Australia Banks

EQUITY: FINANCIALS

All good things come to an end

More intense competition in mortgages should see super-normal returns normalise
Mortgage returns are normalising Our analysis suggests that despite lower funding costs, returns on new mortgages have declined by ~4% in recent periods. This has been the direct result of both a greater level of competition as well as increased usage of the broker channel (we estimate the broker channel delivers ~6% lower returns relative to the proprietary channel). Although mortgages remain one of the most attractive products within the majors portfolios (delivering ~31% RoIC), should recent competitive tension persist we expect overall bank returns to be impacted. We estimate ~4% downside risk to group earnings and ~7bps margin impact if banks back-books re-price to prevailing RoIC levels. However, if returns were to normalise towards the ~25% level (ie. pre-GFC levels) we see ~8% downside risk to the majors earnings. While banks are likely to see some offsetting benefits on the funding side, we believe this downside risk is not fully captured in consensus estimates and we remain cautious on the sector's medium term growth outlook. How profitable are Australian mortgages? While mortgage funding costs and leverage have changed materially since the beginning of the GFC, banks ability to re-price has led to gross margin increasing from 180bps before 2008 to ~345bps today. Based on our estimates this has meant that RoIC on mortgages through the proprietary channel increased from ~24% before the GFC to ~34% in the current environment. While we believe this benefit has been largely consumed by lower profitability on the deposit book, as funding conditions improve we expect competitive pressure to continue to reduce profitability on mortgages. We expect retail banks to be more impacted by these trends. Mystery shopping identified increasing competitive tension Our survey highlighted that the level of discounts on standard variable rate has increased in recent periods. We found that advertised discounts across the banks are as high as 105bps for smaller sized mortgages and 120bps for larger mortgages over A$750k. Our mystery shopping of the broker channel revealed that Bankwest, Suncorp and St George offer the most competitive rates amongst the large players of 4.84-4.89% (ie. discounts range from 105115bps). Also, banks appear to be more willing to extend higher LVR lending with the industry maximum returning to ~97% LVR. More flow through the broker channel suggests lower returns Banks usage of the broker channel has also increased in recent periods. We see this as a result of banks looking for an easy fix to address credit growth challenges. While our analysis highlights that the returns on broker-originated loans remain well above the cost of capital and still arguably one of the higher returning products across the Group, we believe its profitability is ~6% lower than mortgages that were originated through the proprietary channel. Valuations on the expensive side Banks are trading on ~14x forward P/E (~13% above their 10-year averages).

Global Markets Research

26 March 2014

Anchor themes With funding costs having improved, a key concern now is the impact of competition on the asset side, given the low-growth environment. Nomura vs consensus We are slightly below consensus on FY14 bank earnings forecasts. Research analysts
Australia Banks
Victor German - NAL victor.german@nomura.com +61 2 8062 8411 Anthony Hoo - NAL anthony.hoo@nomura.com +61 2 8062 8414

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | Australia Banks

26 March 2014

Competition in mortgages is returning

While the low interest rate environment has stimulated housing market activity, lending growth has remained relatively subdued. In that environment its not surprising that competitive tension in the housing lending market has intensified. As funding pressures have eased, competition from smaller banks appear to have increased with majors market share (as proportion of total ADIs) falling by ~1% over the last 18 months (following a rapid increase of ~4.2% since 2008).
Fig. 1: Originations composition from majors and non bank financials
(%) 86 84 82 80 78 76 (%) 100 95 90 20 85 80 75 15 10

Fig. 2: Refinancing as % of owner-occupied approvals

(%) 35 30 25

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013

Majors as % of ADI total loans (LHS) Banks as % of approvals (RHS)

Source: Nomura research, ABS, RBA

Source: Nomura research, ABS

As the figures below highlight, during the six months to December 2013 only ANZ grew ahead of system, while both CBA and to a larger degree WBC have lost share. Looking at smaller players, MQG has been a standout growing at ~5% of the overall system, while HSBC, AMP and Citi have all grown share, albeit modestly.
Fig. 3: Market share vs share of growth (6m to Dec 2013)
35

Fig. 4: Market share vs share of growth (6m to Dec 2013)

6

Share ofsystem growth (%)

Share ofsystem growth (%)

30 25 20 15 10 10 15 20 Market share (%) 25 30

5 4

MQG SUN

CBA ANZ NAB WBC

3 2 1 0 0

HSBC AMP Citi

1

ING BEN BOQ

2 3 4 5 Market share (%)

(1)
Source: Nomura research, APRA

Source: Nomura research, APRA

Another indicator of the increasing level of competition both from outside of the majors and more important, between them, can be observed through the broker channel, where it appears that lenders are increasingly willing to pay higher levels of commissions to mortgage brokers. The figures below are based on data from Mortgage Choice, and suggest that in recent months, the level of both upfront and trail commissions have been increasing.

2013
2

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26 March 2014

Fig. 5: Average upfront commission rates reported by MOC

(%) 0.65 0.63 0.61 0.59 0.57

Fig. 6: Average trail commission rates reported by MOC

(%) 0.20 0.18 0.16 0.14 0.12

1H13

2H13

1H14

2H14

1H15

2H15

1H16

2H16

1H17

Nov-12

May-12

May-13

Sep-12

Sep-13

Nov-13

Jan-12

Jan-13

Jul-12

Mar-12

Mar-13

Jul-13

0.55

Estimated
Source: Nomura research, MOC

Actual

Average rate total book (Actual) Average rate total book (Estimated) Average rate new settlements* (Estimated)
Source: Nomura research, MOC

Moreover, banks usage of the broker channel has also increased (excluding ANZ) from 2 years ago. We see this as a result of banks looking for an easy fix to their credit growth, and the broker channel (which is generally responsive to price and service) offers a quick and effective remedy. This is particularly evident from WBCs recent experience (where the broker channel represented ~46% of flow in 3Q14) and to a lesser extent CBA.
Fig. 7: Proportion of mortgage flows from 3rd party channel
(%) 60 55 50 45 40 35 30 25 20 ANZ
2H11 1H12

55 51 46 49 47 37 38 35 38 38 38 39 36 41 43 40 37 41 41 43 43 46

CBA
2H12 1H13 2H13

NAB
1H14/1Q14

WBC

Source: Nomura research, company data

Better deals for homeowners

The other aspect of competitive tension is coming through in the form of pricing, where the level of discounting has gradually been increasing. According to RBA data, banks are now offering ~85bps discount from their SVRs. Discounting is generally a sensible way for banks to protect the profitability of their back-books and still remain competitive. In that regard we expect banks to largely maintain their SVR levels and compete more on discounts which should translate through to a more gradual re-pricing. It is worth noting however, that the ban on mortgage exit fees implemented in July 2011 is likely to lead to more churn as consumers respond to discounts.

2H17
3

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26 March 2014

Fig. 8: Industry average discount to SVR for mortgages

(bps) 90 80 70 60 50 40 30

Dec 04

Dec 05

Dec 06

Dec 07

Dec 08

Dec 09

Dec 10

Dec 11

Dec 12

Source: Nomura research, RBA

We also believe that the system level of discounts (reported by the RBA) does not always reflect the best available deal. As the figure below suggests, advertised rates across the banks is as high as 105bps for smaller mortgages and 120bps for larger mortgages (taking SUN as example).
Fig. 9: Comparison of discounts offered
Bank ANZ Current SVR (%) 5.88 Borrowing range (A$) 150,000 - 249,999 < 500,000 > 500,000 250,000 < 500,000 > 500,000 <249,999 250,000 - 499,999 > 500,000 WBC 5.98 150,000 - 249,999 250,000 - 499,999 > 500,000 Bankwest 5.89 200,000 - 500,000 500,000 - 750,000 > 750,000 St George 5.99 150,000 - 249,999 250,000 - 499,999 > 500,000 BEN 6.01 < 50,000 50,000 - 250,000 > 250,000 BOQ 6.01 n/a SVR discount (%) Net variable rate (%) 0.50 5.38 0.80 5.08 4.98 0.90 0.80 0.85 0.60 0.80 0.85 0.70 0.90 1.00 0.95 1.05 1.10 0.70 0.95 1.00 0.00 0.50 0.70 1.14 5.10 5.05 5.28 5.08 5.03 5.28 5.08 4.98 4.94 4.84 4.79 5.29 5.04 4.99 6.01 5.51 5.31 4.87 Clear Path product (A$10/mth) SUN 5.99 < 500,000 500,000 - 749,999 > 750,000 1.05 1.15 1.20 4.94 4.84 4.79 Home Package Plus (A$375 pa) Advantage package (A$395 pa) Premier Advantage k (A$395 pa) Package required to obtain discount Breakfree package (A$375 pa)

CBA

5.90

Dec 13

Jun 04

Jun 05

Jun 06

Jun 07

Jun 08

Jun 09

Jun 10

Jun 11

Jun 12

Jun 13

Wealth package (A$375 pa) Choice package (A$395 pa)

NAB

5.88

No package req'd

No package (A$8/mth)

Source: Nomura research, company data

Nomura | Australia Banks

26 March 2014

Our survey of the broker channel also suggests that ultimate discounts available to customers generally exceed a standard advertised discount. Our mystery shopping through the broker channel identified the following (targeted loan of A$500k or higher): 1. 2. 3. 4. Bankwest, SUN and St George offer most competitive rates amongst the large players (discounts vary from 105-115bps. ANZ and CBA offer most competitive rates across the majors (main brands). Although WBCs headline rate is 8-10bps above peers, its discounts largely offset that and its final rate is broadly in line with peers and lower than NAB. NAB is the least competitive across the majors, which when combined with its offering being made through the Homeside brand, arguably makes it a more difficult product for brokers to sell. BOQs offering of 8-32bps above peers leaves little surprises as to why BOQ has been losing market share. In terms of maximum LVRs (with mortgage insurance), banks generally offer 97% gearing with NAB appearing to be marginally more conservative (maximum LVR of 95%).

5. 6.

Fig. 10: Discounts offered via mortgage broker channel

Bank Bankwest SUN St George ANZ CBA WBC NAB BOQ Current SVR (%) 5.89 5.99 5.99 5.88 5.90 5.98 5.88 6.01 SVR discount (%) 1.05 1.15 1.10 0.98 1.00 1.05 0.80 0.85 Actual variable rate (%) 4.84 4.84 4.89 4.90 4.90 4.93 5.08 5.16 Max LVR (%) 98 97 97 97 97 97 95 n/a

Source: Nomura research, various mortgage brokers

Difference between growth and flows

While home lending growth figures are well understood, we note that in estimating banks success in writing new business, a distinction should be made between growth and flows. Based on the figure below, the average life of the mortgage has started to shorten since May 2011. We attribute three key reasons to the shorter duration of loans. First, as availability of funding has improved consumers are able to refinance with more ease. Secondly, lower interest rates are generally conducive to quicker repayments and thirdly, more competition generally leads to churn. We believe these dynamics are adverse to retail returns, which we will discuss in a later section of this report. Taking retention differences into account we note that over the last 12 reported months, the majors (excluding CBA) have generally seen flows of ~A$50bn in mortgages, while CBAs flows are ~1.7x the average of the peers.

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26 March 2014

Fig. 11: New flows in domestic mortgages

(A$bn) 90 80 70 60 46 50 40 24 30 20 10 0 ANZ 85

Fig. 12: Average loan life

(no. of years) 5 5 4.4 3.7 52 4 3.5 28 4 3 3 5.0 4.6 4.8

4.7

45 25

50

CBA 6-month flows

NAB WBC 12-month flows

2 May 07 May 08 May 09 May 10 May 11 May 12 May 13

Source: Nomura research, MOC

Note: Growth is to September 2013 for ANZ, NAB and WBC, and December 2013 for CBA. WBC data excludes RAMS portfolio Source: Nomura research, company data

Breaking this down into broker and proprietary flows, as the figures below highlight, 3 party flows are similar across the three majors at ~A$10-12bn in the six reported months. CBAs flows are again ~1.55x ahead of peers. Taking market share differences into the account, ANZ and CBA grew ahead of their natural share through the broker channel, while NAB and WBC grew below their natural share. We also note that in more recent periods WBCs flows through the broker channel have improved following changes in the commission structure. Looking at proprietary flows per branch suggests that CBA and NAB are delivering A$24mn and A$20mn respectively within a six-month window, while WBCs branch flows appears to materially lag peers. This suggests that at this point advertised pricing has been an important driver of flows both in proprietary and broker channels (which is not surprising in a relatively commoditised space).
Fig. 13: New flows in domestic m/gages via 3rd party channel
(A$bn) 40 30 20 10 0 ANZ CBA NAB WBC 6-month flows 12-month flows Ratio of mkt share of flows to mkt share of loans (RHS)
Note: Growth is to September 2013 for ANZ, NAB and WBC, and December 2013 for CBA. WBC data excludes RAMS portfolio Source: Nomura research, company data

rd

Fig. 14: New flows per branch

(A$mn) 50 40 30 30 20 10 16 13 24 20 46 39

(x) 1.3 1.1 23 13 0.9 0.7 0.5

32 22 17 11 10 21

23

0 ANZ CBA 6-month flows NAB 12-month flows WBC

Note: Growth is to September 2013 for ANZ, NAB and WBC, and December 2013 for CBA. WBC data excludes RAMS portfolio Source: Nomura research, company data

Nomura | Australia Banks

26 March 2014

Ultimately its all about returns

From a returns perspective, given the easing in funding conditions and re-pricing benefits implemented throughout the GFC, we believe that the returns earned on mortgages remain highly attractive. Our analysis highlights that the majors derive ~34% RoIC on new mortgages, while the regionals derive ~15% RoIC. Its worth noting that this analysis relies on a few key assumptions. In particular, funding costs which we base on a mix of both short term and long term debt as well as cost assumptions, which we estimate based on CBAs disclosure. Given there are clearly scale benefits in mortgages business, CBAs costs are likely to be towards the lower end of peers and hence return metrics for peers (particularly for ANZ and NAB) are likely to be lower (we provide sensitivity to costs below). Regional banks returns are materially lower for two key reasons, namely higher expense ratio (higher cost to income business) and lower level of gearing, albeit some benefits of lower gearing are offset for the majors due to operational risk and IROBB capital charges under the advanced model.
Fig. 15: Estimated ROIC on mortgages written through proprietary channels
(bps) SVR less discount Net Rate Cash rate Cash to bills spread Funding cost over BBSW Estimated cost of liquids Funding costs Gross interest margin Other income (assuming NII represents ~7% of II) Gross margin Costs Credit costs Net margin (after tax) Leverage (assume RWA 25% and CET1 9%) (x) RoIC (%)
Source: Nomura research, company data

RoIC on mortgages written through proprietary channels is ~34% for majors and ~15% for regionals

Majors 589 95 494 250 20 65 8 343 151 10 162 50 3 76 44 34

Regionals 601 95 506 250 20 85 8 363 143 10 153 75 3 53 28 15

When loans are written through a broker channel, there are three key elements that drive returns. First, banks pay upfront and trailing commissions which reduce their margin. Secondly, the cost base of originating the loan is significantly lower, as the origination component is eliminated. Lastly, we believe ongoing costs associated with keeping the mortgage are largely unchanged. Based on our assumptions we estimate the profitability (RoIC) of broker-originated loans to be ~27% for the majors and ~11% for the regionals. While our analysis highlights that the returns on broker-originated loans remain well above the cost of capital and are still arguably one of the higher returning products across the group, its profitability is ~6% lower than mortgages that were originated through the proprietary channel.
Fig. 16: Estimated ROIC on mortgages written through the broker channel
(bps) Gross margin Less amortisation of origination costs Assume ongoing costs Net margin (after credit costs and tax) RoIC for broker loans (%) Difference to proprietary-written loan (%)
Note: Loan life is assumed to be 4 years Source: Nomura research, company data

RoIC on mortgages written through the broker channel is ~6% lower

Majors 162 31 40 61 27 (6)

Regionals 153 31 65 38 11 (4)

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26 March 2014

On a blended basis, assuming ~45% of loans are written through the broker channel we estimate the majors current return on mortgages to be at ~31%. While this is a very healthy level of returns for the majors, we note that it is ~4% below the level of returns we estimate the majors generated 12 months ago (~34.8%). Also, our return analysis is based on discount rates of 95bps, and as we highlighted earlier discounts (particularly though the broker channel) currently exceed that.
Fig. 17: Blended RoIC on combination of proprietary and broker channels
RoIC for proprietary-written loan (%) RoIC for broker-written loan (%) Assume proportion of loans from brokers (%) Blended RoIC (%)
Source: Nomura research, company data

The blended RoIC is around 31%

Majors 34 27 45 31

The figure below provides a sensitivity analysis on the majors profitability based on the level of discounts through both proprietary and broker channels. We believe the level of profitability for the majors falls to ~27% and ~21% respectively when the level of discount is increased to 115bps, while at 125bps discount profitability for the broker channel falls below 20%. We note that all of our calculations are based on SVR rate of 5.89% (broadly consistent across the three majors), while WBCs profitability is enhanced by a higher starting SVR.
Fig. 18: Sensitivity of ROIC to SVR discounts
RoIC (%) 55 50 45 40 35 30 25 20 15 10 45 70 Proprietary 95 Broker 105 115 125 Discount (bps)

Sensitivity of RoIC to the level of discounting

Source: Nomura research, company data

While the life of the mortgage plays an important role in the profitability of that loan, we found that once the loan stays on banks books for over 2 years, the improvement in profitability is gradual. In that regard banks appear to be increasingly protecting themselves by incentivising brokers to reduce churn by paying higher commissions in later years and in some instances not paying trail commission in the first two years.
Fig. 19: Sensitivity of ROIC to life of loans - broker channel
Life of loan (yrs) 1 4 6 10
Source: Nomura research, company data

Sensitivity of RoIC on brokeroriginated loans to loan life

ROIC (%) Majors 23 27 28 28

We found a peculiar arrangement within the broker channel whereby brokers get rewarded upfront commission based on the total amount borrowed rather than the net amount drawn. Given that loans with an offset now represent ~36% of balances and arguably the proportion of new loans with an offset balance is even higher, the profitability of the mortgage could be impacted by the amount that the customer has in savings at the start of the loan.

Nomura | Australia Banks

26 March 2014

We estimate that the RoIC on a four-year mortgage falls by ~1% when the borrower has 20% of the borrowed amount in an offset account. And the RoIC is reduced by ~7% on a mortgage where a customer has ~60% in the offset account.
Fig. 20: Sensitivity of majors RoIC to offset balances broker channel
RoIC (%) 30 25 20 15 10 5 0 10 20 40 60 80 Offset balances(%)

Source: Nomura research, company data

What does this all mean for banks profitability?

While mortgages funding costs and leverage has changed materially since the beginning of the GFC, banks ability to re-price has led to gross margin increasing from 180bps before 2008 to ~345bps today.
Fig. 21: Spread between industry average mortgage SVR and cash rate
(%) 4.0 3.5 3.0 2.5 2.0 1.5 1.0
Jun 04 Oct 04 Feb 05 Jun 05 Oct 05 Feb 06 Jun 06 Oct 06 Feb 07 Jun 07 Oct 07 Feb 08 Jun 08 Oct 08 Feb 09 Jun 09 Oct 09 Feb 10 Jun 10 Oct 10 Feb 11 Jun 11 Oct 11 Feb 12 Jun 12 Oct 12 Feb 13 Jun 13 Oct 13 Feb 14
Source: Nomura research, RBA, IRESS

Based on our estimates this has meant that RoIC on mortgages through the proprietary channel increased from ~24% before the GFC to ~34% in the current environment. We note that our estimates for 2007 assume that the mortgage book was largely funded by short term funding with no liquids and the leverage ratio was 73x (ie. 5.5% required core capital).

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26 March 2014

Fig. 22: Estimated ROIC on mortgages through proprietary channel

(bps) SVR less discount Net Rate Cash rate Cash to bills spread Funding cost over BBSW Estimated cost of liquids Funding costs Gross interest margin Other income (assuming NII represents ~7% of II) Gross margin Costs Credit costs Net margin (after tax) Leverage (assume RWA 25% and CET1 9%) (x) RoIC (%)
Source: Nomura research, company data

2014 589 95 494 250 20 65 8 343 151 10 162 50 3 76 44 34

2007 805 70 735 625 20 0 0 645 90 10 100 50 3 33 73 24

While we believe the benefits of improved mortgage profitability have largely been offset by lower profitability on the deposit book, as funding conditions improve we expect competitive pressure to continue to impact what now appears to be an abnormally highreturning mortgage portfolio. Our analysis suggests that if mortgage returns stay at current levels over time banks overall group returns are likely to decline by ~1%, with ~4% downside risk to earnings and 6-8bps negative impact to margins. However if returns on mortgages were to return to ~25% level which was observed prior to GFC, this is likely to lead to ~8% downside risk to earnings and 13bps decline in group margins (we note that all this is based on all other factors remaining constant). While our analysis suggests NAB is the most impacted bank, we note that this is largely a result of its poor-returning UK business. Assuming UK issues will be resolved through either a sale or an improvement in conditions, NABs impact is less material. As a result we continue to believe that the retail banks (ie. CBA and WBC) are more exposed to the competitive pressures in mortgages (due to their over-65% exposure to the segment). We also believe that WBCs highest SVR leaves the bank most exposed to a reduction in returns in mortgages over the medium term.

10

Nomura | Australia Banks

26 March 2014

Fig. 23: Sensitivity of Group RoIC to changes in mortgage RoIC

ANZ Current RoIC on mortgages (%) Current Group RoIC (%) Implied valuation multiple (x) Sensitivity Mortgage RoIC (%) 30 25 20 Assuming mortgage RoIC at 25% Implied downside to NIM (bps) Implied downside to NPAT (%) Implied downside to valuation (%) Assuming mortgage RoIC at 30% Implied downside to NIM (bps) Implied downside to NPAT (%) Implied downside to valuation (%)
Source: Nomura research, company data

CBA 35 31 5.1

NAB 35 20 3.1

WBC 35 26 4.2

35 24 3.8

Group RoIC (%) 23.2 22.4 21.5 29.3 28.0 26.7 19.4 18.4 17.5 24.9 23.7 22.5

10.9 (6.9) (8.7)

14.7 (8.3) (10.0)

12.0 (9.3) (12.4)

15.1 (9.0) (11.1)

5.5 (3.4) (4.3)

7.4 (4.2) (5.0)

6.0 (4.7) (6.2)

7.6 (4.5) (5.6)

11

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26 March 2014

Annex A Key stats on mortgage exposures

Fig. 24: Bank losses on mortgages
(bps) 100 80 60 40 20 0
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
227bps (09)

Fig. 25: Proportion of loan book in mortgages

(%) 80 70 60 50 40 30 20 10 0 ANZ CBA NAB WBC BEN BOQ
Note: Data based on 2H13 except for CBA and BEN based on 1H14 Source: Nomura research, company data

65 53 55

67

69

73

Australia

US

UK

Source: Nomura research, company data, Federal Reserve,

Fig. 26: Composition of mortgage book by selected types of loans (by value)
(%) 60 50 40 30 20 10 0 All ADIs All banks Building Credit Major banks Other Foreign subs societies unions domestic banks banks With offset Int-only Low-doc loans 3 3 35 35 35 35 25 16 0 16 0 4 3 36 36 27 29 20 32 51

Not surprisingly, the banks have the highest proportion of interest-only loans, likely reflecting a larger investor client base. Across the industry, lowdoc loans are minimal in representation

Source: Nomura research, APRA

Fig. 27: Proportion of book in owner-occupier loans

(%) 88 83 78 73 68 63
Jun 08 Jun 09 Jun 10 Jun 11 Jun 12 Mar 08 Mar 09 Mar 10 Mar 11 Mar 12 Sep 08 Sep 09 Sep 10 Dec 08 Dec 09 Dec 10 Dec 11 Dec 12 Mar 13 Jun 13 Dec 13 Sep 11 Sep 12 Sep 13

The majors have had a consistent weighting to owneroccupier loans, while credit unions and building societies have traditionally had much higher exposure to owneroccupier borrowers

All ADIs Credit unions

Source: Nomura research, APRA

Major banks Other domestic banks

Building societies Foreign subs banks

12

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26 March 2014

Fig. 28: LVR of new loan approvals - major banks

(%) 24 22 20 18 16 14 12 10 8
Sep 08 Sep 09 Sep 10 Sep 12 Sep 13 Dec 08 Dec 09 Dec 10 Dec 11 Dec 12 Dec 13 Sep 11 Jun 08 Jun 09 Jun 10 Jun 11 Jun 12 Mar 08 Mar 09 Mar 10 Mar 11 Mar 12 Mar 13 Jun 13

Post-GFC, the proportion of loans with LVRs >90% fell from ~21% in December 2008 to ~9% in June 2010. This reflected the reduced risk appetite among borrowers, as well as stricter lending standards at the banks

LVR 80%-90%
Source: Nomura research, APRA

LVR>90%

Fig. 29: Breakdown of new approvals by LVR (December 2013 quarter)

(%) 100 90 80 70 60 50 40 30 20 10 0 All ADIs All banks Building societies LVR 60%-80% Credit unions Major banks Other Foreign subs domestic banks banks LVR>90% 25 25 50 20 25 23 25 41 41 24 44 41 42 43 14 21 13 21 13 14 16 20 13 21 17 19 11 20

Risk appetite has recovered slightly, with ~13% of loans having LVRs above 90%. Building societies appear to be most conservative

LVR<60%
Source: Nomura research, APRA

LVR 80%-90%

Fig. 30: Banks policies on LMI risk retention

Banks policies on LMI ANZ For LVR 80-90%, exposure is retained with group captive insurer For LVR >90%, 35% of exposure is retained, remaining 65% is externally insured CBA For LVR of 80-90%, exposure is retained for "low risk customers" For all others, risk is passed to Genworth or QBE NAB WBC All LMI loans are externally underwritten For LVRs of 80-90% (as well as Low Doc LVR 60-80%), WBC will retain risk for 40% of exposures, rest is passed to Genworth,QBE, Arch Re and Tokio Millenium For LVR >90%, risk is passed to external insurers
Source: Nomura research, company data

With respect to LMI risk retention, NAB seems to be the most conservative, while ANZ appears to be taking on most risk and is the only major to retain any risk for loans with >90% LVR

13

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26 March 2014

Appendix A-1
Analyst Certification
We, Victor German and Anthony Hoo, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures

The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers

Issuer ANZ Bendigo and Adelaide Bank Bank of Queensland Commonwealth Bank National Australia Bank Westpac Banking Corp Ticker ANZ AU BEN AU BOQ AU CBA AU NAB AU WBC AU Price AUD 32.55 AUD 11.25 AUD 12.96 AUD 76.39 AUD 35.04 AUD 34.28 Price date Stock rating Previous rating 26-Mar-2014 Neutral Reduce 26-Mar-2014 26-Mar-2014 26-Mar-2014 26-Mar-2014 26-Mar-2014 Buy Buy Neutral Buy Neutral Neutral Neutral Reduce Neutral Buy Date of change Sector rating 01-May-2011 N/A 23-Oct-2013 23-Oct-2013 27-Feb-2013 05-May-2011 10-Oct-2012 N/A N/A N/A N/A N/A

Important Disclosures
Online availability of research and conflict-of-interest disclosures
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The distribution of all ratings published by Nomura Global Equity Research is as follows: 42% have been assigned a Buy rating which, for purposes of mandatory disclosures, are classified as a Buy rating; 43% of companies with this rating are investment banking clients of the Nomura Group*. 47% have been assigned a Neutral rating which, for purposes of mandatory disclosures, is classified as a Hold rating; 55% of companies with this rating are investment banking clients of the Nomura Group*. 11% have been assigned a Reduce rating which, for purposes of mandatory disclosures, are classified as a Sell rating; 26% of companies with this rating are investment banking clients of the Nomura Group*. As at 31 December 2013. *The Nomura Group as defined in the Disclaimer section at the end of this report.

Explanation of Nomura's equity research rating system in Europe, Middle East and Africa, US and Latin America, and Japan and Asia ex-Japan from 21 October 2013
The rating system is a relative system, indicating expected performance against a specific benchmark identified for each individual stock, subject to limited management discretion. An analysts target price is an assessment of the current intrinsic fair value of the stock based on an appropriate valuation methodology determined by the analyst. Valuation methodologies include, but are not limited to, discounted cash flow analysis, expected return on equity and multiple analysis. Analysts may also indicate expected absolute upside/downside relative to the stated target price, defined as (target price - current price)/current price.

STOCKS

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A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. Benchmarks are as follows: United States/Europe/Asia exJapan: please see valuation methodologies for explanations of relevant benchmarks for stocks, which can be accessed at: http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology; Japan: Russell/Nomura Large Cap.

SECTORS
A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Sectors that are labelled as 'Not rated' or shown as 'N/A' are not assigned ratings. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Japan/Asia ex-Japan: Sector ratings are not assigned.

Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan prior to 21 October 2013 STOCKS
Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. A 'Neutral' recommendation indicates that potential upside is less than 15% or downside is less than 5%. A 'Reduce' recommendation indicates that potential downside is 5% or more. A rating of 'Suspended' indicates that the rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain circumstances including when Nomura is acting in an advisory capacity in a merger or strategic transaction involving the subject company. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage of the Nomura entity identified in the top banner. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies.

SECTORS
A 'Bullish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a positive absolute recommendation. A 'Neutral' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a neutral absolute recommendation. A 'Bearish' rating means most stocks in the sector have (or the weighted average recommendation of the stocks under coverage is) a negative absolute recommendation.

Target Price
A Target Price, if discussed, reflects in part the analyst's estimates for the company's earnings. The achievement of any target price may be impeded by general market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the company's earnings differ from estimates.

Disclaimers
This document contains material that has been prepared by the Nomura entity identified at the top or bottom of page 1 herein, if any, and/or, with the sole or joint contributions of one or more Nomura entities whose employees and their respective affiliations are specified on page 1 herein or identified elsewhere in the document. The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries and may refer to one or more Nomura Group companies including: Nomura Securities Co., Ltd. ('NSC') Tokyo, Japan; Nomura International plc ('NIplc'), UK; Nomura Securities International, Inc. ('NSI'), New York, US; Nomura International (Hong Kong) Ltd. (NIHK), Hong Kong; Nomura Financial Investment (Korea) Co., Ltd. (NFIK), Korea (Information on Nomura analysts registered with the Korea Financial Investment Association ('KOFIA') can be found on the KOFIA Intranet at http://dis.kofia.or.kr); Nomura Singapore Ltd. (NSL), Singapore (Registration number 197201440E, regulated by the Monetary Authority of Singapore); Nomura Australia Ltd. (NAL), Australia (ABN 48 003 032 513), regulated by the Australian Securities and Investment Commission ('ASIC') and holder of an Australian financial services licence number 246412; P.T. Nomura Indonesia (PTNI), Indonesia; Nomura Securities Malaysia Sdn. Bhd. (NSM), Malaysia; NIHK, Taipei Branch (NITB), Taiwan; Nomura Financial Advisory and Securities (India) Private Limited (NFASL), Mumbai, India (Registered Address: Ceejay House, Level 11, Plot F, Shivsagar Estate, Dr. Annie Besant Road, Worli, Mumbai- 400 018, India; Tel: +91 22 4037 4037, Fax: +91 22 4037 4111; SEBI Registration No: BSE INB011299030, NSE INB231299034, INF231299034, INE 231299034, MCX: INE261299034) and NIplc, Madrid Branch (NIplc, Madrid). CNS Thailand next to an analysts name on the front page of a research report indicates that the analyst is employed by Capital Nomura Securities Public Company Limited (CNS) to provide research assistance services to NSL under a Research Assistance Agreement. CNS is not a Nomura entity. THIS MATERIAL IS: (I) FOR YOUR PRIVATE INFORMATION, AND WE ARE NOT SOLICITING ANY ACTION BASED UPON IT; (II) NOT TO BE CONSTRUED AS AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITY IN ANY JURISDICTION WHERE SUCH OFFER OR SOLICITATION WOULD BE ILLEGAL; AND (III) BASED UPON INFORMATION FROM SOURCES THAT WE CONSIDER RELIABLE, BUT HAS NOT BEEN INDEPENDENTLY VERIFIED BY NOMURA GROUP. Nomura Group does not warrant or represent that the document is accurate, complete, reliable, fit for any particular purpose or merchantable and does not accept liability for any act (or decision not to act) resulting from use of this document and related data. To the maximum extent permissible all warranties and other assurances by Nomura group are hereby excluded and Nomura Group shall have no liability for the use, misuse, or distribution of this information. Opinions or estimates expressed are current opinions as of the original publication date appearing on this material and the information, including the opinions and estimates contained herein, are subject to change without notice. Nomura Group is under no duty to update this document. Any comments or statements made herein are those of the author(s) and may differ from views held by other parties within Nomura Group. Clients should consider whether any advice or recommendation in this report is suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice. Nomura Group does not provide tax advice. Nomura Group, and/or its officers, directors and employees, may, to the extent permitted by applicable law and/or regulation, deal as principal, agent, or otherwise, or have long or short positions in, or buy or sell, the securities, commodities or instruments, or options or other derivative instruments based thereon, of issuers or securities mentioned herein. Nomura Group companies may also act as market maker or liquidity provider (within the meaning of applicable regulations in the UK) in the financial instruments of the issuer. Where the activity of market maker is

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carried out in accordance with the definition given to it by specific laws and regulations of the US or other jurisdictions, this will be separately disclosed within the specific issuer disclosures. This document may contain information obtained from third parties, including ratings from credit ratings agencies such as Standard & Poors. Reproduction and distribution of third party content in any form is prohibited except with the prior written permission of the related third party. Third party content providers do not guarantee the accuracy, completeness, timeliness or availability of any information, including ratings, and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such content. Third party content providers give no express or implied warranties, including, but not limited to, any warranties of merchantability or fitness for a particular purpose or use. Third party content providers shall not be liable for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including lost income or profits and opportunity costs) in connection with any use of their content, including ratings. Credit ratings are statements of opinions and are not statements of fact or recommendations to purchase hold or sell securities. They do not address the suitability of securities or the suitability of securities for investment purposes, and should not be relied on as investment advice. Any MSCI sourced information in this document is the exclusive property of MSCI Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, re-disseminated or used to create any financial products, including any indices. This information is provided on an "as is" basis. 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Additional information is available upon request and disclosure information is available at the Nomura Disclosure web page: http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx Copyright 2014 Nomura Australia Ltd.. All rights reserved.

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