NAB.005.122.0063

National Australia Bank LimitedA National Australia Bank Group Company 800 Bourke St Docklands VIC 3008

15 September 2017

Mr Gideon HollandGeneral Manager - Diversified Institutions Division APRA1 Martin Place SYDNEY, 2000

Dear Gideon,

NATIONAL AUSTRALIA BANK LIMITED (NAB) - TARGETED REVIEW RESPONSENAB would like to thank APRA for the open and constructive meeting to discuss APRA’s industry and NAB specific observations from the targeted review of Data used in Home Loan Underwriting. NAB acknowledges APRA’s concerns and is committed to addressing the NAB specific and industry level findings.

This letter details the approach and specific actions that NAB will undertake to address the four key areas raised in the 1 September 2017 meeting:

1. Approach to Expenses;2. Treatment of Existing Debts;3. Monitoring of Serviceability and other general weaknesses; and4. NAB’s approach to Ernst & Young’s (EY) 3-star findings, including file exceptions.

1. Approach to Expenses

NAB’s serviceability assessment of customer expenses continues to be based on the higher value of the Household Expenditure Measure (HEM) and the 'bottom up' detailed view of the customer’s General Living and Entertainment Expenses (GLEE).

NAB acknowledges APRA’s observations regarding "bottom up” customer self-disclosed expenses and the industry’s overuse of the HEM "top down" benchmark when assessing customer serviceability. NAB agrees that the industry should continue to improve its approach to expenses and is engaging with relevant experts, advisers and other industry participants to identify improvement options. This work is underway and an update will be provided to APRA by 31 October.

Further detail on NAB's approach to the HEM and GLEE measures is provided below.

"Bottom up" GLEE capture

Given the importance of expense enquiry and capture as part of overall serviceability, NAB is continually improving the living expense capture processes across all Home Lending channels. For example, in September 2016, NAB mandated the use of the Categorised Expense Capture Tool for all applications. Other improvements included:

• Development of expense capture tool that includes 12 expense categories to facilitate deeper conversations with customers (implemented September 2016);

• Integration of various standalone tools (including expense capture tool) into the NAB Banker Tool which enables the ability for enhanced validation of inputs (e.g. minimum values for expense categories); and

National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686 Page 1 of 6

NAB.005.122.0064

• NAB has implemented reporting to monitor the volume of banker GLEE declarations being above HEM which is currently 60%. Similar reporting has been developed for brokers and will be implemented by 30 September 2017.

Benchmark HEM

NAB's current application of HEM is configured to reflect an applicant's marital status, number of dependants and household income. NAB uplifted its application of HEM to address certain limitations in the Melbourne Institute model. Changes included:

• Extrapolating household income up to $400k;® Adjusting income bands to better reflect wage growth; and,• Increasing the maximum number of household dependants from 3 to 9.

NAB's proposed actions regarding approach to expenses are:

Action Target Date

1) Work with experts, advisers and industry participants to develop options for APRA's consideration regarding,

i. standardisation of HEM methodologyii. uplift of HEM benchmark

Under review with an update to APRA by 31 October 2017

2) Continual uplift of expense capture tools, e.g. more granular expense categories relating to a customers' investments

Ongoing

2. Treatment of Existing Debt

NAB's approach to verifying a customer's existing debt repayments is consistent with the recommended approach set out in APRA's Prudential Practice Guide, APG223. However, NAB shares APRA's concerns around the industry's limited ability to capture and verify an applicant's existing debt commitments. NAB is supportive of the government's intention to mandate an industry-wide Comprehensive Credit Reporting Program (CCR) and have demonstrated our commitment by being the first major credit provider to participate by providing repayment history information to credit bureaus in September 2015.

NAB remains committed to a phased introduction of CCR, commencing in 2018. There will be some significant dependencies on technology change, particularly for the third party channels. These are currently being investigated and NAB will update APRA on the proposed implementation plan by December2017.

NAB's actions in relation to its phased rollout of CCR:

Action Target Date

3) NAB to update APRA on implementation plan for CCR. December 2017

4) NAB to fully implement CCR. Under review

3. Serviceability Metrics & Analytics - Monitoring & Insights

NAB acknowledges APRA's observation that tightening in serviceability criteria and policies may not have necessarily resulted in changes to lending practices. To monitor the impact of policies, NAB reports on various serviceability measures to help understand and manage the portfolio within risk appetite and risk setting statements. This includes metrics such as loan to income, GLEE verses HEM, income types and repayments. Additionally NAB monitors decision tool overrides and policy waivers via a Manual Decision Report to understand the reasons for overrides. These reports are used to monitor and produce insights on reasons for manual approvals.

As previously mentioned, NAB has developed reporting that monitors GLEE verses HEM performance by individual banker, and will be expanded to the Broker channel by September 2017.

NAB's reporting and monitoring has resulted in a reduction in decision tool overrides since its introduction in September 2015. NAB is currently expanding its Serviceability Monitoring Dashboard to further improve the identification of market trends, changes in serviceability metrics and areas for investigation. These measures will also provide analytical insights into unusual or exceptional behaviour by banker and brokers.

National Australia Bank Limited Page 2 of 6

NAB.005.122.0065

Examples of new metrics and measures include:

• Expenses:o Proportion of lending with GLEE within a range of HEM o Average GLEE value

• Existing debt:o Proportion of applicants / loans with zero or very low existing debts o Average existing debts by applicant o Average amount of credit card debt

• Income:o Proportion of applications with ‘high’ levels of uncertain income reliance o Proportion of applications with ‘high’ levels of rental income reliance o Number of dependents declared

NAB’s actions in relation to uplifting monitoring serviceability metrics:

Action Target Date

5) Introduce reporting that monitors GLEE verses HEM performance by individual brokers.

September 2017

6) Implement expanded Serviceability Monitoring Dashboard. December 2017

4. NAB specific EY 3-Star Findings and file exceptions

EY Issue: "Ineffective control environment over verification within Business & Private and Business &Private - Agribusiness"

The majority of application volumes across Business & Private Banking (current state approximately 8l%) are processed via Business Fulfilment and are subject to a robust control environment and segregation of duties. NAB’s strategic approach to address the issue is to align the remaining volumes to cover 100% of loans processed via the fulfilment centre.

Strategic programs currently underway will deliver uplift in Business Fulfilment utilisation to approximately 94% by 1 April 2018. Furthermore, a specific program has been confirmed to transition the remaining balance (approximately 6%, predominantly Agribusiness) by 1 October 2018.

In the interim, NAB has committed to refreshing Responsible Lending Training with all Agribusiness Credit Managers and to Agribusiness bankers by the end of December 2017.

To continually monitor the progress of the strategic and tactical solutions underway, a recurring agenda item has been scheduled at the monthly Agribusiness Risk Leadership Team meeting.

EY Issue: Ineffective control environment within Advantedge - Broker Operations

The review found Advantedge was not completing a search of undisclosed liabilities on NAB systems, primarily due to Advantedge being on a separate platform to NAB and not having access to NAB's core systems.

Over several months, NAB has been running a pilot which enables the Advantedge credit teams to validate undisclosed NAB liabilities using the NAB View system. Following completion of the pilot, the Operations Risk Management Forum endorsed the full deployment of NAB View into Advantedge. Advantedge is now working with Technology to understand technology dependencies and to develop the implementation plan for NAB View.

Additionally, Advantedge has undertaken a root cause analysis to identify the underlying drivers behind the control failures identified by EY. The analysis identified technology limitations and improvement opportunities around standardised work and knowledge management and quality control &. assurance. A plan is currently being developed to address these findings and improve the control environment. The plan will be tabled at the Operations Risk Management Forum for endorsement on 19 October 2017.

NAB will update APRA on the NAB View implementation plan in October 2017 following completion of the technology planning work.

National Australia Bank Limited Page 3 of 6

NAB.005.122.0066

EY Issue: File exceptions

During the review, EY performed a combination of control based and risk based sampling on 430 loan files across 8 distribution channels. The overall result of this sampling found 23 loan files with exceptions that potentially impact the customers’ serviceability. The exceptions were predominately in the Business & Private distribution channel and the Advantedge distribution channel.

A detailed review of the 23 customer files is underway and will be completed by 29 September 2017. The outcome of the review will be provided to APRA on 6 October 2017.

Refer to Appendix 1 for a summary of actions and timeframes for EY’s l-star findings.

Conclusion4

NAB will continue to update APRA on the actions outlined in this letter through our regular Mortgages engagements. In the meantime, if you have any queries in relation to NAB's approach and actions, please do not hesitate to contact Tim Hurle or Clare McLeod.

Group Chief Risk Officer

National Australia Bank Limited Page 4 of 6

NAB.005.122.0067

APPENDIX: l-Star Recommendations & Management Response

Rating & Observation

ManagementResponse

Progress Due Date

l * ECLAF file reviews and test results are saved in a central database to support file sampling target.

Management agrees a central database will enhance the ECLAF framework and as such will commence Business requirements to scope and cost development of the database.

Technology quotes have commenced and are currently being reviewed by NAB internal Architects.

31 August 2018

1 * Policy Monitoring-

Appetite and Feedback Loop for serviceability and verification waivers.

Management will consider two new policy waiver settings for inclusion in FY18 RSS. Negative Monthly Budget Surplus waiver limit and Serviceability verification waiver limit.

Management has developed proposals for new Risk Settings for FY18, which set a limit and review trigger on the volume per month of:

• Negative Monthly Budget Surplus waivers; and

• Serviceability verification waiver

These proposals have been discussed at Consumer Lending Risk Council (CLRC) and approval of the risk settings will be conducted through the Personal Risk Management Committee (PRMC) in November 2017 as part of the FY18 Risk Settings Statements (RSS) governance process.

Management will incorporate the serviceability policy waiver review as part of the annual material serviceability policy review which is due in Jan 2018.

31 January2018

1 * Broker Oversight -

ExpenseMonitoring to be expanded

Management will conduct data analysis on feasibility to expand existing reporting to broker level and whether Advantedge data can be included.

Credit Portfolio Management has completed a 30 September review of the availability of Broker data and | 2017 confirmed that the HEM monitoring at the individual broker level can be implemented (subject to additional information to be sourced from the 2nd line credit risk team).

Data feeds are currently being sourced to support the development of the Broker level reporting with a target of delivering the first report before the end of September 2017. The Broker Partnership Management Assurance team have agreed to develop a process to monitor the brokers upon receipt of this report.

Management has conducted a review of Advantedge data available. This review has identified that application HEM data is not stored in a manner that allows for incorporation of the data into enterprise reporting. NAB recognises the importance of monitoring and reporting on this information

I

for Advantedge and further work will be undertaken to determine whether a system change can be implemented to make this data available.

National Australia Bank Limited Page 5 of 6

NAB.005.122.0068

Rating & Observation

ManagementResponse

•

Progress Due Date

l * NAB Policy -

Consider new verification policy relating to dependents & Consider amendments torental policy

•

• •

Management will commence a Feasibility assessment on both recommendations.

Home Lending completed a feasibility review and the recommendation was discussed at the July 2017 Consumer Lending RMC, it was endorsed that NAB will not be verifying number of dependents and agreed to tighten the existing processes relating to dependents to enhance customer experience and exercise stronger due diligence across the value chain.

A review of the yield benchmark has been completed and presented to the July 2016 Housing Lending Forum (HLF). Rental yields in the 8 postcodes associated with most mining town losses are on average higher than this figure of 6%. It was agreed that the yield benchmark was still a valid control and should remain at 6%.

Credit Policy for Advantedge has been updated, and the yield benchmark policy is now applied within Advantedge (effective on15 May 2017). The completed actions have been discussed with EY and evidence submitted for closure.

Management submitted for closure

1 * NAB Assist - NCCP Reviews. Implement a review of the process and ensure findings are shared with relevant businessowners.

Management agrees with therecommendation and as such will review and align existing NCCP process and establish regular reporting to key stakeholders.

%

•

NAB Assist completed a comparison of existing NCCP review processes for mortgages that enter NAB Assist (including Standards, Business Solutions and Advantedge).

Currently, NAB Assist is completing NCCP review for all of Consumer Lending with the exception of Advantedge.

For the interim, Advantedge will continue to undertake its own NCCP reviews in Broker Network Assurance, with outcomes to be incorporated into NAB Assist reporting.However NAB Assist is working withAdvantedge and Management Assurance on a strategic solution to incorporate Advantedge NCCP reviews will be undertaken within theNAB Assist team.

Reporting on the outcomes of NCCP reviews has also been established and is currently being tabled at the NAB Assist RiskManagement Forum on a bi-monthly basis.

The completed actions have been discussed with EY and evidence submitted for closure.

Management submitted for closure

National Australia Bank Limited Page 6 of 6