12.8 11.3 24.9 annualised accumulation) (%) (11) Economic Value Added (EVA(R)) (12) 1,668 1,134 1,284 1,129 1,379 1,390 Dividends per American Depositary 8.15 5.54 7.35 6.75 6.15 5.60 Share (ADS) (5) Dividend payout ratio (%) (5) 62.35 62.35 71.12 111.23 61.10 60.25 Net assets per share 18.09 12.30 15.11 15.15 14.12 12.46 Share price at year-end 30.80 20.93 33.48 25.66 25.51 22.43 Number of shares at year-end (No. 1,504,635 n/a 1,534,840 1,551,575 1,516,111 1,486,295 '000) Adjusted to accord with US GAAP Net income per share (6)(9) Basic 2.21 1.50 2.11 1.03 1.87 1.79 Diluted 2.13 1.45 2.06 1.04 1.81 1.74 Dividends per ADS (US$) (5) (13) n/a n/a 4.12 3.51 3.50 3.62 Dividends as percentage of net 66.69 45.33 65.59 115.94 61.85 61.25 income (%) (6) Group 2003 2002 2001 2000 1999 % % % % % Selected financial ratios Australian GAAP Average equity (ordinary shareholder funds) to 6.9 7.2 7.3 7.3 6.7 average total assets (excluding statutory funds) (14) (16) Return on average assets (15) 1.0 0.9 0.5 1.1 1.1 Return on equity (average ordinary shareholder 18.3 15.1 9.0 17.3 17.8 funds) (15) (16) Average net interest spread 2.2 2.4 2.3 2.4 2.5 Average net interest margin 2.5 2.7 2.7 2.9 3.0 Gross non-accrual loans to gross loans and 0.51 0.62 0.75 0.66 0.82 acceptances Net impaired assets to equity (parent entity 3.9 4.7 5.2 4.9 6.1 interest) Total provisions for doubtful debts to gross 163.4 161.0 160.5 182.5 159.5 impaired assets Capital - risk asset ratios (17) Tier 1 7.8 7.8 7.5 6.6 7.8 Tier 2 3.3 3.7 3.9 4.0 2.9 Deductions (1.4 ) (1.3 ) (1.2 ) (1.3 ) (0.3 ) Total 9.7 10.2 10.2 9.3 10.4 Ratio of earnings to fixed charges (18) 1.6 1.5 1.3 1.4 1.5 Adjusted to accord with US GAAP Net income as a percentage of Average total assets (excluding statutory 1.0 1.0 0.5 1.1 1.0 funds) (6) (14) Average equity (6) 14.8 14.5 7.7 14.6 15.5 Total equity as percentage of total assets 6.6 6.9 7.0 7.0 7.4 (excluding statutory funds) (14) Ratio of earnings to fixed charges (6) (18) 1.6 1.5 1.3 1.4 1.4 5 -------------------------------------------------------------------------------- Group 2003 (1) 2002 (2) 2001(3) 2000 (4) 1999 $m $m $m $m $m Reconciliations of non-GAAP measures (5) Net profit to cash earnings before significant items reconciliation Net profit attributable to members of the 3,955 3,373 2,083 3,239 2,821 Company Adjusted for Net loss/(profit) attributable to outside (16 ) 6 5 2 (1 ) equity interest - Life insurance business Net (profit) attributable to outside equity 8 - - - - interest - other Net profit 3,947 3,379 2,088 3,241 2,820 Adjusted for Net loss/(profit) attributable to outside 16 (6 ) (5 ) (2 ) 1 equity interest - Life insurance business Net (profit) attributable to outside equity (8 ) - - - - interest - other Distributions on other equity instruments (183 ) (187 ) (213 ) (198 ) (74 ) Movement in the excess of net market value over 160 155 (510 ) (202 ) - net assets of life insurance controlled entities Income tax expense on movement in the excess of 40 (3 ) 177 56 - net market value over net assets of life insurance controlled entities Amortisation of goodwill 98 101 167 197 206 Cash earnings 4,070 3,439 1,704 3,092 2,953 Adjusted for Significant revenue - (2,671 ) (5,314 ) - - Significant expense - 3,266 6,866 204 - Income tax expense/(benefit) on significant - (189 ) 384 (68 ) - items Cash earnings before significant items 4,070 3,845 3,640 3,228 2,953 EVA(R) reconciliation Cash earnings before significant items 4,070 3,845 3,640 3,228 2,953 Adjusted for Imputation credit value earned 733 622 695 545 431 Net amortisation of prior period significant (272 ) (243 ) (327 ) (25 ) (25 ) items Other (7 ) (67 ) (127 ) (68 ) (31 ) EVA(R) net operating profit after tax 4,524 4,157 3,881 3,680 3,328 Capital charge (19) (2,856 ) (2,873 ) (2,752 ) (2,301 ) (1,938 ) EVA(R) 1,668 1,284 1,129 1,379 1,390 Average economic capital (20) 24,849 24,985 23,927 20,178 18,457 Cost of capital (21) 11.50 % 11.50 % 11.50 % 11.40 % 10.50 % Average ordinary shareholders funds reconciliation Total average equity 24,111 23,847 23,427 20,261 17,147 Adjusted for National Income Securities (average) (1,945 ) (1,945 ) (1,945 ) (1,945 ) (1,945 ) Preference Shares (average) (730 ) (730 ) (730 ) (730 ) (730 ) Trust Preferred Securities (average) (5 ) - - - - Outside equity interest (average) (852 ) (68 ) (67 ) (46 ) - Average ordinary shareholders funds (16) 20,579 21,104 20,685 17,540 14,472 Group 2003 2002 2001 2000 1999 Other information Total staff Full-time and part-time 45,206 46,642 49,710 51,879 51,566 Full-time equivalent (22) 42,540 43,202 47,597 49,514 46,837 Exchange rates (average and closing per A$1.00) Average British pound 0.3824 0.3622 0.3626 0.3902 0.3934 Euro 0.5648 0.5798 0.5880 0.6310 0.5825 United States dollar 0.6125 0.5324 0.5227 0.6102 0.6404 New Zealand dollar 1.1142 1.1992 1.2474 1.2648 1.2012 6 -------------------------------------------------------------------------------- Group 2003 2002 2001 2000 1999 Closing British pound 0.4072 0.3474 0.3354 0.3710 0.3697 Euro 0.5850 0.5528 0.5393 0.6166 0.6146 United States dollar 0.6804 0.5440 0.4928 0.5427 0.6528 New Zealand dollar 1.1446 1.1565 1.2135 1.3351 1.2589 Group 2003 2002 2001 2000 1999 (US$ per A$1.00) Average (23) 0.6131 0.5322 0.5221 0.6091 0.6404 September 30 0.6797 0.5429 0.4915 0.5415 0.6528 On November 7, 2003 the noon buying rate was US$0.7092 per A$1.00. Group 2003 October September August July June May United States dollar (per A$1.00) High 0.7094 0.6830 0.6595 0.6822 0.6722 0.6604 Low 0.6810 0.6374 0.6379 0.6476 0.6529 0.6268 -------------------- (1) Translated at the noon buying rate on September 30, 2003 of US$0.6797 = A$1.00. (2) Includes amounts relating to operating assets and operating platform of HomeSide US to February 28, 2002, sold on 1 March 2002, and SR Investment, Inc. (the parent entity of HomeSide US) to September 30, 2002, sold on October 1, 2002. (3) Includes amounts relating to Michigan National Corporation and its controlled entities to March 31, 2001. The Group sold this entity on April 1, 2001. (4) Includes amounts relating to the MLC group from July 1, 2000. The Group acquired these entities on June 30, 2000. (5) Dividend amounts for a year represent the final and interim dividend in respect of that year, irrespective of when they are declared, determined and publicly recommended and includes issues under the bonus share plan in lieu of cash and the dividend reinvestment plan. Dividends and book value per ordinary share and per American Depositary Share (ADS) calculations are based on year-end fully paid equivalent ordinary shares, adjusted for loans and rights issues as appropriate. Dividend payout ratio is based on the dividend amounts for a year by net profit attributable to members of the Company after deducting distributions on other equity instruments. (6) Net income according to US GAAP for 2002, 2001, 2000 and 1999 has been restated for the revised interpretation of APB 25 "Accounting for Stock Issued to Employees" (refer to note 58(g) for additional information). Where net income is used to calculate a financial ratio, comparative information has been restated for 2002, 2001, 2000 and 1999. (7) The exchangeable capital units of US$1 billion are recorded in this annual financial report at the historical rate of US$0.7922 = A$1.00. (8) Equity instruments incorporate preference shares, National Income Securities and Trust Preferred Securities. (9) Refer to notes 8 and 58 in the financial report for an explanation of earnings per share. (10) Refer to page 60 for explanations of 'non-GAAP financial measures'. (11) Total shareholder return measures the growth in the value of the investment in shares, assuming reinvestment of dividends. The calculation does not take into account taxation of returns nor franking credits. (12) EVA (R) is a registered trademark of Stern Stewart & Co. (13) Dividend amounts are translated into US dollars per ADS (representing five fully paid ordinary shares) at the exchange rate on each of the respective payment dates for interim and final dividends. The 2003 final dividend of A$0.83 per ordinary share is not payable until December 10, 2003. Accordingly, the total US dollar dividend per ADS cannot be determined until that date. (14) Statutory funds are excluded given the significant restrictions imposed by life insurance legislation, regulations and the regulators thereunder, on these assets. However, current Australian accounting requirements do not allow for these assets and liabilities to be separated and disclosed separately on the statement of financial position. Refer to note 2 for detailed discussion of the separation of assets from the Group's total assets. (15) Return represents net profit attributable to members of the Company after deducting for distributions on other equity instruments. (16) Average ordinary shareholders funds represents the average of total equity adjusted to exclude National Income Securities, preference shares, Trust Preferred Securities and outside equity interest. (17) As defined by Australian Prudential Regulation Authority (refer to 'capital resources' on page 42 and 'regulation of the financial services system' on page 14). (18) For the purpose of calculating these ratios, fixed charges are comprised of interest on all indebtedness including interest on deposits, and one-third of rental charges (which is used to be representative of an interest factor). Earnings are calculated after all operating and income deductions, except fixed charges, extraordinary items and tax based on profit and are stated before outside equity interest. (19) Capital charge is the average economic capital multiplied by the cost of capital. (20) Average economic capital is a measure of the amount of capital invested in the Company by shareholders which is based on average ordinary shareholders' funds adjusted for significant items and those items excluded from the calculation of cash earnings (refer to 'non-GAAP financial measures on page 60 for an explanation of significant items and cash earnings). (21) Cost of capital is calculated based on the capital asset pricing model. (22) Full-time equivalent employees (FTEs) includes part-time staff (pro-rated) and non-payroll FTEs (ie contractors). (23) The daily average of the noon buying rates. 7 -------------------------------------------------------------------------------- Business overview Introduction The Group is an international financial services group that provides a comprehensive and integrated range of financial products and services. The Company traces its history back to the establishment of The National Bank of Australasia in 1858. National Australia Bank Limited is a public limited company, incorporated on June 23, 1893 in Australia, which is the Company's main domicile. Its registered office is 24th floor, 500 Bourke Street, Melbourne, Victoria 3000, Australia. The Company operates under the requirements of the Banking Act 1959 (Cth) and Corporations Act 2001 (Cth). Globally, as at September 30, 2003, the Group had: - total assets of $397 billion; - over $73 billion in assets under management and administration; - $311 billion in funds under custody and investment administration; and - 7.8 million banking customers and more than 2.8 million wealth management customers. The Company is the largest financial services institution (by market capitalisation) listed on the stock market of ASX and is within the 30 most profitable financial services organisations in the world (measure: profit; source: Fortune; date: July 2003). Strategy The Group's purpose statement is 'Growth through excellent relationships'. This simple yet powerful proposition provides clarity for strategic alignment of the Group. It recognises that growth is important to shareholders and that the Group's ability to successfully deliver growth is best achieved by building and maintaining excellent relationships with all stakeholders. The Group's vision is that 'We will be a leading international financial services company which is trusted by you and renowned for getting it right'. The vision is an aspirational statement that reaffirms the Group's continued commitment to international growth and reflects an understanding that excellent relationships must be founded on trust and 'getting things right'. Underpinning the Group's strategic intentions are five core strategies: Deliver solutions that help meet customers' complete financial needs: - deliver a high quality, consistent customer experience by getting the basics right every time; - build valued relationships by developing a superior understanding of the customers' needs and their relationship preferences; and - deliver integrated banking and wealth management advice and solutions; Build and sustain a high performance culture: - recruit, develop and retain people who have the skills and attitude to build excellent relationships and deliver on customer promises; - create an environment which values diversity and encourages people to perform to their full potential; and - measure and reward to drive individual and organisational performance; Build trusted relationships with all stakeholders: - consider each stakeholder group in a balanced way to inform all decisions and actions; - build trust through consistent behaviour, dialogue, transparency and accountability; and - protect and enhance the reputation of the Group as a responsible corporate citizen; Build and manage the Group's portfolio of businesses for strong and sustainable total shareholder return: - pursue sources of sustainable revenue growth in selected markets; - base investment and resource allocation decisions on value to the portfolio; and - manage risk and capital to optimise economic profit; and Create and leverage strategic assets and capabilities for competitive advantage: - build an organisation based on core capabilities defined around providing advice and solutions for customers; and - capture efficiencies and generate revenue growth by leveraging assets and capabilities within, and between, businesses. Business operating model The Group's operating model is a combination of global and regionally-oriented businesses. Where managing or transferring core skills or products between geographical markets give the Group a competitive edge, a global management model exists, and where a regional focus is more important to ensure customer alignment, a regional management structure exists. The Group consists of five lines of business: - Financial Services Australia; - Financial Services Europe; - Financial Services New Zealand; - Corporate & Institutional Banking (formerly Wholesale Financial Services); and - Wealth Management. These business lines are supported by the following global functions - Finance, Technology, People and Culture, Risk Management, Corporate Development and Office of the CEO. Introduction to Financial Services The Group's Financial Services businesses, or the retailing arms of the Group, provide a range of financial products and services tailored to the needs of their customers. The regional structure of these businesses enables broader authority and more control over distribution, products and services. Each region is managed separately with a distinct focus - Financial Services Australia, Financial Services Europe and Financial Services New Zealand. The Financial Services businesses in each region are structured to provide customers with solutions to all their retail financial needs. In each region, the Financial Services businesses have six core business units - Business, Personal, Agribusiness, Cards, Payments and Asset Finance and Fleet Management - supported by the specialist units of Marketing, Channel and Process Optimisation, and Customer Service and Operations (formerly Shared Services). The operations of each of these business units are outlined below. 8 -------------------------------------------------------------------------------- Business Business provides financial solutions to its customers, which range from sole traders to multi-national businesses. Business provides its customers with access to the broad range of products and services of the Group. Personal Personal supports both retail, premium and private customers, with a strong focus on financial solutions to meet all its customers' personal financial needs. Agribusiness Agribusiness is dedicated to serving the agricultural sector and concentrates solely on meeting the needs of primary producers, service providers to agriculture and processors of agricultural produce. With this focus, Agribusiness has a strong understanding of the financial needs of agricultural business. Cards Cards manages the business and personal debit and credit card requirements of customers. Payments Payments is responsible for the processing and completion of payment transactions and the development of payment processes and systems, particularly in e-commerce. Asset Finance and Fleet Management Asset Finance and Fleet Management specialises in plant, equipment and motor vehicle leasing, as well as the broader area of fleet management. Marketing Marketing represents the centralisation of marketing and product development functions within the retailing operations in each region. Channel and Process Optimisation Channel and Process Optimisation is responsible for all the electronic delivery channels, quality delivery of retail products and services and process efficiencies within the retail operations. Customer Service and Operations Customer Service and Operations (formerly Shared Services) enables the Group to more readily take an end-to-end perspective on what it does and to give greater control over the services provided to meet the needs of local customers more effectively. It comprises the following operational services - Collections, Corporate Real Estate, Lending Services, Strategic Sourcing and Transaction Business Services and Finance. Within Customer Services and Operations, the Group undertakes a number of specialised business activities through its controlled entities and its business units. These include a property owning company, NBA Properties Limited, which, with its subsidiary companies, is primarily an owner of the business-related properties of the Group. Financial Services Australia Financial Services Australia is the Australian retailing arm of the Group that provides financial solutions that meet the financial needs of its 3.4 million customers in Australia. At September 30, 2003, Financial Services Australia had 17,233 full-time equivalent employees. The vision for Financial Services Australia is to better serve the financial needs of customers as they change over time and to allow them to meet their life goals. Delivering this vision means working very closely with Wealth Management and Corporate & Institutional Banking to ensure customers' needs are identified and met and the right financial solution is provided every time. Identifying and meeting customers' needs is of paramount importance to Financial Services Australia. This is achieved through the physical distribution network, electronic channels and a strong relationship management philosophy, all underpinned by a comprehensive customer relationship management (CRM) system. Financial Services Australia's customer obsession means time is taken to have quality conversations with customers, build trusted relationships, assist them in identifying their financial needs and provide the right solution. Financial Services Australia's extensive physical distribution operates to service customers at a location convenient to them. Including 20 integrated financial service centres (catering for all customers' financial advice needs), 192 business banking centres, 109 agribusiness locations, 790 branches, and over 3,000 Australia Post outlets. The array of financial solutions available to customers includes a range of deposit and lending products, financial planning, credit cards, payment facilities, leasing, asset finance and transaction accounts. In addition, Wealth Management and Corporate & Institutional Banking products and services are available such as treasury, equity finance, custodian services, superannuation, insurance and investment solutions. Financial Services Australia's electronic distribution provides customers with the choice to meet their financial needs when they want via the internet, over the telephone, through one of 1,700 ATMs or through an extensive network of point of sale (EFTPOS) terminals. At September 30, 2003, there were over 900,000 registered internet banking customers. Only 8% of all transactions (by volume) are now carried out through the branch network, reflecting changing customer preferences. Financial Services Australia's relationship management philosophy is encapsulated in the Group's purpose statement (refer to 'strategy' on prior page) and the objective: 'to be the financial service provider that Australians' trust to meet their needs'. This supports an integrated financial services model as Business, Personal and Agribusiness bankers work closely with Wealth Management and Corporate & Institutional Banking to identify and meet the life goals of customers. 9 -------------------------------------------------------------------------------- Financial Services Australia has the largest market share of business lending (excluding agribusiness) (measure: credit outstandings; source: TNS; date: September 2003) which is the result of initiatives over a number of years, centred on the relationship management model. Initiatives have included the development of Business and Agribusiness banking teams with specialist knowledge and an understanding of the financial needs of customers. For premium personal customers, Financial Services Australia has a relationship management philosophy where each customer has a personal banker to manage their needs. Specialists, such as financial advisers and estate planners, are introduced to meet more complex needs. A comprehensive CRM system underpins the physical and electronic distribution channels and the relationship management philosophy. This CRM system has the capability to record and integrate a substantial proportion of customer interactions, which enables better knowledge of customers' preferences and future financial needs. Analytical capabilities allow this knowledge to be used to identify customer needs and provide leads and information to bankers and financial planners to pro-actively contact customers to meet those needs. Refer to page 30 for detailed information of the financial performance of Financial Services Australia. Financial Services Europe Financial Services Europe is the European retailing arm of the Group that provides financial solutions to meet the needs of its 3.4 million customers in the UK and Ireland. At September 30, 2003, Financial Services Europe had 11,423 full-time equivalent employees. The Group's retailing activities in Europe (UK and Ireland) operate under four brands. The Group's regional banks are Clydesdale Bank in Scotland, Yorkshire Bank in Northern England, Northern Bank in Northern Ireland and National Irish Bank in the Republic of Ireland. Each bank offers a broad range of financial services to both retail and business customers. Supporting these services are the products provided by Wealth Management and Corporate & Institutional Banking, offering customers a further range of financial solutions. Clydesdale Bank is one of the major banks in Scotland, with a strong business customer franchise, and has been part of the Group since 1987. Yorkshire Bank was acquired in 1990 and is a significant player in its natural marketing area of Yorkshire and the surrounding counties. Yorkshire Bank has a strong consumer franchise, with a growing business segment. The Group has owned Northern Bank in Northern Ireland and National Irish Bank in the Republic of Ireland since 1987. Each bank offers a broad range of financial services. Northern Bank is one of the largest banks in Northern Ireland (measure: main current accounts, source: MORI, date: March 2003), and over recent years has expanded its profile in the consumer segment. National Irish Bank's primary strength is in the consumer segment. It has continued to grow consumer lending despite the slowing economy of the Republic of Ireland. The focus of Financial Services Europe has been to grow the business and consumer segments by implementing relationship management models, which have been successfully adopted elsewhere in the Group. This is supported by the introduction of innovative products and services (such as Rapid Repay mortgages), and continued investment in alternative channels to assist customers by extending the range of channels with which they can choose to manage their financial affairs. The 2003 year saw the commencement of the heavy investment in tools, resources and people that will help achieve further organic growth in an intensely competitive market. This strategy is based on three complementary objectives: - growth - not merely for its own sake, but to enable the provision of a tailored approach to the provision of financial services to more customers, across a wider area and at competitive prices; - efficiency - to help deliver the range of financial services rapidly, flexibly and accurately; and - quality - to ensure that everything matches or exceeds the standards that customers demand and to ensure that the needs of customers are at the forefront of the operations. There are 756, outlets including 125 business banking centres and premium outlets. These are supported by two customer contact centres, internet facilities and 1,195 ATMs. This distribution network allows customers full choice in their transaction of business. During 2003, growth in electronic transactions increased threefold compared with over the counter transactions. Customers carried out more than 159 million transactions using the ATM network, 18.0 million using internet banking, 3.8 million using the customer contact centres and 8.6 million using the interactive voice-recognition service. Investment has been made in four new flagship banking centres in Liverpool, Bristol, Reading and Southampton, providing a single, integrated resource covering the financial aspects of business. Developed primarily for business customers, each centre provides access to a relationship manager who acts as day-to-day contact in a way that aims to create a valued partnership between the bank and the customer. Investment has also been made in the branch network with a continuing program of upgrades and improvements. To reduce the need to queue at busy times, customers now have a range of in-branch quick service options for withdrawing or depositing cash and cheques. Some branches are open for longer hours, including Saturdays. The 24 hour interactive voice-recognition service enables customers to check their balance, obtain a statement or review recent transactions. A new front end system is being implemented to provide a more efficient platform for sales and servicing. By capturing all the relevant information at the point of contact with the customer, and having it flow directly through the new back office processing system, more accurate and timely decisions can be made. This enables better service to customers, more efficient processing for the banks, and the opportunity to grow market share. Refer to page 30 for detailed information of the financial performance of Financial Services Europe. 10 -------------------------------------------------------------------------------- Financial Services New Zealand Financial Services New Zealand is the New Zealand retailing arm of the Group that provides financial solutions to meet the needs of its more than 970,000 customers in New Zealand. At September 30, 2003, Financial Services New Zealand had 4,257 full-time equivalent employees. The Group's retailing activities in New Zealand operate under the Bank of New Zealand ('BNZ') brand. BNZ was acquired by the Group in 1992. BNZ has a strong brand position in the New Zealand market with comprehensive coverage across the country. It offers a range of financial services and is one of the largest financial service providers in New Zealand. BNZ enjoys a strong position in the cards market with innovative solutions including GlobalPlus (measure: outstandings, source: Internal data and Reserve Bank of New Zealand, date: September 2003). Continued growth is being driven through BNZ's CRM strategy called TOPS. TOPS is a computer-based system that notifies staff of trigger events from customer transactional activity and milestone attainment, resulting in customers being contacted by BNZ at a time when they need it. The system has been developed from the Group's CRM platform. The ongoing enhancement of the physical distribution network, coupled with improved technology, automation and functionality through electronic and remote channels, continues to be a core strategy. BNZ's vision is to provide customers with tailored financial solutions, which are deliverable through a range of convenient and cost-effective channels. The distribution network is comprised of 178 outlets including 14 business banking centres, 391 ATMs, and shared access to an extensive nationwide EFTPOS network. BNZ also has well-established telephone banking capabilities, in addition to its internet banking service catering for more than 150,000 active users (being users over the last six months of the 2003 year). BNZ has commenced the introduction of the Integrated Systems Implementation ('ISI program'). The ISI program is a multi-staged project designed to provide the Group with a common global enterprise resource planning system across all lines of operations. During the year, BNZ had a successful roll-out of the ISI program for the human resources, procurement and financial modules. As a result, this has improved administration processes. Refer to page 31 for detailed information of the financial performance of Financial Services New Zealand. Corporate & Institutional Banking Corporate & Institutional Banking (formerly Wholesale Financial Services) manages the Group's relationships with large corporations, banks, financial institutions, supranationals (such as development banks) and government bodies. With operations in Australia, Europe, New Zealand, New York and Asia (Hong Kong, Singapore, Seoul and Tokyo), Corporate & Institutional Banking has dedicated leadership teams to provide local, accessible senior management for customers. At September 30, 2003, Corporate & Institutional Banking had 2,612 full-time equivalent employees. Corporate & Institutional Banking provides debt financing, risk management and investor services and products. It comprises Corporate Banking, Financial Institutions, Markets, Specialised Finance, National Custodian Services, Transactional Solutions and a Services unit. It embraces the Group's purpose statement of 'Growth through excellent relationships' by devoting considerable resources to understanding the needs of customers, and to deliver first-class solutions that exceed their expectations. Corporate Banking Corporate Banking is responsible for the Group's relationships with large corporations and provides corporate lending products and other financing solutions. Customer teams are selected to provide the appropriate blend of relationship management, industry knowledge and product skills. Customer coverage is structured along industry segment lines to promote specialist knowledge and understanding. There are five major industry segments: consumer goods and services; telecommunications, media and technology; industrials, materials and health care; energy and utilities; and property and construction finance. Financial Institutions Financial Institutions manages the Group's relationships with banks, other financial institutions (insurance and fund managers), supranationals and government bodies which includes the Group's correspondent banking relationships. Markets Markets focuses on traded products and risk management solutions. It provides foreign exchange, money market, commodities and derivatives products globally through a dedicated 24 hour dealing capability. These products assist both Corporate & Institutional Banking's customers and the Group's small and medium business customers to manage their diverse financial risks. Markets is active in the debt capital markets, securitisation and loan syndications markets, helping customers to diversify their financing arrangements and supplying investors with access to a variety of asset classes. Markets also manages the liquidity portfolio for the Group in each of its major markets. It assists in interest rate risk management and provides short-term funding for the Group. 11 -------------------------------------------------------------------------------- Specialised Finance Specialised Finance supplies a range of financial solutions utilised in large-scale, complex transactions such as project finance, structured finance and acquisition finance. Using its specialised knowledge of the respective legal, commercial, regulatory and financial implications of these transactions, it develops innovative financing structures for customers. National Custodian Services National Custodian Services provides custody and related services to foreign institutions, superannuation funds, government bodies, fund managers, insurance companies and other entities within Australia, New Zealand and Great Britain. The key products offered include sub-custody, global custody, master custody, investment administration outsourcing, trustee services (Great Britain only), securities lending and cash deposit facilities. The Company, through National Custodian Services, is one of the largest custodian banks in Australia (measure: assets under custody and administration, source: Australian Custodial Services Association, date: June 2003). Globally, National Custodian Services had assets under custody and administration of $302 billion at September 30, 2003. On June 6, 2003, the Company entered into an agreement to purchase custody contracts of customers of Commonwealth Custodial Services Limited and Commonwealth Bank of Australia by way of novation, subject to the approval of customers. The purchase provides National Custodian Services greater presence in the Australian market. Transactional Solutions Transactional Solutions provides a range of products and services including cash management, e-commerce, merchant facilities, liquidity management and international payment services. Customers have access to a committed team that includes a specialist implementation manager, a transactional manager and a dedicated contact person. Services Services are responsible for the management of the operating platform for Corporate & Institutional Banking, including technology, operations and marketing. These key areas have two regional hubs (Australia and Europe) to promote efficiency, optimise future investment and provide common product capability across five geographic regions. Refer to page 31 for detailed information of the financial performance of Corporate & Institutional Banking. Wealth Management Wealth Management works closely with Financial Services and Corporate & Institutional Banking to ensure that customers receive an integrated financial services experience. This involves identifying customer needs as they change over time and providing access to the wide range of services and solutions that the Group offers. Wealth Management partners with financial advisers to provide quality financial planning services and a range of wealth creation, wealth protection, banking, superannuation and retirement solutions to build and protect customers' wealth throughout their lives. It also provides corporate and institutional customers with outsourced investment, superannuation and employee benefit solutions. It comprises four main business activities - Investments, Insurance, Advice Solutions and Private Bank. It manages $73.1 billion on behalf of more than 2.8 million retail and corporate customers in Australia, Europe, Asia and New Zealand. In its core Australian market, as at June 30, 2003, it held the largest share of the total retail life insurance market (excluding re-insurers) with a 14.7% share of in force premiums and a 16.5% share of annual new business premiums (source: DEXX&R; date: June 30, 2003). At the same time, it was ranked as the number one provider of retail investment platforms (master funds and wraps) with a 19.2% market share (measure: market share; source: Assirt; date: June 30, 2003). As at September 30, 2003 Wealth Management employed 6,174 full-time equivalent employees. It is the fourth largest manager of managers organisation in the world (measure: assets under management, source: Cerulli, The Global Multimanager and Mutual Fund Subadvisory Markets 2003 report), using the MLC investment process introduced into the Australian marketplace in 1986. Through its business relationships with financial advisers, it is focused on assisting customers to meet their financial and lifestyle goals. The financial adviser network is large, including more than 3,200 aligned and salaried advisers and relationships with more than 1,600 external advisers. Investment in the business has continued with a number of enhancements to financial planning tools, investment platforms and reporting and service capabilities in the Australian market. This aims to position Wealth Management as the partner of choice for financial advisers and a leading provider of quality advice. Internationally it is growing its competitive advantage by leveraging core capabilities that the business has developed in Australia into the European and Asian markets. In the UK, a new business initiative (Pivotal) was launched during the year to introduce its manager of managers capability to financial advisers in that market. Its advice capability has also been expanded in Hong Kong, as well as through China with the expected opening of a representative office in late calendar 2003. 12 -------------------------------------------------------------------------------- Investments Investments incorporates the following business activities: - investment platforms, covering investments, superannuation and retirement solutions for retail customers. This incorporates investment choices ranging from fully implemented solutions for customers utilising the manager of managers capability to fully discretionary options where the customer and financial adviser direct investments to the offering(s) of their choice. All of these platforms provide reporting and administration services; - investment, superannuation and employee benefit solutions for corporate and institutional customers; and - asset management, providing investment management advisory services including research, selection and monitoring of investment managers under a multi-manager, multi-style approach that underpins Wealth Management's investment offerings. Insurance Insurance includes: - life insurance, income protection and other risk insurance cover for retail customers in Australia, New Zealand and Asia; - life insurance services in the UK; - general insurance agency services (incorporating home and contents, motor vehicle, loan protection, credit card and other general insurance cover) for retail customers in Australia and the UK; and - group life insurance for corporate, club or business customers to enable life insurance policies to be incorporated as part of employee entitlements. Advice Solutions Advice Solutions provides the financial planning tools and support services required by financial advisers to assist customers to meet their financial and lifestyle goals, including: - business development and consulting services to assist advisers to operate their financial planning businesses; - marketing, business and customer management tools and processes; - technology, research and technical support to advisers, including paraplanning and quality review services; and - recruitment, education and development of advisers and their support staff, including quality advice programs. Private Bank Private Bank provides financial services to high net worth individuals, including banking, financial planning, superannuation, and access to taxation, estate planning and special expatriate services through business partners. Refer to page 31 for detailed information of the financial performance of Wealth Management. Other Support functions The Group's support functions focus on strategic and policy direction for the Group and incorporate the following units: Finance, Technology, People and Culture, Risk Management, Corporate Development and Office of the CEO. While these support functions are organised on a global basis, many of their operations are integrated within the Group's business lines and their contribution to the Group is reported within the results of those businesses. Sale of HomeSide US The sale of the operating assets and platform of HomeSide US to Washington Mutual Bank, FA. was completed on March 1, 2002, in accordance with the agreement reached on December 12, 2001. Under the terms of the sale, the Group received cash of $2,299 million (US$1,184 million) for the operating assets, which consisted primarily of $2,081 million (US$1,072 million) in warehouse and pipeline mortgage loans. After allowing for transaction costs and triggered costs, primarily employee liabilities, a loss (after tax) of $19 million (US$10 million) was recorded by the Group. On October 1, 2002, the Group sold SR Investment, Inc. (the parent entity of HomeSide US) to Washington Mutual Bank, FA. Controlled entities other than HomeSide US were excluded from the sale. The assets and liabilities of SR Investment, Inc. and its controlled entities' were included in the Group's financial position up to and including the year ended September 30, 2002 and their results were included in the Group's financial performance up to and including the year ended September 30, 2002. The Group received proceeds on sale of $2,671 million (US$1,453 million) for assets with a cost of $2,686 million, resulting in a profit on sale of $6 million after all disposal costs and income tax. This result was included in the Group's financial performance for the year ended September 30, 2002. Competition The Australian financial system is characterised by a large number of traditional and new players and well-developed equity and, more recently, corporate bond markets. There are four major national banks (including the Company) and many other financial conglomerates with national operations offering a complete range of financial services, as well as a number of smaller regional institutions and niche players. Mutual societies have been a force in the Australian financial system, although many have demutualised over the past several years to capture capital-related and other competitive advantages. These institutions have also widened their portfolio of products and services from insurance, investments and superannuation (pensions) to compete in the markets traditionally serviced by banks. Competition also comes from numerous Australian and, in many cases, international non-bank financial intermediaries including investment/merchant banks, specialist retail and wholesale fund managers, building societies, credit unions and finance companies. More recently, product and functional specialists have also emerged as important players in the household and business mortgage, credit card and other payment services markets. The rapid development and acceptance of the internet and other technologies have increased competition in the financial services market and improved choice and convenience for customers. These forces are evident across all of the Group's businesses in each of its geographic markets. Within the broader financial services industry, increased competition has led to a reduction in operating margins only partly offset by 13 -------------------------------------------------------------------------------- fees and other non-interest income and increased efficiencies. The latter has been largely achieved through greater investment in new technologies for processing, manufacturing and retailing products and services. These trends towards increasingly contestable markets offering improved access, wider choice and lower prices are expected to continue in the future. In a number of countries, regulatory authorities have reviewed competition issues, including the UK Competition Commission with regard to small business banking, the Reserve Bank of Australia (RBA) and the Australian Competition Commission (ACCC) with regard to the payments system (refer to 'payment system reforms in Australia' on page 16), and the review of the Trade Practices Act 1974 (Cth) conducted by an Australian Commonwealth Government appointed committee chaired by Sir Daryl Dawson. In March 2002, the UK Competition Commission issued its conclusion on its inquiry into the small to medium enterprise banking market. The Commission found that major banks in England, Scotland and Northern Ireland, including Clydesdale Bank and Northern Bank, were acting as part of a complex monopoly. Yorkshire Bank was not named as part of the complex monopoly, due to its relatively small share of the English market. As a result of the Commission's proposals, the four largest clearing banks operating in England were required to comply with a pricing remedy from January 1, 2003. The four largest clearing banks were singled out as they were not only considered to be acting as part of a complex monopoly, but were considered to be acting against the public interest. This remedy has resulted in these banks offering their small to medium enterprise banking market customers a more competitive proposition. It is still too early to gauge the impact of these changes on the Group's UK operations. In 2003, the UK Office of Fair Trading also obtained further undertakings from the eight main banking groups, including Clydesdale Bank and Northern Bank, relating to the time it takes for small to medium entreprises to switch their main bank accounts to other lenders. The banks must report their performance against targets effective January 1, 2004. The committee chaired by Sir Daryl Dawson reviewing the Trade Practices Act 1974 (Cth) reported its findings on April 16, 2003. At the time of this report, the Australian Commonwealth Government was yet to introduce enabling legislation. The recommendations of this review focused on six key areas: mergers and acquisitions, joint ventures, authorisation, third line forcing, ACCC powers and ACCC accountability. The Group supports a number of the committee's recommendations as these will provide greater flexibility and accountability in the merger approval process, provide more certainty in respect of pro-competitive joint ventures and simplify the regulatory process for industry reform. Regulation of the financial services system Australia The Australian Prudential Regulatory Authority (APRA) is the prudential regulator of Australian authorised deposit-taking institutions (referred to as ADIs, which comprise banks, building societies, and credit unions) as well as insurance companies, superannuation funds and friendly societies. The RBA has overall responsibility for monetary policy, financial system stability and, through a Payments System Board, payment system regulation including the operations of Australia's real-time gross settlement system. The Australian Securities and Investments Commission (ASIC) and the ACCC have responsibility for certain consumer protection measures. ASIC has primary responsibility for market integrity and disclosure issues. The Banking Act 1959 (Cth) allows APRA to issue prudential standards that, if breached, can trigger legally enforceable directions. While existing prudential standards (see below) require an ADI to inform APRA of breaches of prudential requirements and of any materially adverse events (whether in respect of an ADI in a group or the overall group containing that ADI), proposed amendments to Banking Act 1959 (Cth) would bring these requirements into law. The proposed amendments also make provision for the application of 'fit and proper' tests for directors and senior management of ADIs. APRA's prudential framework for ADIs and groups containing ADIs includes prudential standards covering liquidity, credit quality, market risk, capital adequacy, audit and related arrangements, large exposures, associations with related entities and group risk management, outsourcing, funds management and securitisation, and risk management of credit card activities. APRA is reviewing board composition, fit and proper requirements and other issues relating to ADIs. This will involve the issue of draft prudential standards in the future. APRA carries the responsibility for depositor protection in relation to the ADIs it supervises. To achieve this, it has strong and defined powers to direct the activities of an ADI in the interests of depositors or when an ADI has contravened its prudential framework. These 'direction powers' enable APRA to impose correcting action without assuming control. APRA requires banks to provide regular reports covering a broad range of information, including financial and statistical data relating to their financial position and prudential matters. APRA gives special attention to capital adequacy (refer to 'capital adequacy' on page 43 for current details), sustainability of earnings, loan loss experience, liquidity, concentration of risks, potential exposures through equity investments, funds management and securitisation activities, and international banking operations. In carrying out its supervisory role, APRA supplements its analysis of statistical data collected from banks with selective on-site visits by specialist teams to overview discrete areas of banks' operations. These include asset quality, balance sheet interest rate risk management, market risk and operational risk reviews and formal meetings with banks' senior management and external auditors. APRA has also formalised a consultative relationship with each bank's external auditor at the agreement of the banks. The external auditors provide additional assurance to APRA that prudential standards agreed with the banks are being observed, and that statutory and other banking requirements are being met. External auditors also undertake targeted reviews of specific risk management areas selected at the annual meeting between the bank, its external auditors and APRA. In addition, each bank's chief executive officer attests to the adequacy and operating effectiveness of the bank's management systems to control exposures and limit risks to prudent levels. 14 -------------------------------------------------------------------------------- There are no formal prohibitions on the diversification by banks through equity involvements or investments in subsidiaries. However, without the consent of the Treasurer of the Commonwealth of Australia, no bank may enter into any agreement or arrangement for the sale or disposal of its business (by amalgamation or otherwise), or for the carrying on of business in partnership with an ADI, or effect a reconstruction. Wealth Management is regulated by both ASIC and APRA. ASIC administers legislation relating to Wealth Management's key financial services, including managed investments, superannuation, retirement income streams and insurance. Its role is to ensure industry participants comply with legislation, while promoting fair, confident and informed participation in the Australian market by investors and consumers. APRA provides prudential regulation, through the oversight of approved trustees of superannuation funds. Non-Australian jurisdictions APRA, under the international Basel framework, assumes the role of 'home banking supervisor' and maintains an active interest in overseeing the operations of the Group, including its offshore branches and subsidiaries. The Group's branches and banking subsidiaries in Europe (UK and Republic of Ireland) are subject to supervision by the Financial Services Authority (FSA) and the Irish Financial Services Regulatory Authority, respectively. The Group's banking subsidiary in New Zealand is subject to supervision by the Reserve Bank of New Zealand (RBNZ). Branch operations in the US are subject to supervision by the Office of the Comptroller of the Currency. In the UK and the Republic of Ireland, the local regulatory frameworks are broadly similar to those in force in Australia. Each of the banking regulatory authorities in these countries has introduced risk-based capital adequacy guidelines in accordance with the framework developed by the Basel Committee on Banking Supervision. The emphasis of RBNZ's regulatory approach is primarily on enhanced disclosure and directors' attestations to key matters. Under conditions of registration, banks are required to comply with minimum prudential and capital adequacy requirements. RBNZ monitors banks' financial condition and conditions of registration, off-site, principally on the basis of published disclosure statements. In the UK, Wealth Management is regulated by the FSA, which is responsible for maintaining market confidence, promoting public awareness, protecting customers and reducing financial crime. In other offshore areas of banking and wealth management activity, the Group is subject to the operating requirements of relevant local regulatory authorities. Changing regulatory environment Both within the financial services industry and more generally, businesses are working within a changing regulatory environment. There is a heightened emphasis on corporate governance, disclosure, accounting practices and audit oversight. In addition to these legislative requirements, regulators are taking a more pro-active approach to regulation, monitoring and enforcement. Other areas are also the subject of substantial regulatory change. Measures have been adopted to restrict the financial capacity of terrorists and their organisations in most countries in which the Group operates. International standards for determining capital adequacy are changing under the Basel II Capital Accord. The regulation of the Australian financial sector has recently been significantly altered by the Financial Sector Reform Act 2001 (Cth), and the Australian Bankers Association recently released a revised Code of Banking Practice, which has been adopted by the Group. There has also been a sustained regulatory emphasis within Australia and elsewhere on privacy and the use of customer information. In response to these and other new legislative and regulatory requirements, the Group has established initiatives to implement compliant business processes with particular focus on improving the customer experience. The Group continues to develop its business practices and systems for the detection and prevention of payments that may involve prescribed terrorists. In July 2003, the Group formally applied to ASIC for its new Australian financial services licences. The Group's Australian operations will be operating under 20 licences representing the wide variety of financial services that it offers. The Group intends to enter the new regulatory regime late in calendar 2003, ahead of the conclusion of the industry transition period of March 11, 2004. Plans are underway to complete the required licensing changes designed to provide even greater protection for the Group's customers. In August 2003, the Group's Australian banking operations adopted the revised Code of Banking Practice which brings a series of major benefits for consumers and small business customers that improves service through defined principles of conduct, disclosure and standards of service. The revised Code builds upon the earlier version (1993) and includes new provisions for small business customers, prospective guarantors, customers experiencing hardship, direct debit cancellation, and credit card charge-backs. The Group manages its regulatory obligations within a global compliance framework. It intends to maintain standards of compliance within the changing regulatory environment and has mechanisms in place to address the current regulatory developments impacting on the Group. On October 8, 2003, the Australian Commonwealth Government released its Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill for public consultation. The underlying objective of the draft legislation is to improve the operation of financial markets by promoting transparency, accountability and shareholder rights and improving the overall regulatory framework for external auditors. The Group is considering its response to the draft bill, however, the legislation, when enacted, is not expected to have an material impact on the financial condition of the Group. Refer to page 62 for detailed information on the corporate governance regulatory environment. 15 -------------------------------------------------------------------------------- Basel II Capital Accord In 1988, the Bank for International Settlements (BIS) developed the Basel Capital Accord that sets out international benchmarks for assessing banks' capital adequacy requirements. In response to recent changes in banking practices, BIS reviewed the Basel Capital Accord and released new measures known as the Basel II Capital Accord (Basel II). APRA has indicated support for Basel II and announced an intention to implement it in Australia. It is expected that Basel II will be operational in 2007, with a parallel run of existing and new standards in the 2006 calendar year. Basel II proposes changes in the formula used to measure banks' minimum capital requirements with various levels of complexity. The three pillars set out by Basel II are: - minimum capital requirements; - supervisory review; and - public disclosure. The Group periodically reviews its risk management framework and Basel II provides the Group with an opportunity to revisit these frameworks. The Group's approach is to invest in risk management systems where appropriate business improvements can be achieved. The Group is committed to the implementation of Basel II and has a program underway to evaluate the approach the Group will undertake and assess the areas of impact on the Group. These areas of impact are expected to include the Group's risk management processes and public disclosure of the Group's risk profile. APRA is due to release Basel II prudential standards in the first quarter of the 2004 calendar year. The Group continues to monitor these developments and will work with its key regulators in Australia and overseas to ensure that the Group's Basel II program aligns with their regulatory requirements. International Financial Reporting Standards In July 2002, the Financial Reporting Council in Australia formally announced that for financial reporting periods beginning on or after January 1, 2005 all entities reporting under the Corporations Act 2001 (Cth) will be required to comply with accounting standards equivalent to those set by the International Accounting Standards Board. These standards are referred to as International Financial Reporting Standards (IFRS). The Group will be required to adopt these standards for the financial year commencing October 1, 2005. The Group is committed to the implementation of IFRS. The Group continues to evaluate the areas most impacted by adoption of IFRS and the associated technology requirements. IFRS frequently require application of fair value measurement techniques. This will potentially introduce greater volatility to the Group's financial performance. Hedge accounting will be a major area of activity affected by the proposed changes, together with life insurance accounting. Several important IFRS, including standards on hedging and life insurance accounting, are not yet finalised and as a consequence it is difficult to assess the full impact of the changes upon the Group's financial performance and financial position as well as the necessary technology requirements at this time. A full suite of IFRS equivalent standards to be applied by Australian reporting entities for reporting periods beginning on or after January 1, 2005 is expected to be published by AASB around April 2004. The Group continues to monitor these developments. A project team was assembled to undertake an assessment of overlaps between IFRS and Basel II, as well as the joint impact upon technology. These overlaps have been identified and reported to executive management. Australian tax consolidation regime Under income tax legislation that has now been enacted (tax consolidation regime), Australian resident entities of a corporate group may be taxed as a single taxpayer from July 1, 2002. The tax consolidation regime only applies to corporate groups that make an election to consolidate for income tax purposes. The decision by a corporate group to elect to be treated as a single taxpayer for income tax purposes can only be made by the ultimate Australian parent entity of that corporate group. On such an election, the consolidated group would comprise the ultimate Australian parent entity and all of its wholly-owned Australian resident controlled entities (tax consolidated group). Further, when that election is made, the ultimate Australian parent entity must nominate the date from which the tax consolidated group should be taxed as a single taxpayer. Subject to certain limitations, this date may be retrospective. At this time, the Company (as the ultimate Australian parent entity of the Group) has not made this election. However, the Company may make the election to form a tax consolidated group and be taxed as a single taxpayer from October 1, 2002. To do so it must make the election no later than the date on which it is required to lodge its tax return for the year ended September 30, 2003 (currently no later than April 15, 2004). However, a final decision has not been made and the Company may choose not to elect to form a tax consolidated group and continue to be taxed as a single taxpayer. The Board of the directors of the Company (the Board) is responsible for making the election to have the Group taxed as a single taxpayer. Accordingly, the Board will determine if, and from when, the tax consolidation regime will apply to the wholly-owned Australian controlled entities of the Group. Payment system reforms in Australia The first stage of the RBA's reforms on the credit card payment system in Australia was introduced this year, providing merchants with the ability to charge an additional fee for credit card transactions. The Group has not noticed any impact from this change. The second stage of the credit card reforms, effective October 31, 2003, introduces a new cost-based approach to calculating interchange fees. Interchange fees are wholesale fees that banks pay one another. The cost-based approach will significantly reduce interchange fees; however, the impact on revenues and expenses of the Group should be partly mitigated by a number of strategic decisions undertaken. The third stage of the credit card reforms will allow non-banks to issue and acquire credit cards. Although guidelines have been set by APRA, a date for the introduction of this stage is still to be determined by the RBA. 16 -------------------------------------------------------------------------------- Two other payment systems reforms initiated by the RBA relate to EFTPOS and ATM interchange fee arrangements. In February 2003, an industry working group comprising banks, building societies and credit unions (of which the Company is a member), lodged an authorisation application outlining reforms to EFTPOS (debit) interchange fees with the ACCC. The ACCC has released a draft determination rejecting the proposal on the grounds that it did not deal with scheme access, and has called for further submissions from interested parties. The industry working group continues to pursue the authorisation route, and is awaiting the ACCC's final determination. The Group is also part of another industry working group, comprising banks, building societies, credit unions and ATM operators, which intends to lodge an authorisation application outlining proposed reforms to ATM interchange fees with the ACCC. Organisational structure National Australia Bank Limited is the holding company for the Group, as well as the main operating company. During 2003, the Company had seven wholly-owned main operating subsidiaries: Bank of New Zealand, Clydesdale Bank PLC, MLC Limited, National Australia Financial Management Limited, National Irish Bank Limited, Northern Bank Limited and Yorkshire Bank PLC. Refer to note 44 in the financial report for details of the principal controlled entities of the Group. Description of property The Group operates around 2,092 outlets and offices worldwide, of which 49% are in Australia, with the largest proportion of the remainder being in the UK. Approximately 19% of the 2,092 outlets and offices are owned directly by the Group, with the remainder being held under commercial leases. The Group's premises are subject to continuous maintenance and upgrading and are considered suitable and adequate for the Group's current and foreseeable future requirements. Certain legal proceedings Entities within the Group are defendants from time to time in legal proceedings arising from the conduct of their business. On August 29, 2003, a civil class action complaint was filed against the Group and others for alleged violations of the US federal securities law relating primarily to disclosure concerning the valuation of the mortgage servicing rights held by HomeSide US (sold in October 2002). The complaint failed to specify any quantum of damages. The Group does not consider that the outcome of any proceedings, either individually or in aggregate, is likely to have a material effect on its financial position. Where appropriate, provisions have been made. For further information on contingent liabilities of the Group, refer to note 45 in the financial report. 17 -------------------------------------------------------------------------------- Financial review Summary Group 2003 2002 2001 $m $m $m Net profit 3,947 3,379 2,088 Adjust for significant items: Significant revenue - (2,671 ) (5,314 ) Significant expenses - 3,266 6,866 Attributable income tax expense/(benefit) - (189 ) 384 Significant expenses after tax - 406 1,936 Net profit before significant items 3,947 3,785 4,024 Net profit attributable to members of the Company 3,955 3,373 2,083 Adjust for: Distributions on other equity instruments (183 ) (187 ) (213 ) Significant revenue - (2,671 ) (5,314 ) Significant expenses - 3,266 6,866 Movement in the excess of net market value over net assets of 160 155 (510 ) life insurance controlled entities Attributable income tax benefit/(expense) 40 (192 ) 561 Amortisation of goodwill 98 101 167 Cash earnings before significant items 4,070 3,845 3,640 Year ended September 30, 2003 compared with year ended September 30, 2002 Net profit of $3,947 million in 2003, increased $568 million or 16.8% compared with 2002. Significant items are those individually significant items included in net profit. There were no significant items in 2003. The prior year result included the following significant items: - $412 million (after-tax) of restructuring expenses paid/ provided for; and - $6 million net profit (after-tax) on sale of SR Investment, Inc., including its controlled entity, HomeSide US, which conducted the Group's mortgage servicing rights business in the US. Net profit before significant items of $3,947 million in 2003, increased $162 million or 4.3% compared with 2002. Cash earnings (before significant items) of $4,070 million in 2003, increased $225 million or 5.9% compared with 2002. Net interest income of $7,419 million in 2003, was $197 million or 2.7% higher than 2002. This was driven by asset growth, particularly in relation to housing lending, partly offset by exchange rate movements and a 14 basis point decrease in net interest margin to 2.53%. The fall in margin largely arose from the impact of strong growth in housing lending within the retail banking business, which has been slightly offset by the funding benefit on the proceeds from the sale of HomeSide US. Refer to page 20 for a more detailed discussion of net interest income. Net life insurance income increased by $454 million to $444 million in 2003, from a $10 million loss in 2002. This was driven by an increase in investment earnings resulting from improved performance in major stock markets over the six months to September 2003. Refer to page 22 for a more detailed discussion of net life insurance income. Other banking and financial services income of $5,010 million in 2003, was $1,996 million or 28.5% lower than 2002. Excluding the proceeds received from the sale of HomeSide US's operating assets and operating platform of $2,314 million in 2002 (refer to page 13 for an explanation on the sale of HomeSide US), other banking and financial services income was up 6.8%. This was driven by higher income resulting from fee growth with higher volumes in housing lending and transaction fees, partly offset by exchange rate movements. Refer to page 23 for a detailed discussion of other banking and financial services income. Mortgage servicing and origination revenue was $nil in 2003, as compared to $378 million in 2002. Following the sale of SR Investment, Inc. (the parent entity of HomeSide US) on October 1, 2002, mortgage servicing and origination revenue was no longer derived by the Group. Refer to page 24 for a detailed discussion of mortgage servicing and origination revenue. The movement in the excess of net market value over net assets of life insurance controlled entities was a loss of $160 million in 2003, a slight decline of $5 million from 2002, impacted by the effect of assumption and experience changes underlying the valuation. Refer to page 25 for a detailed discussion of the movement in the excess of net market value over net assets of life insurance controlled entities. Personnel, occupancy and general expenses of $6,354 million in 2003, were $2,353 million or 27.0% lower than 2002. Excluding the expenses relating to HomeSide US of $2,693 million in 2002, total expenses increased 5.7%. This outcome reflects salary increases, higher pension fund expense, computer and software expenses, an increase in costs associated with regulatory reform and compliance, partly offset by a reduction in the Group's staff numbers and exchange rate movements. Refer to page 26 for a detailed discussion of operating expenses. The charge to provide for doubtful debts of $633 million in 2003 was $64 million or 9.2% lower than 2002. The current year's charge has been favourably impacted by exchange rate movements. Refer to page 27 for a detailed discussion of the charge to provide for doubtful debts. Income tax expense relating to ordinary activities of $1,681 million in 2003, was $719 million or 74.7% higher than 2002. It has been impacted by the accounting regime, which applies to unrealised gains and losses relating to Wealth Management's statutory funds of the life business. The income tax expense in 2003 attributable to this impact was $126 million expense, compared to an income tax benefit of $248 million in 2002. Refer to page 29 for a detailed discussion of income tax expense. Year ended September 30, 2002 compared with year ended September 30, 2001 Net profit of $3,379 million in 2002, increased $1,291 million or 61.8% compared with 2001. Significant items are those individually significant items included in net profit. The 2002 result included the following significant items: - $412 million (after-tax) of restructuring expenses paid/ provided for; and - $6 million net profit (after-tax) on sale of SR Investment, Inc., including its controlled entity, HomeSide Lending US, which conducted the Group's mortgage servicing rights business in the US. 18 -------------------------------------------------------------------------------- The 2001 result included the following significant items: - $1,681 million net profit on sale of Michigan National Corporation and its controlled entities; and - $3,617 million (after-tax) write-downs of mortgage servicing rights and goodwill relating to HomeSide US. Net profit before significant items of $3,785 million in 2002, decreased $239 million or 5.9% compared with 2001. Cash earnings before significant items of $3,845 million in 2002 increased $205 million or 5.6% compared with 2001. Net interest income of $7,222 million in 2002 was $262 million or 3.8% higher than 2001. This was driven by asset growth, particularly in relation to housing lending and a 4 basis point decrease in net interest margin to 2.67%. The fall in margin largely resulted from the loss of contribution of Michigan National Corporation following its sale and the impact of product mix in Financial Services Australia. Net life insurance income decreased by $138 million to a $10 million loss in 2002, from $128 million income in 2001. This was driven by a decline in investment revenue resulting from uncertain global equity markets in the second half of the year and an increase in claims more than offsetting higher premium and related revenue. Other banking and financial services income of $7,006 million in 2002, was $2,257 million or 47.5% higher than 2001. Excluding the proceeds received from the sale of HomeSide US's operating assets and operating platform of $2,314 million, other banking and financial services income was down 1.2%. This was driven by a decline in treasury-related income resulting from subdued foreign exchange and interest rate market volatility, partially offset by fee growth as housing lending and card volumes grew. Mortgage servicing and origination revenue of $378 million in 2002, was $432 million or 53.3% lower than 2001. Servicing fees declined as a result of higher prepayment activity. Following the sale of HomeSide US's operating assets and operating platform on March 1, 2002, the Group no longer derived origination revenue. The movement in the excess of net market value over net assets of life insurance controlled entities was a loss of $155 million in 2002, a decrease of $665 million from 2001, impacted by the effect of assumption and experience changes underlying the valuation. Personnel, occupancy and general expenses of $8,707 million in 2002, were $2,237 million or 34.6% higher than 2001. Excluding the carrying value of HomeSide US's operating assets and operating platform sold and other expenses attributable to the sale of $2,322 million, total expenses were down 1.3%, largely driven by a reduction in employee numbers during 2002. The charge to provide for doubtful debts of $697 million in 2002, was $292 million or 29.5% lower than 2001. The 2002 year's charge reflected an improvement in credit risk resulting from a review of the loan portfolio. Income tax expense of $962 million in 2002, was $929 million or 49.1% lower than in 2001. The 2001 income tax expense was impacted by a $292 million amount relating to a non-allowable impairment loss on goodwill, and a $764 million amount relating to the non-recognition of future income tax benefits relating to the HomeSide US's mortgage servicing rights impairment loss incurred in that year. Adjusted to accord with US GAAP Prepared in accordance with US GAAP, consolidated net income for the year to September 30, 2003 was $3,527 million compared to $3,455 million in 2002 and $1,794 million in 2001. Net income according to US GAAP for 2002 and 2001 has been restated for the revised interpretation of APB 25 'Accounting for Stock Issued to Employees' (refer to note 58 footnote (g)). Note 58 in the financial report discloses reconciliations of the Group's financial statements for the last three years for any significant adjustments to Australian GAAP, which would be reported in applying US GAAP. There were no individually material adjustments between US GAAP net income and Australian GAAP net profit attributable to members of the Company for the years ended September 30, 2003, 2002 and 2001, other than those disclosed in note 58 in the financial report. Economic outlook This section contains forward-looking statements. Refer to 'forward-looking statements' on page 2. The slowdown in the global economy toward the end of calendar 2002 has generally continued into 2003. Improvement in activity is expected towards the end of this calendar year. However, the outlook for the economies and markets in which the Group operates remains varied. The recovery of the US economy has been uneven and sluggish throughout 2003 due to the effect on growth of the September 11, 2001 attacks, major corporate failures, stock price declines, and the war in Iraq. While output growth slowed markedly at the end of calendar 2002 and early 2003, it has gathered pace as calendar 2003 progressed. Economic growth in Europe was lacklustre throughout calendar 2002 and remains very weak. Against this backdrop, business conditions in the economies that contain the bulk of the Group's assets - namely Australia, New Zealand and the UK have generally fared better during calendar 2003. The magnitude and timing of growth will vary across economies and sectors, with Australia and New Zealand outperforming the UK. At the sectoral level, house prices and consumer spending have continued to grow, albeit at more modest rates, which underpin the ongoing expansion in home mortgage lending and consumer credit. The outlook for business lending has improved. The Group's main areas of operation face similar economic risks and vulnerabilities for the 2004 calendar year. House prices could soften after their rapid growth in past years. Consumer debt levels have increased as a proportion of net worth. The household sector will be more sensitive to increases in interest rates. 19 -------------------------------------------------------------------------------- Net interest income 2003 $ 7,419 million 2002 $ 7,222 million 2001 $ 6,960 million Net interest income is the difference between interest income and interest expense. Net interest income is derived from diverse business activities, including extending credit to customers, accepting deposits from customers, amounts due to and from other financial institutions, regulatory deposits and managing the Group's other interest sensitive assets and liabilities, especially trading securities,available for sale securities and investment securities. Net interest income increased by $197 million or 2.7% to $7,419 million in 2003, after increases of 3.8% in 2002 and 9.2% in 2001. During 2003, movements in exchange rates decreased net interest income by $124 million, after increases of $25 million in 2002 and $264 million in 2001. Excluding the impact of exchange rate movements, the increase in 2003 was 4.4%, compared with 3.4% in 2002 and 5.1% in 2001. This increase was the result of strong housing lending growth, modest business lending growth and the lower cost of debt funding, partly offset by lower Corporate & Institutional Banking income and growth in lower yield structured finance products. Volume and rate analysis The following table allocates changes in net interest income between changes in volume and changes in rate for the last three years ended September 30. Volume and rate variances have been calculated on the movement in average balances and the change in interest rates on average interest-earning assets and average interest-bearing liabilities. The variance caused by changes of both volume and rate has been allocated in proportion to the relationship of the absolute dollar amounts of each change to the total. 2003 over 2002 2002 over 2001 2001 over 2000 Increase/ Increase/(decrease) Increase/(decrease) (decrease) due to change in due to change in due to change in Average Average Total Average Average Total Average Average Total balance rate balance rate balance rate $m $m $m $m $m $m $m $m $m Interest-earning assets Due from other financial institutions Australia 41 (34 ) 7 39 (47 ) (8 ) 27 4 31 Overseas (66 ) 15 (51 ) (45 ) (303 ) (348 ) 153 (80 ) 73 Marketable debt securities Australia 135 34 169 106 (18 ) 88 (18 ) 4 (14 ) Overseas (129 ) (4 ) (133 ) (29 ) (410 ) (439 ) 448 (39 ) 409 Loans and advances Australia 1,166 (23 ) 1,143 755 (895 ) (140 ) 797 (69 ) 728 Overseas 645 (648 ) (3 ) 261 (1,559 ) (1,298 ) 883 (206 ) 677 Regulatory deposits Overseas 1 (2 ) (1 ) - - - - - - Other (1,271 ) 765 (506 ) (489 ) (810 ) (1,299 ) 917 (419 ) 498 interest-earning assets Change in interest 522 103 625 598 (4,042 ) (3,444 ) 3,207 (805 ) 2,402 income 20 -------------------------------------------------------------------------------- 2003 over 2002 2002 over 2001 2001 over 2000 Increase/ Increase/(decrease) Increase/ (decrease) due to change in (decrease) due to change in due to change in Average Average Total Average Average Total Average Average Total balance rate balance rate balance rate $m $m $m $m $m $m $m $m $m Interest-bearing liabilities Due to other financial institutions Australia 28 (24 ) 4 31 (54 ) (23 ) 42 (9 ) 33 Overseas 164 10 174 39 (652 ) (613 ) 600 (148 ) 452 Savings deposits Australia 83 (1 ) 82 25 (60 ) (35 ) (18 ) 8 (10 ) Overseas (2 ) 8 6 (22 ) (258 ) (280 ) (19 ) (34 ) (53 ) Other demand deposits Australia 32 137 169 124 (302 ) (178 ) 100 111 211 Overseas (45 ) (101 ) (146 ) 82 (120 ) (38 ) 77 (19 ) 58 Time deposits Australia 437 (7 ) 430 202 (323 ) (121 ) 20 75 95 Overseas 54 (86 ) (32 ) (71 ) (1,019 ) (1,090 ) 635 (127 ) 508 Government and official institution deposits Australia 4 1 5 3 (8 ) (5 ) (2 ) 1 (1 ) Overseas 5 (21 ) (16 ) (20 ) (59 ) (79 ) 34 (6 ) 28 Short-term borrowings Overseas (39 ) (125 ) (164 ) (136 ) (177 ) (313 ) 16 7 23 Long-term borrowings Australia 5 (154 ) (149 ) 66 (421 ) (355 ) 320 (6 ) 314 Overseas (103 ) 23 (80 ) (91 ) (55 ) (146 ) 153 (111 ) 42 Other debt issues Australia (11 ) 2 (9 ) (4 ) (9 ) (13 ) 15 (9 ) 6 Overseas 9 (26 ) (17 ) (7 ) (1 ) (8 ) (4 ) 24 20 Other 107 64 171 830 (1,239 ) (409 ) (171 ) 258 87 interest-bearing liabilities Change in interest 728 (300 ) 428 1,051 (4,757 ) (3,706 ) 1,798 15 1,813 expense Change in net (206 ) 403 197 (453 ) 715 262 1,409 (820 ) 589 interest income Average interest-earning assets for 2003 increased by $22.8 billion or 8.4% to $293.3 billion, from $270.5 billion in 2002 and $256.6 billion in 2001. (Refer to 'volumes' below for information). The impact of the increasing volumes on interest income, was an increase of $522 million in 2003, $598 million in 2002 and $3,207 million in 2001. The movement in rates over the same period resulted in an increase in interest income of $103 million in 2003, and falls of $4,042 million in 2002 and $805 million in 2001. This reflected an environment of volume growth in low margin products. Average interest-bearing liabilities increased by $15.6 billion in 2003, after increases of $10.8 billion in 2002 and $37.8 billion in 2001. The impact of the increasing volumes on interest expense was an increase of $728 million in 2003, $1,051 million in 2002, and $1,798 million in 2001. The movement in rates over the same period resulted in a decline in interest expense of $300 million in 2003, $4,757 million in 2002 and an increase of $15 million in 2001. This has resulted from a changing mix of borrowings, with term deposits increasing as investors seek safe and low risk investments, thus reducing the short-term borrowing requirements, and a fall in interest rates reducing expense. Interest spreads and margins 2003 2002 2001 $m $m $m Australia Net interest income 3,792 3,613 3,374 Average interest-earning assets 151,225 129,458 115,747 Interest spread adjusted for interest foregone on non-accrual 2.37 2.67 2.59 and restructured loans (%) Interest foregone on non-accrual and restructured loans (%) (0.04 ) (0.04 ) (0.03 ) Net interest spread (%) (1) 2.33 2.63 2.56 Benefit of net free liabilities, provisions and equity (%) 0.18 0.16 0.35 Net interest margin (%) (2) 2.51 2.79 2.91 21 -------------------------------------------------------------------------------- 2003 2002 2001 $m $m $m Overseas Net interest income 3,627 3,609 3,586 Average interest-earning assets 160,169 154,282 151,104 Interest spread adjusted for interest foregone on non-accrual 1.86 2.03 2.05 and restructured loans (%) Interest foregone on non-accrual and restructured loans (%) (0.02 ) (0.02 ) (0.02 ) Net interest spread (%) (1) 1.84 2.01 2.03 Benefit of net free liabilities, provisions and equity (%) 0.43 0.33 0.34 Net interest margin (%) (2) 2.27 2.34 2.37 Group Net interest income 7,419 7,222 6,960 Average interest-earning assets 293,318 270,527 256,603 Interest spread adjusted for interest foregone on non-accrual 2.21 2.41 2.37 and restructured loans (%) Interest foregone on non-accrual and restructured loans (%) (0.03 ) (0.02 ) (0.03 ) Net interest spread (%) (1) 2.18 2.39 2.34 Benefit of net free liabilities, provisions and equity (%) 0.35 0.28 0.37 Net interest margin (%) (2) 2.53 2.67 2.71 -------------------- (1) Net interest spread represents the difference between the average interest rate earned and the average interest rate incurred on funds. (2) Net interest margin is net interest income as a percentage of average interest-earning assets. Net interest income increased by $197 million to $7,419 million in 2003, driven by 8.4% growth in average interest-earning assets to $293.3 billion, partly offset by a 14 basis point decline in net interest margin to 2.53%. Australian net interest income increased by 5.0% to $3,792 million, with average interest-earning assets growing 16.8% to $151.2 billion and net interest margin declining 28 basis points to 2.51%. Overseas net interest income increased by 0.5% to $3,627 million, with average interest-earning assets growing by 3.8% to $160.2 billion, and the net interest margin falling 7 basis points to 2.27%. Volumes Average interest-earning assets for 2003 increased by $22.8 billion or 8.4% to $293.3 billion, from $270.5 billion in 2002 and $256.6 billion in 2001. The main contributors to the growth were loans and advances in Australia and New Zealand, which increased by 17.0% and 8.9% respectively, over the year to September 30, 2003. Loan growth was predominantly in real estate. Average interest-earning assets were impacted by the sale of HomeSide US. For a further discussion of the main factors influencing the movement in average interest-earning assets, refer to 'gross loans and advances' on page 45. Net interest margin The net interest margin (net interest income as a percentage of average interest-earning assets), which includes the impact of non-accrual and restructured loans on net interest income, decreased by 14 basis points to 2.53% in 2003, from 2.67% in 2002 and 2.71% in 2001. The decrease during 2003 was impacted by lower deposit margins, reduced trading income and an increase in structured lending products in Corporate & Institutional Banking. The impact of these items were partially offset by the funding benefit on the proceeds of the sale of HomeSide US and lower cost of debt funding. The interest rate on Australian interest-earning assets decreased by 52 basis points to 6.4% in 2003, from 6.9% in 2002 and 8.5% in 2001, while the interest rate on interest-bearing liabilities decreased by 24 basis points to 4.1% from 4.4% in 2002 and 6.1% in 2001. Net interest margins in Australia declined during 2003, resulting from lower deposit margins and adverse product mix with growth in housing lending and the focus on selective business lending to enhance the portfolio asset quality. The interest rate on overseas interest-earning assets was flat at 5.2% in 2003 compared to 5.3% in 2002 and 7.2% in 2001, while the interest rate on interest- bearing liabilities was also flat at 3.2% in 2003, compared to 3.2% in 2002 and 5.0% in 2001. Overseas net interest margins decreased by 7 basis points to 2.27% from 2.34% in 2002 and 2.37% in 2001. The decrease is due to an increase in structured lending products in Corporate & Institutional Banking. Net life insurance income 2003 $ 444 million 2002 $ (10 ) million 2001 $ 128 million Net life insurance income comprises the revenue and interest component of premiums, dividends, realised and unrealised capital gains and other returns on investments under the life insurer's control, net of claims expense, change in policy liabilities, policy acquisition and maintenance expense, and investment management fees (refer to note 57 in the financial report for a definition of the life insurer). 22 -------------------------------------------------------------------------------- Net life insurance income increased by $454 million to $444 million income in 2003, from a $10 million loss in 2002 and $128 million income in 2001. Life insurance revenue increased by $3,562 million to $3,708 million in 2003 from $146 million in 2002 and $197 million in 2001. This increase was impacted by an increase in investment revenue (increase of $3,747 million in 2003) reflecting the improved performance of global equity markets, particularly over the six months to September 30, 2003. This is offset by an increase in policy liabilities. There is a further offset within the income tax expense, which includes the tax expense for policyholders relating to investment income. Premium and related revenue decreased $185 million or 16.3% to $949 million due to decreased premium revenue from the international businesses arising from the strength of the Australian dollar, decreased investment business sales in Australia and a decline in premiums from the closed book of traditional business. This has been partly offset by increased insurance premiums reflecting growth in volumes. Life insurance expenses increased by $3,108 million to $3,264 million in 2003 from $156 million in 2002 and $69 million in 2001. This is due to the increase in policy liabilities resulting from the improved performance of global equity markets, and is consistent with the increase in investment revenue. Claims expense increased $2 million or 0.2% to $958 million as a result of increased surrenders in the closed traditional life business, as well as increased insurance claims resulting from the growth in volumes, partly offset by the decrease in claims expense from the international businesses due to the impact of strengthening Australian dollar. Other banking and financial services income 2003 $ 5,010 million 2002 $ 7,006 million 2001 $ 4,749 million Other banking and financial services income includes loan fees from banking, money transfer fees, fees and commissions, treasury-related income, investment management fees, fleet management fees and other income (including rental income, dividends received and profit on sale of property, plant and equipment and other assets). Other banking and financial services income decreased by $1,996 million or 28.5% to $5,010 million in 2003, after increases of 47.5% in 2002 and 15.2% in 2001. The movement reflects the inclusion in 2002 of the $2,314 million proceeds received from the sale of HomeSide US's operating assets and operating platform to Washington Mutual Bank, FA. on March 1, 2002, as well as the loss of contribution from HomeSide US in 2003. Refer below for a detailed analysis of the main categories of other banking and financial services income. Loan fees from banking 2003 $ 1,441 million 2002 $ 1,361 million 2001 $ 1,334 million Loan fees from banking primarily consist of acceptance fees for accepting bills of exchange, application fees to cover costs of establishing lending facilities, commitment fees to compensate for undrawn funds set aside for a customer's ultimate use, and service fees to cover costs of maintaining credit facilities. Loan fees from banking increased by $80 million or 5.9% to $1,441 million in 2003, after increases of 2.0% in 2002 and 7.1% in 2001. This increase reflects lending growth, primarily in Australia and New Zealand, particularly in relation to housing lending. Money transfer fees 2003 $ 1,026 million 2002 $ 1,014 million 2001 $ 1,043 million Money transfer fees are fees earned on the transfer of monies between accounts and/or countries and also include fees for bank cheques and teletransfers, dishonours and special clearances, and periodical payments. Money transfer fees increased by $12 million or 1.2% to $1,026 million in 2003, after a decrease of 2.8% in 2002 and 0.5% in 2001. This increase reflects sustained activity across all regions during the year. Fees and commissions 2003 $ 1,158 million 2002 $ 1,118 million 2001 $ 998 million Fees and commissions consist of fees charged to cover the costs of establishing credit card facilities, commissions from selling insurance and investment products and other fees. 23 -------------------------------------------------------------------------------- Fees and commissions increased by $40 million or 3.6% to $1,158 million in 2003, after an increase of 12.0% in 2002 and a decrease of 9.1% in 2001. This increase is primarily due to higher fees in relation to structured finance transactions, partly offset by lower income from the outsourcing of the merchant acquiring business in Europe. Treasury-related income 2003 $ 625 million 2002 $ 563 million 2001 $ 721 million Treasury-related income includes all realised and unrealised profits and losses resulting directly from foreign exchange trading activities, trading securities and interest rate-related and other derivative trading activities. Treasury-related income increased by $62 million or 11.0% to $625 million in 2003, after a decrease of 21.9% in 2002 and an increase of 54.1% in 2001. The increase during 2003 has primarily resulted from higher activity in Corporate & Institutional Banking largely due to higher interest rate derivative income, partially offset by lower foreign exchange derivative income. Investment management fees 2003 $ 303 million 2002 $ 297 million 2001 $ 305 million Investment management fee income relates to management fees received for services rendered acting as a responsible entity and/or an approved trustee for retail and wholesale unit trusts. Investment management fees increased by $6 million or 2.0% to $303 million in 2003, after a decrease of 2.6% in 2002. The increase in 2003 reflects sustained activity in Wealth Management during the year. Fleet management fees 2003 $ 85 million 2002 $ 56 million 2001 $ 54 million Fleet management fees consist of fleet and custom fleet management fees. Specifically, fleet management fees include fleet management, maintenance and fleet fuel card fees, whilst custom fleet management fees includes operating lease, sale and leaseback and management service fees. Fleet management fees increased by $29 million or 51.8% to $85 million in 2003, after an increase of 3.7% in 2002 and decrease of 12.5% in 2001. The increase in 2003 reflects the impact of the acquisition of Custom Service Leasing (New Zealand) Limited (formerly Hertz Fleetlease Limited) on November 1, 2002. Other income 2003 $ 372 million 2002 $ 2,597 million 2001 $ 294 million Other income includes rental income, dividends received, profit on sale of property, plant and equipment and other assets, foreign exchange income and sundry income. Other income decreased by $2,225 million or 85.7% to $372 million in 2003, after increases of 783.3% in 2002 and 36.1% in 2001. Excluding the impact of the sale of HomeSide US, other income increased by 56.3% during 2003, primarily reflecting the sale of properties in Australia and a gain on the restructure of hedging swaps. Mortgage servicing and origination revenue Net mortgage servicing fees 2003 $ - million 2002 $ 187 million 2001 $ 474 million 24 -------------------------------------------------------------------------------- Net mortgage servicing fees related to HomeSide US and represented fee income derived from mortgage servicing activities less amortisation of capitalised costs (refer to note 1 in the financial report). Net mortgage servicing fees decreased from $187 million in 2002 to $nil in 2003. On October 1, 2002, the Group sold SR Investment, Inc., the parent entity of HomeSide US, to Washington Mutual Bank, FA. The sale has resulted in the complete disposal of the associated mortgage servicing rights. Following this sale, mortgage servicing fees were no longer derived by the Group. Net mortgage origination revenue 2003 $ - million 2002 $ 191 million 2001 $ 336 million Net mortgage origination revenue related to HomeSide US and comprised fees earned on the origination of mortgage loans, gains and losses on the sale of loans, gains and losses resulting from hedges of secondary marketing activity, and fees charged to review loan documents for purchased loan production. Net mortgage origination revenue decreased from $191 million in 2002 to $nil in 2003. On March 1, 2002, Homeside US sold its operating assets and operating platform to Washington Mutual Bank, FA. Following this sale, mortgage origination revenue was no longer derived by the Group. Movement in the excess of net market value over net assets of life insurance controlled entities 2003 $ (160 ) million 2002 $ (155 ) million 2001 $ 510 million Australian Accounting Standard AASB 1038 "Life Insurance Business" (AASB 1038) requires life insurance entities of the Group to value their investments in controlled entities at market value, with changes in the excess of net market value over net assets reflected in the consolidated statement of financial performance. The revaluation of life insurance entities' interest in controlled entities gave rise to a loss of $160 million before tax, reflecting the movement in the excess of the net market value over the net assets of companies owned by National Australia Financial Management Limited (NAFiM), adjusted for capital. Values shown are directors' market valuations. The valuations are based on discounted cash flow (DCF) valuations prepared by Tillinghast-Towers Perrin, using, for the Australian and New Zealand entities, risk discount rates specified by the directors. NAFiM subsidiaries market value summary Net Value of Embedded Value of Market assets (1) in force value future new value business business (2) $m $m $m $m $m Market value at September 30, 2002 1,301 2,252 3,553 2,922 6,475 Operating profit after tax (3) 293 - 293 - 293 Net capital transfers (4) 25 - 25 - 25 Increase in shareholders' net 318 - 318 - 318 assets Movement in the excess of net market value over net assets of life insurance controlled entities, components before tax: Roll forward and business assumptions Roll forward of DCF (5) - 399 399 - 399 Change in assumptions and experience - (235 ) (235 ) (324 ) (559 ) Movement in the excess of net market value - 164 164 (324 ) (160 ) over net assets of life insurance controlled entities before tax (6) Excess movements (7) (47 ) 47 - - - Market value at September 30, 2003 1,572 2,463 4,035 2,598 6,633 -------------------- (1) Net assets represent the shareholder capital, reserves and retained profits. A portion of these net assets is non-distributable, as it is required to support regulatory capital requirements. The cost of this capital support is reflected in the value of inforce business. (2) For some smaller entities, the projection of future new business and inforce business is combined for the purposes of valuation. For these entities, the value of future new business is reflected in the embedded value. (3) Operating profit after tax is before the movement in the excess of net market value over net assets of life insurance controlled entities and excludes the profits of entities outside the market value accounting environment; ie. the operating profits after tax from NAFiM's own business, and other entities not owned by NAFiM. 25 -------------------------------------------------------------------------------- (4) Capital and other movements represent movements in value such as the payment of dividends, capital injections and reductions, acquisitions of subsidiaries and foreign exchange movements on intragroup debt related to international subsidiaries. (5) The roll forward represents the growth over the period at the valuation discount rate over and above operating profit. (6) The movement in excess of net market value over net assets of life insurance controlled entities before tax does not include revaluation uplift in respect of NAFiM's own business. AASB 1038 requires assets of a life company to be valued at net market value; since NAFiM is the parent life entity, the change in market value of its own life business is not brought to account. (7) Excess movements represent excess on the increase of the Group's interest in Plum Financial Services Limited and Advance MLC Assurance Co. Ltd and foreign exchange impacts on the net assets of international subsidiaries and market value of intragroup debt. The components that contributed to the $160 million ($200 million after tax) negative movement in the excess of net market value of the life insurance controlled entities comprised: - the effect of assumption and experience changes primarily comprising lower retail sales volumes than anticipated at September 2002, the effect of weaker operating environments reducing the values of the international businesses, and the over all strengthening in the Australian dollar. The impact of these factors has been partially mitigated by the active management of expenses; and - the anticipated growth in the business above current levels of operating profit (ie. the roll forward of the discounted cash flow). Significant revenue Proceeds from the sale of foreign controlled entities The results and assets and liabilities of SR Investment, Inc. and its controlled entities were included up to and including the year to September 30, 2002. On October 1, 2002, the Group sold SR Investment, Inc. (the parent entity of HomeSide US) to Washington Mutual Bank, FA. Controlled entities other than HomeSide US were excluded from the sale. The Group received proceeds on sale of $2,671 million (US$1,453 million) for assets with a cost of $2,686 million, resulting in a profit on sale of $6 million after all disposal costs, including income tax. Michigan National Corporation and its controlled entities' results were included up to and including the six months to March 31, 2001. On April 1, 2001, the Group sold Michigan National Corporation and its controlled entities to ABN AMRO North America, Inc., a subsidiary of ABN AMRO NV. The Group received proceeds on sale of $5,314 million (US$2,750 million) from the sale of assets with a cost of $2,929 million, resulting in a profit on sale of $1,681 million after all disposal costs, including taxation. Further, an amount of $1,118 million was transferred from the foreign currency translation reserve to distributable retained profits in relation to the sale, giving rise to a total gain of $2,799 million. Operating expenses Personnel expenses 2003 $ 3,416 million 2002 $ 3,379 million 2001 $ 3,725 million Personnel expenses increased by $37 million or 1.1% to $3,416 million in 2003, after a decrease of 9.3% in 2002 and an increase of 9.5% in 2001. Excluding the impact of the sale of HomeSide US, personnel expenses increased 5.7% during 2003. This increase reflects market-based salary increases across regions, increased pension fund expenses and higher contractor costs. The impact of this was partly offset by a reduction in staff (full-time equivalent employee) numbers as a result of the implementation of productivity initiatives across the Group (refer to 'employees' on page 35). Occupancy expenses 2003 $ 556 million 2002 $ 559 million 2001 $ 587 million Occupancy expenses decreased by $3 million or 0.5% to $556 million in 2003, after a decrease of 4.8% in 2002 and an increase of 14.6% in 2001. The decrease reflects a reduced contribution from HomeSide US following its sale, offset by appreciating rental rates and on-costs (ie. security expenses) and higher costs associated with the sale and lease-back of buildings in Australia and New Zealand. 26 -------------------------------------------------------------------------------- General expenses 2003 $ 2,382 million 2002 $ 4,769 million 2001 $ 2,158 million General expenses decreased by $2,387 million or 50.1% to $2,382 million in 2003, after increases of 121.0% in 2002 and 13.9% in 2001. Excluding the impact of the sale of HomeSide US, general expenses increased $146 million during 2003. The increase has been impacted by higher computer and software expenses impacted by the write-off of the development work associated with the global roll out of the SAP core banking module and the write-off of European Monetary Unit development costs. In addition, higher professional fees and other expenses associated with the industry-wide regulatory reform such as Basel II, Financial Services Reform Act, International Financial Reporting Standards, and the United States Sarbanes-Oxley Act of 2002 have also contributed to the increase. This has been partially offset by the compensation provided of $64 million in 2002 compared with $27 million in 2003, for investors relating to a reduction in unit prices. Further, the decrease has been impacted by lower fees and commissions within Wealth Management, and a reduction in communications, postage and stationery costs with the renegotiation of telecommunication contracts within Australia and Europe. (Refer to notes 4 and 5 in the financial report for details of revenue and expense items). Charge to provide for doubtful debts 2003 $ 633 million 2002 $ 697 million 2001 $ 989 million The total charge to provide for doubtful debts decreased by $64 million or 9.2% to $633 million in 2003, after a decrease of 29.5% in 2002 and an increase of 68.2% in 2001. The charge in Australia increased by $213 million to $321 million in 2003, after a decrease of 77.2% in 2002 and an increase of 128.5% in 2001. The 2003 charge was impacted by a small number of large corporate exposures in Financial Services Australia and Corporate & Institutional Banking, During the 2002 year, a review of the risk profile within the Corporate & Institutional Banking and Financial Services Australia (Business) loan portfolios, resulted in a reduced charge. (The nature of general and specific provisioning is explained in note 1(q)(i) in the financial report.) The charge in Europe decreased by $108 million or 28.1% to $277 million in 2003, after a decrease of 2.8% in 2002 and an increase of 36.1% in 2001. Clydesdale and Yorkshire Banks' charges decreased by $112 million reflecting a change in the mix of the loan portfolio, with falling personal loan volumes and higher housing volumes. Northern and National Irish Banks' charges decreased by $24 million, reflecting the recovery of a large corporate exposure. The balance of the reduction reflects the impact of the realignment of Corporate & Institutional Banking's loan portfolio during 2002, in order to reduce its risk profile. The charge in New Zealand increased by $23 million to a charge of $11 million in 2003, compared with a credit of $12 million in 2002 and a charge of $10 million in 2001. The increase has resulted from a charge in relation to a large corporate exposure in Corporate & Institutional Banking, whilst during 2002 the loan portfolio provisioning requirement was reviewed resulting in a write-back to the general provision. The charge in the United States decreased by $181 million or 84.2% to $34 million in 2003, after increases of 100.9% in 2002 and of 52.9% in 2001. The decrease has resulted from the inclusion of a major provisioning charge in 2002 for a large corporate exposure in Corporate & Institutional Banking. The charge in Asia decreased by $11 million to a credit of $10 million in 2003 compared with a charge of $1 million in 2002 and $3 million in 2001. The decrease has resulted from a review of the portfolio favourably impacting the charge to provide for doubtful debts. Charge to provide for doubtful debts by region 2003 2002 2001 2003/2002 $m $m $m % change Australia 321 108 473 large Europe Clydesdale and Yorkshire Banks 250 362 348 (30.9 ) Northern and National Irish Banks (1 ) 23 16 large Other 28 - 32 large 277 385 396 (28.1 ) New Zealand 11 (12 ) 10 large United States 34 215 107 (84.2 ) Asia (10 ) 1 3 large Total charge to provide for doubtful debts 633 697 989 (9.2 ) 27 -------------------------------------------------------------------------------- Net write-offs (bad debts written off less recoveries) in 2003 were $798 million compared with $814 million in 2002 and $587 million in 2001. As a percentage of risk-weighted assets, net write-offs were 0.3% in 2003, 0.3% in 2002 and 0.2% in 2001. Percentage of risk-weighted assets 2003 2002 2001 % % % Australia (1) Charge 0.22 0.08 0.36 Net write-offs 0.29 0.23 0.19 Europe (1) Charge 0.41 0.53 0.53 Net write-offs 0.49 0.55 0.41 New Zealand (1) Charge 0.05 (0.05 ) 0.05 Net write-offs 0.05 0.05 0.05 United States (1) Charge 0.35 1.35 0.43 Net write-offs 0.34 0.64 0.09 Asia (1) Charge (0.23 ) 0.02 0.04 Net write-offs 0.05 (0.02 ) (0.01 ) Group Charge 0.25 0.28 0.38 Net write-offs 0.32 0.33 0.23 -------------------- (1) Ratio calculated as a percentage of risk-weighted assets of Australia, Europe, New Zealand, United States and Asia, as appropriate. The Group maintains a conservative and prudent approach to actual and potential loan losses. The overall provision for doubtful debts (refer to notes 1(q)(i) and 17 in the financial report) is augmented as necessary by a charge against profit having regard to both specific and general factors. An explanation of the Group's lending and risk analysis policies is provided within 'risk management' on page 51. Significant expenses Restructuring costs During 2002, the Group recognised restructuring costs of $580 million resulting from the Positioning for Growth and other restructuring initiatives (refer to note 5(a) in the financial report). The majority of these costs are expected to be recovered by the end of 2004 from annual productivity improvements and revenue enhancements. The Positioning for Growth initiative was a fundamental reorganisation of the management and organisational structure of the Group, including the appointment of a new senior management team. The restructuring costs were incurred to deliver a significant proportion of the announced cost reduction target of $370 million per annum by September 2004. It is the achievement of this target that will reflect the recovery of the majority of the restructuring costs incurred in 2002. Of these savings, approximately 80% relate to personnel costs, which are directly measurable each reporting period. Redundancy payments have a payback period of approximately one year. The balance of the savings relate to non-personnel costs, which are not measured at an account level. In addition, further costs savings will also effectively be achieved through the reduction in rental charges over the remaining term of the leases, which extend beyond 2004, as result of an accounting benefit for the charge to provide for surplus lease space and the accounting benefit from the write-off of technology- related property, plant and equipment of $132 million is reflected in the cessation of future stream of depreciation and amortisation. Other restructuring costs incurred in 2002 and 2001 have been expensed as incurred. Such costs were not material (refer to note 5 in the financial report). Cost of foreign controlled entities sold The results and assets and liabilities of SR Investment, Inc. and its controlled entities were included up to and including the year to September 30, 2002. On October 1, 2002, the Group sold SR Investment, Inc. (the parent entity of HomeSide US) to Washington Mutual Bank, FA. Controlled entities other than HomeSide US were excluded from the sale. The Group received proceeds on sale of $2,671 million (US$1,453 million) for assets with a cost of $2,686 million, resulting in a profit on sale of $6 million after all disposal costs, including income tax. 28 -------------------------------------------------------------------------------- Michigan National Corporation and its controlled entities' results were included up to and including the six months to March 31, 2001. On April 1, 2001, the Group sold Michigan National Corporation and its controlled entities to ABN AMRO North America, Inc., a subsidiary of ABN AMRO NV. The Group received proceeds on sale of $5,314 million (US$2,750 million) from the sale of assets with a cost of $2,929 million, resulting in a profit on sale of $1,681 million after all disposal costs, including taxation. Further, an amount of $1,118 million was transferred from the foreign currency translation reserve to distributable retained profits in relation to the sale, giving rise to a total gain of $2,799 million. Impairment loss on mortgage servicing rights In July 2001, the directors of the Company determined that the carrying value of the mortgage servicing rights asset held by HomeSide US, a controlled entity of the Company, exceeded the fair value. An impairment loss of $888 million was recognised to reflect the asset at its fair value. This impairment was the result of hedging positions which were adversely impacted by extreme volatility in US interest rate markets. In September 2001, the directors of the Company determined that a second impairment loss on mortgage servicing rights was required in order to reflect the mortgage servicing rights asset at their fair value. This impairment loss of $755 million was the result of an incorrect interest rate assumption discovered in an internal model used to determine the fair value of HomeSide US's mortgage servicing rights. Charge to provide for mortgage servicing rights valuation adjustment On September 2, 2001, the directors of the Company decided to value HomeSide US at its estimated market sale value, rather than as an ongoing part of the Group, after reviewing its position within the Group's current core strategies of banking and wealth management. As a result of this decision, the carrying value of HomeSide US's core asset, mortgage servicing rights, was revalued and a provision for mortgage servicing rights valuation adjustment of $1,436 million was recognised in order to reflect the mortgage servicing rights asset at its estimated market sale value. Impairment loss on goodwill In conjunction with the directors' decision to value HomeSide US on an estimated market sale value basis, the decision was made that the carrying value of goodwill which arose on the acquisition of HomeSide US was in excess of its recoverable amount. Accordingly, an impairment loss of $858 million was recognised, in order to reduce the carrying value of this goodwill to $nil. Income tax expense 2003 $ 1,681 million 2002 $ 962 million 2001 $ 1,891 million Income tax expense increased by $719 million or 74.7% to $1,681 million in 2003, after a decrease of 49.1% in 2002 and an increase of 15.9% in 2001. The level of income tax expense is impacted by the accounting regime which applies to unrealised gains and losses relating to Wealth Management's statutory funds of the life business. The income tax expense in 2003 attributable to this impact was $126 million tax expense, compared to an income tax benefit of $248 million in 2002. 29 -------------------------------------------------------------------------------- This information is provided by RNS The company news service from the London Stock Exchange MORE TO FOLLOW FR IIFIRLTLRFIV
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