We've prioritised strength, delivered a solid result and made significant progress on transforming the Group
Dear fellow shareholders
Two hundred years ago this month, on the 22nd of November 1816, a group of prominent Sydney business people met formally for the first time to consider Governor Lachlan Macquarie’s request that they advise him on how to create a local currency for the still-new colony.
The request reflected Governor Macquarie’s desire to build a strong, independent economy—an objective that was not shared by his colonial overseers in London.
The group’s response—that to have a currency, the colony needed its own bank—led to the founding in April 1817 of the Bank of New South Wales: Australia’s first company, and first bank.
Since that first meeting 200 years ago, the company we now call Westpac has always recognised that our success is inexorably tied to the prosperity of the local economy, through the success of our customers. As our home communities of Australia and New Zealand have faced and responded to many challenges over the centuries—economic, environmental, demographic, cultural, and political—so too we at Westpac have constantly adapted to support the economic development of these nations.
We reflect this role in our vision statement: “To be one of the world’s great service companies, helping our customers, communities, and people to prosper and grow.”
In last year’s letter I outlined our strategy to fulfil this vision, and why we believe that a strategy focused on service is the right response to our rapidly changing environment.
Our strategy has not changed, and because we have the right business mix and are not burdened with major underperforming or non-core businesses we’ve been firmly focused on implementation.
This year my aim, once again, is to give you a candid assessment of our performance, as well as update you on our strategic progress and provide my perspective on the challenges and priorities for the next period.
And, given all the negative political and media attention paid to the banking industry in recent months, I’d like to add a few further thoughts to those of our Chairman on the industry’s reputation and what we are doing to close what I’ve been referring to as the ‘trust gap’. As part of this, I’ve included several real customer stories that I believe highlight the sort of company that Westpac is today.
As in every year, our highest priority is to maintain the strength of our balance sheet. This financial year we took significant steps to increase our equity capital base—through an entitlement offer raising $3.5 billion—which followed other initiatives last financial year, including the underwritten dividend reinvestment plan in May 2015 and the partial sale of BT Investment Management (BTIM). As a result, our common equity Tier 1 ratio stands at 9.5%, or 14.4% on an internationally comparable basis—one of the highest ratios of any large bank in the world.
We strengthened our funding mix, with customer deposits rising 9% to comprise 70.5% of loans. The average tenor of wholesale funding raised this year was 5.4 years, up from less than 5 years in 2015, and our Liquidity Coverage Ratio (LCR) reached 134%—an important regulatory measure of our ability to absorb market shocks. We also assessed our Net Stable Funding Ratio (NSFR) as exceeding 100%—a milestone set by APRA (our key prudential regulator) that all banks must achieve by the beginning of the 2018 calendar year.
Turning to profit, cash earnings for the Westpac Group—our preferred performance measure—was $7,822 million compared to $7,820 million for Full Year 2015.
Earnings per share fell 5% to 235.5 cents, reflecting the significant increase in capital issued over the last 12 months. Return on equity (ROE) was also lower at 14.0%, down from 15.8% in 2015.
On a reported basis, Westpac’s net profit was $7,445 million, down 7% over the year.
The difference between cash earnings and reported profit reflects a number of infrequent items that, in aggregate, boosted reported profit by $375 million in 2015 (but were excluded from the calculation of cash earnings in that year). These items included gains associated with the partial sale of BTIM and tax benefits linked to the acquisition of Lloyds Australia in 2014, partially offset by a reduction in capitalised software charges following a review of how we account for some technology investments.
While these results are lower than we’d like, the flat cash earnings growth masks the fact that below the surface we were doing a lot of paddling—and making real progress.
It’s also worth noting that these results took place in an environment that was difficult for banks, with more financial headwinds than we expected at the start of the year.
Interest rates were lower, which is a significant drag on earnings for a bank like Westpac. Global financial market conditions also contributed to reduced customer activity for our institutional business.
At the same time, regulatory and legal costs were higher, as we responded to an increased number of requests by regulators both at home and abroad. And, after a number of years of very low credit losses—indeed, net write-backs—in our Institutional business, we saw a small number of relatively large ‘names’ get into difficulty. This meant that we increased our credit provisions substantially in Westpac Institutional Bank (WIB)—an occasional feature of being in this business, but a drag on earnings nonetheless.
Looking within the result, operating income for the group increased 3%, with net interest income growth of 8% partially offset by lower non-interest income. The growth in net interest income was driven by loan growth of 6%, customer deposit growth of 9%, and a 5 basis point improvement in our net interest margin.
It’s worth noting that the net interest margin picture is complex; encompassing changes across our entire suite of lending, deposit, and wholesale borrowing costs, as well as changing capital and liquidity requirements from our regulators.
Although there has been a lot of media and political attention on our pricing of late, the fact remains that our margin has come down over the last ten years. Ten years ago the net interest margin was 2.29%; five years ago it was 2.22%, and this year it averaged 2.13%—while the second half margin was a bit lower still at 2.11%. The perception that we have repriced loans to lift the overall margin fails to consider all the movements across our entire balance sheet, and how we seek to balance the impact of these movements across borrowers, depositors, and shareholders.
Setting aside the margin picture, net interest income growth reflected strong performance in our Consumer and Business Bank divisions. Australian mortgages grew $28 billion, or 8% year-on-year. We grew our share in mortgages, despite the imposition by APRA of a cap on investor property lending and certain other regulatory adjustments to underwriting standards. The net result of these and other changes was to more evenly balance home loan growth across owner-occupied and investor lending.
Small business lending—one of our key focus areas—also grew strongly, with loans up 8% over the year. This reflects the benefit from our new online loan origination platform, LOLA, and the use of video conferencing to immediately connect customers with business specialists in areas like transaction banking, trade, and merchant (credit card) processing. Herb Smith’s story illustrates how customers can now walk into their local branch and connect with experts to help them reach their goals.
New Zealand’s loan book grew strongly across both business and consumer lending, at 9%1 over the year. This growth was broad-based across industries and regions. However, a highly competitive market for both deposits and loans put significant pressure on the net interest margin in New Zealand, which fell sharply in the first half (although there are signs of stabilisation in the second half of the year).
In WIB, the ongoing phenomenon of ‘quantitative easing’ by central banks around the world has continued to put pressure on margins for institutional lending here in Australia—as global banks from markets with low to zero interest rates seek higher returns elsewhere. In this environment, we are focusing on managing return and margins while preserving our most important long-term transactional and lending relationships. As a consequence, we stood back from a number of large transactions in the market (especially in commercial property and trade finance), and overall lending fell 3%—an outcome we are comfortable with.
The other key driver of our revenue result was non-interest income, which was down $446 million over the year. Much of the decline was due to lower gains on asset sales, the partial sale of our investment in BTIM, as well as reduced customer activity in WIB. At the same time, the Consumer Bank experienced a regulated reduction in interchange income on credit cards.
1. In NZ$
Given the lower revenue environment this year, we’ve remained disciplined on our expenses while continuing to invest in ways that will drive a step-change in long-term productivity.
Essentially our goal is to neutralise ordinary expense growth through disciplined productivity initiatives, so that most of the net growth in expenses is investment-related. This year we achieved $263 million in productivity savings (3% of our cost base) including through digitising processes, further reconfiguring our network and renegotiating major contracts. Given our flat financial performance, this included a reduction of around 10% in the overall variable incentives paid to our senior employees.
At the same time, we materially increased our strategic investments in service and productivity; with an annual spend of $1.2 billion against last year’s total of around $1 billion. This meant that total expenses grew 3% and our cost-to-income ratio was maintained at 42%—a number that we aim to drive below 40% in coming years.
We are also investing in technology to transform customer experiences and further strengthen our core infrastructure.
In New Zealand, after a significant upgrade to our online platform last year, we’ve rolled out several new innovations—most recently the CashNAV mobile app developed in conjunction with fintech leader Moven. This app allows customers to better track and manage their spending. We also achieved a significant technology milestone this year with the upgrade of our deposit and transaction system for St.George—called Celeriti. This system will ultimately serve as our single transaction and deposit platform for all our consumer and business relationships.
In BTFG, our new wealth platform, Panorama, has achieved a number of development milestones, and balances are beginning to grow on the platform. We believe this system will give us a significant functionality and cost advantage in the high-growth wealth business in years to come.
With a wide variety of fintech firms emerging we are keeping an eye on developments and are selectively investing in new models that have the potential to disrupt traditional banking. We are partnering with businesses in areas as diverse as blockchain, quantum security, and digital mortgage broking.
We have also separately invested $100 million in Reinventure, a venture capital fund that directly invests in fintech businesses with the potential to make a significant impact in Australia. The fund currently has 11 investments, including data marketplace platform Data Republic, employee platform provider Flare HR, peer-to-peer lender Society One, and crime prevention software provider Auror, which you can read about in more detail below.
The other major impact on our earnings was credit provisions, with impairment charges up 49% to $1,124 million. Much of the rise was due to single ‘names’ mentioned earlier. We take a conservative approach to such facilities and therefore significantly increased the provisioning associated with each.
Setting aside these large impairments, overall asset quality is in good shape: stressed assets to total committed exposures were low at 1.20%. This is more than 60% below financial crisis levels in 2010. There has been a small rise in stress through the year in certain sectors and regions impacted by the slowing in mining investment along with some challenges in New Zealand dairy, but in our judgment these trends don’t indicate a broader deterioration in quality.
Although there has been some commentary recently about credit risks in commercial property and housing, we remain very comfortable with our book, thanks in part to actions we took in previous years. In commercial property, for example, back in 2012 we identified regions where residential apartment supply looked to be increasing too rapidly, and in response we further tightened our lending criteria. Those decisions have proven to be prudent, with those same regions now being flagged as oversupplied.
There is no doubt that house prices are high and customers are more leveraged. But we believe that, with a few localised exceptions, market conditions reflect the impact of lower interest rates along with genuine supply and demand imbalances, rather than being fuelled by excessive speculation or an easing in lending standards. Therefore, we do not subscribe to the view that there is a housing bubble.
Elsewhere in the portfolio we have had some concerns on the New Zealand dairy industry given depressed global milk prices, but efforts of farmers to re-align their cost bases—along with recent improvements in milk prices—have alleviated some of our concern.
In consumer lending we have seen a small rise in mortgage 90+ day delinquencies, but these tend to be concentrated in regions affected by the slowdown in mining investment mentioned above, and overall remain within our normal tolerance levels. In fact, of the 1.5 million mortgages we have outstanding, there are only 262 houses that are currently in possession—which is a very low level in absolute terms and relative to history.
Taking all of these factors into account, the combination of earnings and capital/funding actions meant that we finished the year with a much stronger balance sheet than we started. For our shareholders, this meant that we have continued to grow the net tangible assets per share by 7% or 88 cents per share—an important measure of intrinsic value.
Including total dividends paid and share price movements, total shareholder return for the 2016 financial year was 6.3%. This compares with the average total return for the banking sector of 6.2% over the same period.
As part of our service strategy we changed our organisational structure in 2015 to better align with our customer segments. This led to the creation of two new divisions: Consumer Bank, with end-to-end accountability for consumer banking relationships across both Westpac and our regional brands; and Business Bank, which serves commercial and small business customers. The structures of BT Financial Group (BTFG), WIB, and Westpac New Zealand remained largely unchanged.
This is the first year we are reporting under our new structure and comparative financials have been restated to compare like for like.
The Consumer Bank performed strongly this year. In total, more than 500,000 new customers joined us, contributing to net customer growth of 3% and helping to lift cash earnings by 14%. From a service point of view, the outcomes were mixed. Customer satisfaction for the Consumer Bank was down a little, from 83.8% to 81.3%1.
When we look beneath that overall survey result—which has almost certainly been negatively impacted by the general media climate for banks—we see substantial improvements in how customers rate their direct experience with us. For example, the net promoter score (NPS) across our call centres rose from 65.5 to 68.1 and branch NPS2 for St.George, Bank of Melbourne and BankSA for instance grew from 55 to 57 over the year. Complaints in the Consumer Bank reduced by 29%, and over the last quarter we recorded three times as many compliments as complaints in our branch network.
One particular area of focus has been on digital service, where we saw an increase in digital logins of 11%; digital channels now represent 23% of sales. Our Westpac Live mobile application was rated No.1 in the world by Forrester Research, reflecting the work underway to transform our digital capabilities and position Westpac as the best in class digital customer service bank. In fact, we introduced more than 180 new features and enhancements across our digital channels this year. For example, customers can now activate a credit card using their phone’s camera, or manage a term deposit rollover, all without having to visit a branch.
The Business Bank also performed well, with core earnings growth of 5% over the year. Market share increased across SME and in the merchant credit cards, to the point where around 50% of Australian businesses now have a banking relationship with the Westpac Group.
While customer satisfaction3 in the Business Bank was down slightly from 7.4 to 7.3, we continue to be ranked number 1 for total Business in NPS4.
During the year we rolled out a new online banking system for St.George business customers, significantly improving service, and our online loan origination platform, LOLA, is now processing two out of every three eligible loans. We also rolled out around 127,000 merchant terminals which are all enabled with market-leading contactless tap and go functionality.
Despite the good core earnings growth, higher impairment charges meant that cash earnings in this business rose by a more modest 1%. The main driver of the increased provisions was the fact that we had lower write-backs than in previous years; we also had an increase in provisions in auto finance. Overall, however, credit quality in this business remains sound.
BTFG continued to see good underlying growth in its business, with FUM and FUA balances growing 5% and 7% respectively, while insurance premiums were also higher. However a number of specific issues reduced reported cash earnings by 4%; adjusting for the partial sale of BTIM, cash earnings would have been down 2%. The other issues holding back BTFG’s earnings this year included the impact of higher claims and lower renewals in Insurance, currency movements in Ascalon (our boutique funds management investor), and higher regulatory costs.
As discussed earlier, WIB cash earnings were down $245 million, reflecting higher impairment charges and our decision to focus on return rather than growth in a difficult market. Despite this, WIB grew its core customer base this year, continuing to invest in service quality and grow its leading position in transaction banking. WIB changed its operating model to increase the focus on service and reduce its cost base—which has set the business up for improved performance in the years ahead.
Full Year 2016 has been a year of change for Westpac New Zealand with the start of a major transformation program and the relaunch of its brand. Cash earnings for the division were lower over the year, down 4% in $NZ, principally due to the highly competitive market for home loans, and costs associated with its transformation program. While the overall financial result is below what we would like, I am confident that David McLean and his refreshed management team are taking the steps necessary to deliver a significant lift in service and cost efficiency in the years ahead.
In summary, we are well underway with our ‘Service Revolution’, making real steps towards delivering world-class service, digitising our business, and building a culture that puts a dedication to helping at the heart of a truly sustainable business.
The environment in which our 40,000 people are working is changing. This includes how customers wish to interact with us, changes in daily work tasks, and expectations around diversity and flexibility. Public scrutiny of culture across the sector has also intensified.
With this in mind, we have been working hard to find new ways to build the workforce of the future: where people with diverse backgrounds can adapt to change and, importantly, maintain a relentless focus on providing exceptional service.
As part of this, our flagship initiative during the year was the introduction of Our Service Promise, a set of principles and practices that clearly defines our expectations of what it means to deliver great service—consistently.
During the year, we conducted a survey which showed an employee engagement score of 69%. While this was a good outcome, it is below the high bar of global best practice – a benchmark to which we aspire. Given the amount of change in our organisation this year, the result was not a surprise; but nevertheless we’ve listened to feedback and are already rolling out a number of actions to address those areas our employees told us needed to improve.
Our new city-based corporate offices are now providing more than 10,000 employees with some of the world’s best physical environments, tools, and technologies, and a new way of working that is driving greater agility, mobility, and productivity.
We also continued to foster a more diverse and inclusive workplace, delivering some excellent results during the year. This included an increase in the number of women in leadership positions to 48%—up from 46% last year—which brings us closer to our target of 50% by 2017; and an increase in the cultural diversity of our employees. Notably, the percentage of employees who self-identify as Indigenous Australians increased to more than 4%, which is greater than the proportion in the broader Australian population.
Kate Holloway’s story shows how employees are applying our approach to diversity and flexibility to help solve customer issues and better meet their needs.
That leads me to the final issue I wanted to address in this year’s letter.
Trust is fundamental to the service we provide. For us to fulfil our role, customers need to trust that we are acting in their interests; that our advice is honest; and that their money is safe.
We recognise that there have been times when we have not met customers’ expectations and this has contributed to a trust gap between the community and the banking sector.
We are working hard to rebuild that trust.
There has been an increase in public and political scrutiny, with calls for further regulation and investigations into Australian banking activity—including a potential Royal Commission on conduct in the banking and financial services sector.
A number of banks also face individual challenges, such as the civil proceedings in Federal Court commenced by ASIC in April this year, which allege manipulation of the Bank Bill Swap Rate between the period 6 April 2010 and 6 June 2012. We don’t accept ASIC’s allegations and think this complex matter is now best resolved by the Courts.
In our Code of Conduct we commit to doing the right thing by customers. Given the changing environment and need to build trust we’re implementing a number of programs to ensure our products, policies, reward frameworks and processes are even more closely aligned to customers’ interests. As part of this program we have:
Westpac’s principles are clear: when something doesn’t measure up, we change it. When we find a problem, we fix it, so that it doesn’t happen again. And we’re open about the issues we find.
At an employee level, we’re changing our remuneration frameworks to ensure we reward our people based on the value and outcomes delivered to customers. In November 2016, we were the first bank to remove all product related incentives across our 2,000 tellers in the Westpac branch network. Their incentives are now based entirely on the quality of service customers receive.
We have increased transparency in financial planning and remain the only company to invite customers to publicly rate the service provided by our financial planners via the online Adviser View. We were also early movers in removing commissions paid to financial planners back in 2014, and are now revisiting the way we reward other specialised sales roles. Similarly, we have led the market on educational standards for financial advisers, and our current requirements are above the new standards recently proposed by the Federal Government.
Over the year, a range of financial issues emerged for some of our peers across financial planning and insurance. We have thoroughly investigated our own operations and while we are not perfect, I can assure you that our record in this area is strong: BTFG has been a role model in seeking to genuinely help customers manage and protect their wealth. To bring this to life, the experience of Bob Mac Smith is similar to many other stories I have heard across our organisation.
At an industry-level, we publicly committed to implement six areas of industry reform – the Australian Bankers' Association's (ABA) 6-point plan. The plan’s aim is to protect customer interests and increase transparency and accountability across the industry.
As CEO, I know our people overwhelmingly set out to do the right thing by customers, and I want customers and the community to be confident of that too. The contract we hold with customers is one we’ve never taken for granted: Customers trust us to help them live the lives they want; to grow; to be more secure; and to be better off.
By focusing on customer needs, delivering world-class service, and measuring our success on customers’ success, I believe we have a business strategy that will, in time, help us to restore trust.
As I mentioned at the outset, Westpac is fast approaching its 200th anniversary. It’s an exciting time to be part of this organisation; a time to reflect on our past and recognise our successes. But more importantly, we are looking to the future and positioning Westpac for its third century.
That means ensuring our business is strong, our strategy is right, and that we are continuing to support our customers, shareholders, employees and the broader community. It also means taking a leadership role in tackling emerging issues that we believe will affect future prosperity.
It’s this approach that has contributed to Westpac being named—for the third year in a row—the most sustainable bank in the world in the Dow Jones Sustainability Indices Review. This marks the ninth time we have topped this global annual index.
During the year we invested in the people, businesses, and community organisations that are helping to shape our nation. Our $100 million Westpac Bicentennial Foundation is on track to award its 200th scholarship and will continue to add 100 scholars to the alumni every year, in perpetuity. We also launched the Westpac Businesses of Tomorrow program to identify 200 promising businesses that will receive direct support and intellectual capital from some of Australia’s leading business people.
At the same time, the grants awarded by the Westpac Foundation have helped create more than 2,900 employment pathways for Australians experiencing disadvantage, and the number of businesses set up or expanded with support from Westpac’s microfinance partner, Many Rivers, exceeded 1,000.
Our total committed exposure to the CleanTech and environmental services sector reached $6.2 billion, directed to activities such as generating renewable energy and developing green buildings. Over the past five years, we have increased the proportion of renewable energy financing in our total electricity generation portfolio from 45% to 59%. We also brought to market a $500 million Westpac Climate Bond and an Energy Efficiency Finance Program. These are important steps in supporting the shift to a more sustainable economic model that is less dependent on fossil fuels. This demonstrates our commitment to supporting the transition to an economy that limits global warming to less than two degrees above pre-industrial levels.
Our lending to help grow the stock of social and affordable housing grew to $1.05 billion, as we look to play our part in addressing the shortage of affordable housing.
It is an exciting time to be in banking. The industry is highly competitive, our operating environment remains challenging and we face increased regulatory and public scrutiny. However, with change comes opportunity and we are already responding and adapting across all elements of the business.
Our service-led strategy is right for the times. We have strengthened our business and are committed to transforming our operations in ways that will give us a sustainable competitive advantage and bring benefits to all of our stakeholders.
As we enter our third century of business, my executive team and I are proud to lead a company that is dedicated to serving our customers and our communities and is committed to operating with courage and integrity. As a result we’re confident that we will continue to deliver growth, returns, and stability that increases the value of your shares and makes you proud of your decision to invest in the Westpac Group.
With warm regards,
Chief Executive Officer