2017 has been a landmark year for the Westpac Group. As CEO, it has been an immense honour to lead this company through our 200th year and into our third century of business.
At events across the country, and in many of our overseas offices, I have had the pleasure of speaking with thousands of our customers, community partners, and staff members. It has given me—and I know many of our people—a tremendous sense of pride in this company and the role it has played in the lives of so many Australians and New Zealanders throughout its history.
There were many special moments during these events. As a history ‘tragic’, a particular highlight for me was meeting Bill McRae, a former employee who served as a Lancaster Bomber Command pilot in the Royal Air Force during the Second World War. Bill joined the Bank of New South Wales in 1929, working in Sydney before our legendary General Manager, Alfred Davidson, sent him to London to help build our business in the UK (Alfred Davidson helped restore Australia’s prosperity during the Great Depression by initiating the devaluation of the Australian pound). Bill shared anecdotes of his time in the Royal Air Force and at the Bank on both sides of the war—including how he was chosen to set up the Bank’s first training academy, thanks to his experience training pilots during the War. I will cherish his stories.
I also enjoyed meeting customers such as the McDonald family from Cloncurry, who have banked with Westpac (or the Bank of New South Wales) since the 1860s. One customer even brought along his ancestor’s Bank of New South Wales passbook from 1827—still proudly passed down as a family heirloom.
We are proud of such long-term connections, but few have been longer than our partnership with AGL. For 170 years we have worked together to build their business and create a brighter future (literally) for Australians.
Another highlight was sharing a stage in April with five of Westpac’s former leaders: Gail Kelly, David Morgan, Bob Joss, Frank Conroy, and Bob White (who sadly passed away in June). As the Chairman writes in his letter, it was extraordinary to have some of the great minds of Westpac all in one place. To put it in perspective, since 1992 these executives have presided over an increase in the value of your bank from just less than $5 billion to over $108 billion today—the total shareholder return over that time averaging 13% per annum.
There aren’t many companies of our size who could get such an unbroken chain of former leaders together; and each of them provided interesting insights from their time as CEO and observations about today’s business. What really struck me though was the consistency of their message over time—the focus on customers, the importance of a strong balance sheet and inclusive culture, and their pride in Westpac’s broader role in the community. It was also pleasing to hear each of them endorse our ‘Service Revolution’ as the natural extension of these principles and the right strategy for today.
As I’ve described in previous letters, our ‘Service Revolution’ strategy is designed to bring to life our vision “To be one of the world’s great service companies, helping our customers, communities, and people to prosper and grow”. Our strategy has remained consistent over several years now, and I’m pleased to report that we’ve continued to build momentum and deliver projects against each of the five priorities that comprise the strategy: Performance disciplines, service leadership, digital transformation, targeted growth, and workforce revolution.
At its heart, this strategy recognises that we’re a service business, not a product business—which means that our core purpose is to help customers achieve what’s important to them. For shareholders, this means that we create value by building long-term relationships with our customers—supporting them through thick and thin.
Customers like Ian Peterson from Airlie Beach in Northern Queensland who we have supported for many years but never more critically than in the aftermath of Cyclone Debbie.
We recognise that our industry, like the economy as a whole, is currently undergoing a period of substantial change. That’s why our primary focus as a management team is on transforming the company—through the ‘Service Revolution’ program—to make sure we can continue to compete and grow value successfully over the medium-to-long term.
In summary then, our long-term strategy to create value is to:
With this in mind, let me turn now to our 2017 performance.
At the start of the financial year, with the support of your Board, the executive team and I agreed three over-arching goals for our 200th year:
Looking back over the year, I’m pleased with the progress on each of these goals—although we’ve clearly got more to do.
Our financial performance exceeded the internal earnings target that we set at the start of the year. Cash earnings rose 3%, with a 2% increase in operating income, a 2% rise in expenses, and a substantial reduction in impairment charges for bad debts. At the same time, we significantly strengthened our balance sheet, lifting our common equity tier 1 (CET1) capital ratio above APRA’s benchmark for banks to be seen as ‘unquestionably strong’. As these results include the start of the Federal Government’s new bank levy, increased ‘macro-prudential’ lending requirements, and a provision to remediate a number of historical customer issues (I’ll address these shortly), we consider this to be a good result. (Note too that our cash earnings exclude the gain on the sale of shares in BT Investment Management (BTIM) during the period, which benefits shareholders’ equity. This gain is included in our reported statutory profit.)
All of our banking divisions performed well, with cash earnings growth of between 4% and 18%. However, earnings from BT Financial Group (BTFG) (our wealth management and insurance business) were 11% down on last year. This was primarily driven by a number of infrequent items, as well as significant incremental regulatory and compliance costs. However, underlying growth in funds under administration, insurance premiums, and lending within BTFG continued to be strong.
We sold down our shareholding in BTIM this year from 29% to 10%, booking a gain of $279 million. It’s worth reflecting that this has been an outstanding investment for our shareholders, many of whom also participated in BTIM’s initial float back in 2007. The decision to sell down reflects our belief that the future of this business is about ‘open architecture’ platforms that provide customers and advisors with a convenient place to manage all of their money, wherever they choose to invest it. While some of our competitors are increasingly looking to exit their wealth and insurance businesses, we continue to believe that having a strong business in this category will give us an increasing competitive advantage as Australia’s population ages in the years ahead.
Within our banking businesses, there were a number of significant dynamics at play this year that are worth highlighting.
The first was in Australian mortgages, where APRA extended its requirements for banks in ways designed to improve the resilience of the sector to a potential downturn or substantial increase in interest rates. Specifically, we were required to maintain investor mortgage growth to less than 10% per year, and to reduce the proportion of new mortgage lending with an interest-only option to below 30%. Through a combination of pricing and other actions, both of these targets were met: Investor mortgage lending grew at around 6%, and the proportion of interest-only lending for the September 2017 quarter was 26%. However, the consequence of these and other changes on loan serviceability assessments was that our overall mortgage lending grew a little slower than the overall financial system this year—a result we were comfortable with.
Looking at our balance sheet more broadly, we continued to prioritise strong growth in deposits while limiting growth in lending to where returns remain attractive. Total deposits were up 4% for the year, with high quality household deposits growing faster than the financial system. Overall loans grew 3%, with strong growth in small and medium business as well as the faster-growing service sectors of health, education, and tourism. However, this was offset by slower growth in areas such as commercial property, trade finance and auto finance, where strong competition from offshore firms has made the returns much less attractive.
We substantially increased the strength of our capital position this year as well. Our CET1 capital ratio increased more than a full percentage point to 10.6%, due to business unit profit growth, our dividend reinvestment plan, the further sell-down in BTIM, and better capital efficiency. Although we are still waiting for APRA’s final capital rules, it is satisfying to know that the strengthening of our balance sheet required post the GFC is now nearing its end.
Our funding and liquidity position also improved over the year. We’ve grown deposits, reduced our reliance on offshore short-term wholesale funding, and further lengthened the tenor of funding. We also met the new Net Stable Funding Ratio requirements (essentially a measure of our longer-term liquidity position) almost a year before the required 1 January 2018 start date.
The combination of all of these factors meant that net interest margin was down 4 basis points over the year, including one quarter’s impact of the Federal Government’s Bank Levy (which reduced the margin by 1 basis point). Most of the margin decline happened early in the year, with the impact of repricing and a greater focus on return leading to higher margins in the second half of the financial year.
Asset quality remained strong during the year, with the ratio of stressed assets to total committed exposures (TCE) declining 15 basis points to 1.05%, and a significant reduction in credit impairment charges over the year. This reflects both a reduction in new impaired assets along with the work-out of a small number of larger impairments during the year. Mortgage delinquencies have also been sound with little change over the year—although we are monitoring Western Australia and regional Queensland closely, as these regions continue to be impacted by the slowdown in mining investment. Fortunately, recent indicators suggest that the worst may now have passed, especially in Western Australia.This year we’ve deliberately prioritised strength and return over growth to reshape the balance sheet
Non-interest income was a little lower over the year (down $36 million). The Group recorded higher markets income (particularly in the first half of the year), improved business line fees, and good funds management and insurance flows—however these gains were offset by regulatory reductions to credit card interchange fees as well as provisions for customer payments that totalled $169 million (most of which was included in non-interest income).
Operating expenses grew 2% over the year, which was at the lower end of the 2-3% medium term range that we expect—a good result. In a challenging revenue environment, our goal continues to be to offset business-as-usual expense growth with productivity savings. This year we generated $262 million in productivity savings—equal to around 3% of our cost base—and removed over 900 roles. Some of the productivity initiatives we completed this year included:
Thanks to initiatives like these, the overall 2% rise in expenses was largely driven by investments we are making in our strategic agenda, along with some increases in cost for regulatory and compliance activities. The cost to income ratio for Full Year 2017 was 42.2%, which puts us among the most efficient banks in the world, and we remain committed to taking this ratio below 40% over the next few years.
At a cash earnings level, 3% growth in cash earnings translated to a 2% increase in earnings per share—mostly due to the impact of additional shares issued under the dividend reinvestment plan. What this highlights is that higher capital levels come at a cost: With increased capital during the year contributing to a 22 basis point decline in return on equity (ROE) to 13.8% (although that level remains within the 13% to 14% band the Group is seeking to achieve).
The best assessment of whether we are achieving our goal of becoming one of the world’s great service companies comes from our customers and, given the size and scope of our businesses, we look at a number of different customer feedback measures to help us evaluate our performance.
Although any sample-based survey of customer feedback has its drawbacks, one of the best overall measures is the Net Promoter Score (NPS), which looks at the relationship between customers who are advocates for the bank versus customers who are detractors of the bank. Pleasingly, the NPS of our consumer banking business has gradually improved over the year, moving from the bottom of our major bank peer group 12 months ago to being ranked first in September 2017.
Another measure we track is the volume of complaints we receive, and the relationship between those complaints and the compliments received over the same period. This year customer complaints across our Australian operations fell 18% compared to Full Year 2016, continuing a trend that we’ve seen for the last several years. Meanwhile compliments received by our branch network outnumbered complaints by 3.5 to 1, improving from 3 to 1 last year.
Few things frustrate customers more than not having services available when they need them. This year, improvements to our infrastructure have led to a material reduction in system downtime: In the first half of Full Year 2017 we recorded five ‘severity one’ incidents (system outages with a significant customer impact) in Australia—and we had no such outages in the second half of the year. This compares with 19 such incidents in the previous year.
Improvements in our technology and processes are reinforced by the Our Service Promise program, a Group-wide initiative that defines excellent service for our people and reminds them to incorporate this mindset into action every day. The program is fundamental to our efforts to build a genuine service culture, and it’s working. Across the Westpac Group I regularly see examples of our people taking the initiative to solve a customer’s problem, to find creative ideas that help our customers to thrive financially, and to build genuine long-term relationships.
It’s also important that I, and my leadership team, support our people to deliver that high standard of service. So this year we’ve worked to reduce roadblocks for our people and free up more time for them to spend with customers: We’ve digitised time-absorbing tasks, improved the usability of staff tools, and reduced the number of products on offer—making it easier for our people to recommend the right product and navigate our processes.
In our Consumer Bank, we’ve also removed product-based sales incentives for our front line tellers and personal bankers, replacing them with service-based metrics. This means that our people are now more empowered to deliver better service to customers and indeed are explicitly rewarded for doing so.
Westpac’s 3% increase in cash earnings was mainly due to good balance sheet growth combined with a 24% reduction in impairment charges.
Net interest income was 2% higher over the year with most of the growth due to an increase in housing lending and a 4% rise in customer deposits. Business lending was more subdued with an increase in facilities to small and medium enterprises partially offset by a reduction in commercial property and asset finance where returns were lower. Margins were 4 basis points lower over the year with continuing strong competition across both lending and deposits.
Non-interest income was down with a lower contribution from credit cards and wealth offset by stronger markets income. Most of the 2% rise in expenses was due to higher investment and increased regulatory and compliance costs.
Impairment charges declined by $271 million as asset quality continued to improve. The improvement was due to fewer new impaired assets emerging over the year along with more companies returning to fully performing.
As a service business in a highly competitive market, the quality of our people and culture is a major determinant of our success. That’s why we’re so focused on making the Westpac Group attractive to the best bankers in the market, and creating an environment where those people can do their best work.
The 200th anniversary gave us the opportunity to remind our people of the role our company has played—and continues to play—in helping our customers and Australia/New Zealand as a whole to thrive. As a result, we’ve seen a significant increase in staff pride over the year. This—along with investments we’ve made in our people’s skills, leadership training, and a variety of community and sustainability initiatives during the year—has led to a significant increase in staff morale, as measured by our employee survey.
We recognise careers are changing and we’re supporting our people to develop their skills and embrace new opportunities. Johanne Parniczky is a great example of this. From a former career as a commercial pilot, Johanne is bringing a fresh perspective and innovation to our organisation as a change director on one of our biggest technology infrastructure programs.
On our preferred measure of ‘staff engagement’, we saw a 10 percentage-point increase over the year to 79%. This is above the global high-performance benchmark for large companies, and a remarkable increase in a year for a company with over 39,000 employees.
As well as investing in our people’s skills, we continue to work hard to make sure the culture is one where everyone feels welcome and supported. Our 2017 Sustainability Performance Report sets out a number of the initiatives we undertook this year, but one milestone deserves special mention: In 2017 Westpac reached its target of having 50% of its leadership positions held by women. Of course, we have more to do to ensure diversity is better reflected across the organisation, but this is a significant achievement.
It’s no secret that bank reputations have been under scrutiny over the past few years, and Westpac has not been immune. Given the amount of media attention this has received in recent months, I’d like to make a few observations about the causes of this situation and what we’re doing about it.
There are a number of causes, starting with missteps by the banks themselves—including Westpac. These include high-profile incidents around poor financial advice, denied insurance claims, poor service, loose or inadequate risk controls, and allegations of inappropriate staff behaviour. Although many of these incidents have been specific to individual institutions, in the current environment each one affects the reputation of the industry as a whole.
Compounding these issues has been a significant step-up in community expectations and regulatory intervention. This has meant that some policies or business practices that were acceptable in the past no longer pass muster.
At the same time, the volatile political situation in our State and Federal Parliaments means that issues which would previously have been dealt with by the appropriate regulator are now attracting attention from all sides of politics.
The banking sector is working hard to address these concerns and has nearly completed implementing a six-point action plan that addresses issues like sales incentives, complaint handling, support for whistle-blowers, and the removal of individuals from the industry who breach the law or codes of conduct. Westpac is fully committed to this effort and has completed its work on five of the six points (the final point, a re-write of the Code of Banking Practice, should be finished next month).
In Westpac’s case, we have participated in a large number of formal reviews this year by our various regulators and political bodies, covering topics such as financial planning, insurance, superannuation, mortgage lending and pricing practices, credit cards, systems stability, and anti-money laundering. The Australian Securities and Investments Commission (ASIC) has also initiated various legal proceedings against us, alleging we manipulated the bank bill swap rate (BBSW), provided inappropriate financial advice through our ‘scaled advice’ phone channel, and breached our responsible lending obligations. Our principle is to accept responsibility when we have done the wrong thing, but in each of these cases we disagree with ASIC’s position and are defending our actions.
Regardless of the merits, the reality is that the industry has a significant challenge ahead to rebuild its reputation. In particular, we need to address the perception that we put our own needs ahead of those of our customers.
In funding loans to customers, Westpac draws from three main sources: customer deposits, wholesale funding and equity. The rates we pay on each of these sources of funds is determined by market forces within each category.
While the Reserve Bank of Australia’s cash rate is a market indicator, banks do not borrow money at that rate. Moreover, the relationship between the cash rate and the rates we pay over time varies. Prior to the GFC for example term deposit rates were generally below the cash rate. Today, those taking out a term deposit can often receive a rate well above the cash rate.
We set our lending rates based on our funding costs, ensuring we earn an appropriate return for shareholders and for the risk we take when we lend money. It is a balancing act and we need to consider the needs of borrowers, depositors and shareholders. We understand that these decisions impact people but feel we achieved the right balance with margins declining 4 basis points this year.
Across the bank we are proactively reviewing our products and services and the way we have engaged with our customers. I call this program ‘Get it Right/Put it Right’. The idea is to make sure that we align all of our products and services with our customers’ interests, while making them simpler, fairer, and more transparent. And, where we uncover an issue that we need to put right, we ensure that no customer has been disadvantaged from these past practices. This work has already led to a number of important changes and actions.
We’ve introduced our new Westpac Lite credit card, with an interest rate of 9.9% p.a.—the first card of its kind in the Australian market. We’ve also reduced everyday transaction fees on our ‘legacy’ personal transaction accounts, and removed ATM withdrawal fees when non-customers use one of our ATMs.
Our reviews of our superannuation disclosure resulted in payments to some customers with pre-existing conditions who did not have the benefit of our improved disclosure practices. Similarly, we identified that for some product packages sold in the past, customers did not receive all the benefits to which they were entitled—and we’re now going back and rectifying the error for each affected customer. We’ve also automated these benefits so this can’t happen again.
Based on what we know now, we believe we have dealt with the most significant of these issues in our 2017 result. However, these reviews will continue for some time and it is possible that more issues will emerge that we need to address. In any event I am confident that this is the right approach to put our business on a more sustainable footing.
In November last year we appointed Adrian Ahern, a highly respected former senior lawyer, as our first ‘Customer Advocate’. Mr. Ahern reports through to me separate from our businesses, and is thus an independent avenue for customers to seek a fair and balanced outcome for their complaints. Our new Customer Council and the new Stakeholder Advisory Panel are both designed to help us better understand customer and community views and identify areas where we could do better. We have also taken steps to encourage our people to speak up when they see something that isn’t right, including a new anonymous phone line and additional protections for whistle-blowers. As a result, we have seen a significant (up 10%) increase in employees confirming they feel it is ‘safe to speak up’¹.
The current level of public and political scrutiny is likely to continue for some time. Hopefully you can see from the initiatives above that we are committed to taking actions that will address the substantive issues over time.
One of the highlights of 2017 was retaining our position as the most sustainable bank globally in the Dow Jones Sustainability Index (DJSI). This was the fourth year in a row and 10th time overall that Westpac has achieved the global banking sector’s leadership position. The DJSI assesses companies on a range of criteria including corporate governance, codes of conduct, HR practices, community involvement, and environmental policies.
A commitment to sustainable business practices is a big part of the culture at Westpac: In fact many of our staff have told me that they were attracted to work at Westpac in large part because of these policies.
This year we released an updated Climate Change Action Plan, which attracted significant media and community attention. In our plan we outlined the steps we will take to meet our commitment to helping limit global warming to less than two degrees. This includes our approach to lending to energy-intensive and renewable sectors, reducing our own carbon footprint, and helping Australian households to become more climate-resilient, improve their energy efficiency and reduce their environmental impact.
The feedback we received on our new climate policy was overwhelmingly positive. However I know that there are some shareholders who do not agree with our policy, and who believe that our actions have overstepped the mark. Some of you told us that banks should stay out of the climate debate and just focus on their lending activities. We respectfully disagree, for two reasons. First, it’s important that we assess all the risks associated with any lending proposal, and environmental risks—along with potentially-related government actions—are increasingly a risk in many transactions. Second, we believe it is in the best long-term interest of the economy—and therefore our shareholders—to support a balanced but deliberate transition towards a two degree economy.
The final topic I would like to address is how we’re preparing Westpac for the rapidly-arriving digital future. As many of you would recall, 2017 saw the 10-year anniversary of Apple’s iPhone—and it’s astonishing to reflect on how many aspects of our economy and our daily life have changed in 10 short years.
The impact of digital technology on banking around the world has been profound, and the changes aren’t close to done yet. In early October, I visited our branch in Shanghai, where the vast majority of customers now use an app on their mobile phone as their main payment device. And two of the biggest payment applications—WeChatPay and AliPay—are operated by companies that aren’t even banks. The threats—and opportunities—created by mobile banking are profound.
Meanwhile, advances in software development, data storage, and broadband internet mean that so-called ‘cloud computing’ is an increasingly viable tool for large companies to improve efficiency and reduce technology costs.
At Westpac one of the main reasons we have survived 200 years is that we’ve always been willing to adapt—to changes in the economy, in society, and in technology. So we’re staring straight into these changes and adapting both our customer service and our underlying technology to make sure we stay nimble and competitive—and support our customers to do the same.
For example, nimbleness is something we have recognised in Cam Greenwood—a customer who has been leveraging the power of social media to build his online company Monsta Surf.
This year we also rolled out numerous technology innovations to customers, including our new wealth platform (BTPanorama), a new corporate lending portal for customers of Westpac Institutional Bank, e-conveyancing for mortgages, cheque digitisation, Lantern Pay (a new payment platform that supports the Government's National Disability Insurance Scheme), and numerous feature and useability enhancements for mobile banking across all brands.
Our Panorama wealth platform has been a highlight. Panorama allows investor customers and their advisors to manage and protect an individual’s wealth and insurance in a simple-to-use, mobile-accessible platform that integrates fully into the Group’s online banking systems. The number of advisers using the platform has continued to grow, with around $4 billion of funds added to the platform—nearly 100% growth over the year. Other major projects delivered this year included a new call centre platform, a new ‘big data’ platform, and the first phase of our new ‘customer service hub’—which will ultimately help us to consolidate the St.George and Westpac back-end systems.
We also recognise that much of the innovation and advances in technology will emerge from small fintech companies, and so are working hard to build our links with potential leaders in this arena. To date our Reinventure venture capital fund has made early-stage investments in around 15 fintech startups, giving us an early insight into emerging innovations in data analysis, payments, and digital lending. We have also made direct investments in companies such as zipMoney and UnoHome Loans, which have the potential to serve as important partners in areas that are a related but a bit outside of our core businesses.
We must acknowledge that investments in early-stage companies such as these are inherently risky. However we have been very pleased so far with the progress these companies are making. We also find that our involvement gives us valuable exposure to trends in technology and some of the emerging business models with which we will need to compete.
As you can see, 2017 has been a huge year for the banking industry, and for the Group. Despite the challenges we faced, I’m proud of our team and what we have delivered for you and the future value of your investment in Westpac shares.
I’ll finish by assuring you that we enter our third century in great shape, with a clear strategy, growing momentum, and renewed confidence that we are well on the way to building one of the world’s great service companies.
All the best,
BRIAN HARTZERChief Executive Officer