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Presale Report: CommBank PERLS IX Capital Notes Technical Tailwinds Support Attractive Pricing Recommendation: Subscribe

Executive Summary Commonwealth Bank of Australia, or Commonwealth Bank, will raise AUD 750 million — with the ability to raise more or less — via a Tier 1 hybrid issue, to be listed on the Australian Securities Exchange, or ASX, called CommBank PERLS IX Capital Notes (ASX Code: CBAPF). This issue will provide Additional Tier 1, or AT1, regulatory capital for Commonwealth Bank.

The offer comprises a broker firm offer, eligible securityholder offer and a priority offer for eligible holders of Colonial Group Subordinated Notes (ASX Code: CNGHA) to reinvest into CBAPF. There is no general offer.

CBAPF is a fully paid, non-cumulative, convertible, transferrable, redeemable, subordinated, perpetual, unsecured note with a AUD 100 face value and mandatory exchange date of 31 March 2024. Mandatory exchange on that date is subject to exchange conditions. CBAPF may be exchanged earlier as a result of a trigger event or Commonwealth Bank exercising an option to call the security two years early on 31 March 2022. Distributions are discretionary, non-cumulative and fully franked with a dividend stopper. Distributions will be paid quarterly in arrears, based on the 90-day bank bill swap, or BBSW, rate plus a margin in the indicative range of 3.90% to 4.10% per annum. For example, using the current 90-day BBSW rate of 1.78%, this equates to a total estimated gross running yield range of 5.68% to 5.88% per annum.

Key Takeaways × We recommend investors subscribe to the offer for CBAPF. We believe the indicative pricing range

of 3.90% to 4.10% is an attractive price for hybrid investors looking to gain exposure to a Morningstar preferred issuer.

× While the new issue premium of approximately 10 basis points relative to the major bank Basel III Compliant Additional Tier 1, or AT1, curve is attractive, the approximate 25 basis point premium to the average trading margin of the same securities in the past 30 days is compelling.

× The near-term outlook for hybrid pricing should remain supported by technical factors including diminishing hybrid supply and a preference for floating rate distributions. We maintain our preference for moat-rated issuers, such as the major banks.

× It is important to reiterate hybrid securities should not be viewed as traditional fixed-income products, nor should they be considered a substitute for low-risk investments such as term deposits.

Morningstar Research 23 February 2017

John Likos, CFA Senior Credit Analyst, Australia

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Morningstar Equity Research | 23 February 2017

Recommendation We recommend investors subscribe to the offer for CBAPF. We assign CBAPF a medium investment risk rating, the same as other major bank AT1 hybrids in our coverage list. The terms and conditions, such as non-viability and capital conversion to equity triggers in this new breed of hybrid securities make them more equity-like and, consequently, riskier than the "old-style" issues. Exhibit 1 highlights the rally in major bank hybrid securities since Commonwealth Bank issued PERLS VIII (ASX Code: CBAPE) in early 2016. More recently we have witnessed a slow reversal in this trend, which is not unexpected given the duration of the rally. Nevertheless, we expect various tailwinds to support hybrids in 2017, including: (i) favourable supply dynamics as several hybrid issuers opt to redeem without replacement issues; (ii) attractive yields relative to other securities in the capital structure; and (iii) floating rate distributions are leveraged to benefit from the increasing expectation that Australia has hit a bottom in the cash rate cycle.

Exhibit 1 Trading Margins of Comparable Major Bank Listed Tier 1 Hybrid Securities

Source: Morningstar.

Between a trading margin of 3.90% and 4.10%, CBAPF is being priced fairly relative to its position in Commonwealth Bank’s capital structure. A Commonwealth Bank 5-year term deposit, which has the benefit of a guarantee under the Australian government financial claims scheme, yields approximately 310 basis points less than CBAPF. On the other end of the capital structure, Morningstar forecasts a gross equity dividend yield of about 7.10% on Commonwealth Bank ordinary shares for fiscal year 2017, approximately 140 basis points higher than CBAPF's yield to call, based on the low end of the indicative issue range.

3.00%

3.50%

4.00%

4.50%

5.00%

5.50%

6.00%

Jan-2016 Feb-2016 Apr-2016 Jun-2016 Jul-2016 Sep-2016 Nov-2016 Dec-2016 Feb-2017

ANZPD ANZPE CBAPD CBAPE NABPD WBCPE WBCPF WBCPG

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Exhibit 2 Commonwealth Bank Capital Structure Relative Yields, as at 17 February 2017

Source: Morningstar, Commonwealth Bank.

We expect hybrid supply dynamics to provide a strong tailwind to hybrid prices in 2017. Exhibit 3 is a collection of debt and hybrid securities that have either not been replaced recently or we do not expect to be replaced. These include the Woolworths Notes II (WOWHC) and Origin Energy Subordinated Notes (ORGHA), both of which were called and not replaced in late 2016. Going forward, we believe the Tabcorp Subordinated Notes (TAHHC), the Goodman PLUS II (GMPPA) and the Caltex Subordinated Notes (CTXHA) are more than likely to be called and not replaced. There is also the possibility that ANZ Bank opts to refinance their Tier-2 ANZ Subordinated Notes (ANZHA) in the wholesale market as opposed to the retail market. Nevertheless, if we exclude ANZHA, the other securities mentioned make up total potential withdrawn supply of approximately AUD 2.7 billion. If we include ANZHA, this amount blows out to AUD 4.2 billion. Of course, we must keep in mind that we are dealing with different types of debt and hybrid securities when we compare AT1 hybrids to those issued by corporates so there is a possibility that this money will not look to move into AT1's. Exhibit 3 Supply technical to provide hybrid tailwind in 2017 (AUD million)

Source: Morningstar. Red shading denotes securities that have already been called without a replacement transaction.

2.55%2.90%

3.76%

5.68%

7.10%

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

8.00%

5 Year Term Deposit Senior Unsecured Bond(Jan-22)

Subordinated Bond(Jun-22)

CBAPF (@ 3.90% TM) FYE17 Dividend Yield

0

200

400

600

800

1,000

1,200

1,400

1,600

WOWHC ORGHA TAHHB CTXHA GMPPA ANZHA

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It is important to reiterate that hybrid securities should not be viewed as traditional fixed-income products, nor should they be considered a substitute for low-risk investments such as term deposits. Therefore, they should offer a yield premium over these lower-risk products. Hybrid prices can become volatile in times of distress, similar to shares and unlike traditional senior bonds. Due to their complex terms and conditions, investors often confuse key differences between hybrid securities and other investments from the same issuer. Exhibit 4 outlines some of the key differences between Commonwealth Bank savings accounts, term deposits, CBAPF and ordinary shares. Investors should consider these differences in light of their investment risk and return profile.

Exhibit 4 Differences Between CBAPF and Other Commonwealth Bank Investments

Source: Morningstar, Commbank PERLS IX Capital Notes Prospectus.

In the event of a winding up, CBAPF ranks ahead of ordinary shares, equally with equal-ranking capital securities such as CommBank PERLS VI (CBAPC), PERLS VII (CBAPD), PERLS VIII (CBAPE), behind senior creditors, liabilities preferred by law (such as bank deposits) and secured debt (covered bonds). Exhibit 5 provides a summary of Commonwealth Bank's capital structure ranking, highlighting the relatively low position of CBAPF (PERLS IX) in the event of a winding up, an event we consider highly unlikely.

Savings Account Term Deposit CBAPF Ordinary SharesGuarantee under the Australian Government Financial Claims Scheme (1)

Yes Yes No No

Term At call (usually)One month to five years (normally).

Perpetual (Mandatory Exchange Date in seven years) (2)

Perpetual

Distribution Rate Variable (usually) Fixed (usually) FloatingVariable dividends are payable

Distribution Payment Date Monthly (usually)End of term or per annum (usually)

Quarterly Semi-annually

Distributions are Discretionary No No Yes Yes

Transferable N/A No (3) Yes, quoted on the ASX (4) Yes, quoted on the ASX

1. The guarantee is provided for up to A$250,000 deposited per person with each Australian authorised deposit-taking institution2. The Mandatory Exchange Date is 31 March 2024 or, if the Mandatory Exchange Conditions are not satisfied on that date, the first Distribution Payment Date after that date on which the Mandatory Exchange Conditions are satisfied3. Can be withdrawn subject to conditions4. CBA will apply for PERLS IX to be quoted by ASX and they are expected to trade under code “CBAPF”

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Exhibit 5 Ranking of CBAPF in the Event of a Winding Up of Commonwealth Bank

Due to the uncertainty of the period between transaction announcement and listing, our preference is for issuers to compensate investors with a new issue premium. Exhibit 6 plots the trading margins as at the close of 17 February 2017 of CBAPF's closest like-for-like major bank issued AT1 securities. These are all similar to CBAPF being Basel III compliant, however, issuer risk profiles may vary slightly between the major banks. We have selected AT1 securities with between four and six-year terms to call for the purposes of our comparison. Exhibit 6 CBAPF new issue premium evident when compared to similar AT1 securities

Source: Morningstar. Red scatter plot denotes the lower range of CBAPF's proposed trading margin.

CBAPF

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

4 4.2 4.4 4.6 4.8 5 5.2 5.4 5.6 5.8 6Years to First Call

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CBAPF offers an attractive new issue premium on both the most recent closing prices of comparable securities and on the average trading margin of those securities during the last month. Exhibit 7 highlights the sell-off in major bank AT1 securities in the last 30 days. We believe a significant proportion of this is the result of security repositioning in anticipation of CBAPF. Nevertheless, it is clear to us that CBAPF provides attractive value when this "market noise" is considered. Aside from the attractive 10 basis point premium being offered over the most recent closing prices of comparable securities, the approximate 25 basis point premium being offered over the average trading margin of comparable securities in the most recent 30 days is particularly compelling. Exhibit 7 CBAPF margin attractive on current and recent pricing (%)

Source: Morningstar.

3.81

3.66

3.76

3.88

4.17

3.30

3.40

3.50

3.60

3.70

3.80

3.90

4.00

4.10

4.20

Close (17-Feb-2017) 30 Days 60 Days 90 Days 180 Days

AT1 Average CBAPF

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The Offer The offer comprises: × a broker firm offer; and × a securityholder offer; and × a priority securityholder offer

The broker firm offer is available to retail investors who are clients of a syndicate broker. If you are applying under the broker firm offer, you should contact the syndicate broker, who has offered you an allocation from their own broker firm allocation, for information about how and when to lodge your application and accompanying application monies. The securityholder offer is available to eligible securityholders. You are an eligible securityholder if, on 9 February 2017, you: • are a holder of CBA ordinary shares; or • are a holder of PERLS VI (ASX Code: CBAPC), PERLS VII (ASX Code; CBAPD) or PERLS XIII (ASX Code: CBAPE); or • are a holder of Colonial Group Subordinated Notes (ASX Code: CNGHA), and: • you have a registered address in Australia; or • you have a registered address outside Australia and you satisfy the conditions outlined in “restrictions on foreign jurisdictions” on the inside front cover of the CBAPF Prospectus. CNGHA holders have to opt in to participate in the priority offer. If they take no action their securities will be redeemed for cash at face value plus applicable interest payable on the 31 March 2017, the first call date. Holders of CNGHA who participate in the securityholder offer will receive a priority allocation to other securityholders in relation to reinvesting their CNGHA holdings into PERLS IX. Additional information relevant to CNGHA holders in relation to an offer by Commonwealth Bank to redeem their CNGHA notes for AUD 100 per CNGHA note on the basis that those proceeds are to be automatically reinvested into CBAPF under the CBAPF Prospectus, is contained in the separate Colonial Group Subordinated Notes Information Booklet provided to eligible holders with the CBAPF Prospectus. If you are an institutional investor, you must apply to participate in the offer by contacting the arrangers prior to the bookbuild who will provide additional information about how to apply. Due to the differences between the CNGHA and CBAPF issues, more information regarding how to apply can be found in Section Six of the CBAPF Prospectus.

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The Key Differences between CNGHA and CBAPF × CNGHA was issued by Commonwealth Bank subsidiary, Colonial Holding Company Limited, but is

not explicitly guaranteed by Commonwealth Bank. CBAPF is being issued by Commonwealth Bank. The risks associated with each business are different.

× CNGHA is a subordinated debt security maturity date of 31 March 2017, while CBAPF is more equity like being a perpetual hybrid security. CNGHA will be redeemed on 31 March 2017 as per the CBA management announcement on 20 February 2017. Risks between CBAPF and CNGHA are different also due to the difference in the types of the securities.

× CNGHA has a margin of 3.25% per annum. CBAPF will have a margin between 3.90% and 4.10%. × CNGHA distributions are not franked. CBAPF distributions will be franked. × CNGHA has no capital trigger or non-viability conversion triggers in its terms. CBAPF has both

which also make it more equity like. Further information on the key differences between CNGHA and CBAPF can be found in Section 1 of the Colonial Group Subordinated Notes Information Booklet. Security Risks Capital Trigger Risk CBAPF has a capital trigger event clause which requires immediate exchange of some, or all, securities into ordinary shares if Commonwealth Bank's Common Equity Tier 1 capital ratio equals or falls below 5.125%. Commonwealth Bank's Common Equity Tier 1 capital ratio, on a Basel III basis, was 9.90% as at 31 December 2016, representing a healthy buffer above the 5.125% minimum. If a capital trigger event does occur, Commonwealth Bank must immediately exchange such number of CBAPF that is sufficient to return the Common Equity Tier 1 capital ratio back above 5.125%. Furthermore, if this ratio did fall below 5.125%, CBAPF holders could suffer a capital loss as a result of the maximum exchange number of shares condition, where holders potentially receive ordinary shares worth less than the face value of CBAPF securities. Non-Viability Risk CBAPF also has a non-viability trigger, which is required by the prudential regulator, APRA, as part of the Basel III reforms. The non-viability trigger gives APRA the discretion to require some, or all, of CBAPF to be exchanged into Commonwealth Bank ordinary shares, making CBAPF more equity-like than the "old-style" issues issued under the previous, less-stringent, regulatory framework. Similar to exchange following a capital trigger event, holders could potentially receive ordinary shares worth less than face value. A non-viability trigger event occurs if APRA believes Commonwealth Bank would become non-viable without an exchange of some, or all, of CBAPF, or a public-sector injection of capital, or equivalent, support is necessary because, without it, Commonwealth Bank would become non-viable. It should be noted that whether a non-viability trigger event will occur is at the discretion of APRA and currently there are no precedents for this. APRA may exercise this discretion should it have a concern regarding Commonwealth Bank's capital, liquidity or funding levels.

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Capital Conservation Buffer Risk Commonwealth Bank, along with the other Australian major banks, are required to maintain a capital conservation buffer in the form of Common Equity Tier 1 capital of 2.5% of risk-weighted assets. As a Domestic Systemically Important Bank, or D-SIB, the capital conservation buffer that applies to Commonwealth Bank increases by 1.0%, to 3.5% of risk-weighted assets. On top of the Basel III requirements of maintaining a minimum Common Equity Tier 1 capital ratio of 4.5%, the minimum total Common Equity Tier 1 capital requirement is now at least 8.0% for Australia's four major banks. APRA maintains the discretion to apply an additional countercyclical buffer up to 2.5% of Common Equity Tier 1 capital. If Commonwealth Bank's Common Equity Tier 1 capital ratio falls into the capital conservation buffer, distributions on CBAPF may not be paid. This is because Commonwealth Bank will only be able to use a certain percentage of its earnings to make discretionary payments such as dividends, hybrid distributions and bonuses. Distributions that are not paid do not accrue and do not subsequently have to be paid. However, if this occurs, the dividend stopper will take effect, preventing Commonwealth Bank from either: (i) declaring a dividend on ordinary shares; or (ii) returning any capital or undertaking any buybacks or repurchases in relation to ordinary shares. For this reason we believe the dividend stopper acts a strong incentive prioritising hybrid distributions. Commonwealth Bank's Common Equity Tier 1 capital ratio, on a Basel III basis, was 9.9% as at 31 December 2016, representing a healthy buffer above regulatory requirements. On an internationally comparable basis, the be capital ratio was very strong at 15.4%. Write-Off Risk If, following a trigger event (capital trigger or non-viability), conversion has not been effected within five business days of the conversion date, investors' rights under the terms of CBAPF will be terminated, taken to have occurred on the date of the Trigger Event and the value of the entire investment in CBAPF could lose all its value. Mandatory Exchange Risk A fall in Commonwealth Bank's share price to below pre-determined levels relative to the issue date volume weighted average price, or VWAP, required under the terms of mandatory exchange, would result in CBAPF not being exchanged on the mandatory exchange date (31 March 2024) and remaining on issue until the next distribution payment date when the exchange conditions are satisfied. Credit/Default Risk This is the risk of loss arising from Commonwealth Bank defaulting on its payments, whether in the form of distribution payments or principal repayment. This is largely offset by Commonwealth Bank's strong credit profile. Nevertheless, investors should be aware CBAPF is an unsecured, subordinated investment, so in a wind-up scenario, investors could potentially lose all of their investment.

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Subordination Risk If Commonwealth Bank issues more equal or higher-ranking securities on the capital structure, CBAPF may become further subordinated. Market Price Risk The market price of CBAPF could decrease below face value, depending on various market-related factors, such as credit spreads, interest rates or Commonwealth Bank's underlying share price performance. Liquidity Risk Hybrids are generally less liquid than the shares in the same company. Low levels of liquidity can make it difficult to buy or sell a security, raising the risk of buying at an inflated price or selling at a capital loss. Extension Risk If CBAPF is not called at the first call date (31 March 2022), it may trade like a perpetual security. We encourage investors to refer to Section 4 of the Prospectus for further detail on the risks associated with investing in CBAPF. Key Dates for the Offer × Securityholder offer record date: 9 February 2017 × Lodgement of Prospectus with ASIC: 20 February 2017 × Bookbuild: 27 February 2017 × Announcement of margin: 28 February 2017 × Opening date for the offer and lodgement of the replacement Prospectus with ASIC: 28 February

2017 × Closing Date for the Offer: 5:00pm (Sydney time), 24 March 2017 × Issue Date: 31 March 2017 × Commencement of deferred settlement trading: 3 April 2017 × Despatch of holding statements: 4 April 2017 × Commencement of trading on normal settlement basis: 5 April 2017 × Key Dates for Eligible CNGHA Noteholders × Priority securityholder offer record date: 9 February 2017 × Lodgement of the CBAPF Prospectus and CNGHA priority securityholder offer information booklet

with ASIC: 20 February 2017 × Lodgement of the CBAPF replacement Prospectus and opening date for the priority securityholder

offer: 28 February 2017 × Record date for final distribution on CNGHA (both participating and not participating in the priority

securityholder offer): 23 March 2017 × Closing date for the priority securityholder offer 5.00pm (Sydney time): 24 March 2017 × Last day of ASX trading for CNGHA: 21 March 2017 × Purchase Date: 31 March 2017

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× Issue Date – when CBAPF are issued under the priority securityholder offer: 31 March 2017 × Payment date for final distribution on CNGHA: 31 March 2017 × Redemption date for Colonial Group Subordinated Notes which did not participate in the priority

securityholder offer: 31 March 2017 Key Dates for CBAPF Capital Notes × First Distribution Payment Date: 15 June 2017 × First Call Date: 31 March 2022 × Scheduled Conversion Date: 31 March 2024 Key Terms × Face value: AUD 100 per security. × Minimum subscription amount: AUD 5,000 (50 units). Minimum application does not apply to

Eligible Colonial Group Subordinated Noteholders applying under the Priority Securityholder Offer. Additional amounts can be bought in increments of AUD 1,000 (10 units).

× Amount to be raised: Commonwealth Bank plans to raise AUD 750 million via the issue of 7.5 million securities with the ability to raise more or less.

× Cash distribution rate: (90-day BBSW rate + margin) x (1 − corporate tax rate). This assumes the CBAPF distribution is fully franked.

× Margin: The indicative margin range is 3.90% to 4.10% per annum. × Frequency of distributions: Quarterly on 15 March, 15 June, 15 September, and 15 December. × Franking: Distributions are fully franked. If a distribution is not franked, the cash distribution

amount will be increased to compensate for any franking shortfall. × Distributions: Payment of distributions is discretionary and subject to payment conditions being

satisfied, the most material being that payment does not cause Commonwealth Bank to breach its regulatory capital requirements or become insolvent and APRA not objecting. Distributions are not cumulative, so unpaid distributions do not accumulate.

× Dividend stopper: If a CBAPF distribution is not paid in full within five business days of the scheduled payment date, Commonwealth Bank cannot, without approval of CBAPF holders, pay dividends on its ordinary shares, undertake a buyback or reduce capital on any ordinary shares until a distribution is paid in full on a subsequent distribution payment period.

× Capital conservation buffer: As of 1 January 2016, APRA required the major banks, as D-SIB's, including Commonwealth Bank, to increase their Common Equity Tier 1 capital ratio from 7.0% to 8.0%, as part of the D-SIB framework. Restrictions on the proportion of profits that can be used to pay ordinary share dividends, Tier 1 capital distributions (including distributions on CBAPF) and discretionary staff bonuses will apply if Commonwealth Bank's Common Equity Tier 1 capital ratio falls below 8.0%. APRA also has the discretion to apply an additional countercyclical capital buffer to all banks with an indicative range of between 0% and 2.5% of Common Equity Tier 1 Capital. If applicable, this forms part of the CCB. APRA has set the countercyclical capital buffer applicable to Australian exposures at 0%.

× Term: Perpetual, with a mandatory exchange date of 31 March 2024, or any subsequent distribution payment date, subject to exchange conditions, or if the security is exchanged earlier as a result of a trigger event or Commonwealth Bank exercising an option to call the security two years early on 31 March 2022.

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× Capital classification: Additional Tier 1 regulatory capital. × Mandatory exchange date: If CBAPF has not been exchanged or redeemed earlier, on 31 March

2024, CBAPF will convert into a variable number of Commonwealth Bank ordinary shares worth approximately AUD 101.01 at a 1% discount to the 20 business day VWAP of Commonwealth Bank ordinary shares (subject to exchange conditions). If these conditions are not satisfied, exchange will be deferred until the next distribution payment date upon which the conditions are met.

× The mandatory exchange conditions are: × First condition: The VWAP of Commonwealth Bank ordinary shares on the 25th business

day before (but not including) a potential mandatory exchange date is greater than 56% of the issue date VWAP of Commonwealth Bank ordinary shares;

× Second condition: The VWAP of Commonwealth Bank ordinary shares during the 20 business days before (but not including) a potential mandatory conversion date is greater than 50.51% of the issue date VWAP of Commonwealth Bank ordinary shares;

× Third Condition: Commonwealth Bank ordinary shares are listed and admitted to trade on the Australian Securities Exchange as at the mandatory exchange date.

× For example, if the issue date VWAP is AUD 83.00, the relevant VWAP for the first mandatory conversion condition to be satisfied would need to be greater than AUD 46.48, and for the second mandatory conversion condition would need to be greater than AUD 41.92.

× Capital trigger event: If Commonwealth Bank determines, or APRA believes, that Commonwealth Bank's Common Equity Tier 1 capital ratio is equal to or less than 5.125%, Commonwealth Bank must exchange a sufficient number of CBAPF securities into Commonwealth Bank ordinary shares to return this ratio above 5.125%. The number of shares on exchange would be based on the VWAP five business days before the exchange date. However, exchange following a capital trigger event is not subject to mandatory exchange conditions being satisfied. This means CBAPF holders could potentially receive Commonwealth Bank ordinary shares worth less than face value. This is because the maximum exchange number of shares would apply based on 20% of the issue date VWAP. For example, if the issue date VWAP of Commonwealth Bank ordinary shares was AUD 83.00, the maximum exchange number of shares would equal 6.0241 Commonwealth Bank ordinary shares for each CBAPF (AUD 100/(AUD 83.00 x 20%)). For example, if the Commonwealth Bank share price on exchange was AUD 10.00, then CBAPF holders would receive Commonwealth Bank shares worth approximately AUD 60.20 (6.0241 x AUD 10.00) for each security.

× A non-viability trigger event occurs if APRA notifies Commonwealth Bank it believes that exchange of some, or all, CBAPF (or some action in relation to other Commonwealth Bank capital instruments) is required, because without it, Commonwealth Bank would become non-viable; or a public-sector injection of capital is required because without it, Commonwealth Bank would become non-viable. Following such an event, Commonwealth Bank must immediately exchange such number of CBAPF securities specified by APRA or necessary to satisfy APRA that Commonwealth Bank will no longer be non-viable. Exchange following this event is not subject to mandatory exchange conditions being satisfied. The consequence is similar to exchange following a capital trigger event where CBAPF holders could potentially receive Commonwealth Bank ordinary shares worth less than face value.

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× Optional exchange: Commonwealth Bank has the option to redeem, resell or convert some or all CBAPF early on the 31 March 2022 optional exchange date. Commonwealth Bank has the right to redeem all CBAPF for tax or regulatory reasons at any time. It should be noted that Exchange and Redemption, as applicable, is subject to satisfaction of certain conditions and APRA’s prior approval.

× CBAPF holders have no right to request exchange. We have presented a summary of the key terms. Investors should examine the CBAPF Prospectus in detail if they intend to invest in CBAPF. Issuer Details Investment Thesis Commonwealth Bank of Australia is the largest of Australia's four highly profitable, wide-moat-rated major banks. It offers a full suite of banking services in Australia and New Zealand, also operates in certain Pacific and Asian countries, and sells wealth management, life insurance, and general insurance in Australia. The financial crisis exposed some poor commercial lending decisions, but in the long run, the bank has consistently increased shareholder wealth in favourable economic times. The loan book's large weighting to home loans and the high proportion of customer deposits reduce risk. In our opinion, a wide moat rating is justified. Securitising nonbank financials and foreign banks previously provided fairly strong competition for Commonwealth Bank in home and business loans and business deposits, but the bank's return on equity has not fallen below the cost of equity for the past 10 years at least. Foreign banks are a lesser force now, but even in their heyday, they never mounted a serious assault on the retail franchises, market shares, or branch networks of the major banks. The sunk costs and infrastructure were too great to replicate. Local regional banks follow the majors on pricing and are not currently in a position to threaten Commonwealth Bank's economic returns. Bouts of apparently intense price competition between the four major banks have not threatened superior shareholder returns. Many investors are concerned about a potential sharp downturn or crash in the Australian housing market. While Australian housing is expensive and debt/household income ratios are high, we remain comfortable for several reasons. Tight underwriting standards, lender's mortgage insurance, low average loan/valuation ratios, a high incidence of loan prepayment, full recourse lending, a high proportion of variable rate home loans, and the scope for interest-rate cuts by the Reserve Bank of Australia, or RBA, combine to mitigate potential losses from mortgage lending. We cannot rule out falling home prices, but investors who readily compare the Australian residential real estate market to that of the U.S. and other markets are ignoring fundamental differences. The modernisation of Commonwealth Bank's core banking systems is driving real competitive advantage by providing faster and targeted marketing campaigns, real-time banking, and a smoother, more efficient customer experience.

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The main current influences on earnings growth are modest credit growth, a product of household risk aversion and deleveraging, and delays to business plans for capital expenditure. Despite reduced pressure on funding costs, competition is constraining interest margins. Bad and doubtful debts expense peaked in first-half fiscal 2009 and continued to decline until the start of fiscal 2016, but the credit cycle has clearly turned and we expect higher bad debts going forward. Write-backs of the economic overlay, a general provision for higher bad debts in case the economy deteriorates sharply, are on hold despite improving economic conditions. Wealth-management earnings are trending higher as equity markets improve. Australia's superannuation system guarantees strong long-term growth in assets for Australia's wealth-management industry. In addition, well-managed cost control will underpin earnings growth, particularly in periods of soft revenue growth. Commonwealth Bank's wide economic moat will enable it to grow profitably at the rate of system credit growth despite a range of headwinds. The four major banks have a powerful grip on lending markets and are also the first choice of depositors seeking capital security. Commonwealth Bank has one of the most recognised and trusted bank brands in Australia, the advertising and marketing budget, and customer fulfilment capacity (branches, systems, funding capacity) to capitalise on this brand equity. Commonwealth Bank has proven it can increase cross-sell ratios, and we expect further improvements. Excellent cost-efficiency and room for further incremental improvement facilitate profitable growth even during periods of pricing pressure. Financial Health On Dec. 31, 2016, Commonwealth Bank had a Basel III Common Equity Tier 1 capital ratio of 9.9% based on the Australian regulator's interpretation of Basel III rules. Commonwealth Bank is one of the world's highest credit rated banks and continues to generate capital organically, given its high return on equity (16.0% in first-half fiscal 2017), and modest lending growth. We forecast return on equity to average 16.3% during the next five years. Recent announcements by global regulators helped clarify future capital and liquidity requirements for the Australian banking industry. The Basel III requirements regarding capital are manageable for Commonwealth Bank. On a globally harmonised basis, Commonwealth Bank's Common Equity Tier 1 ratio of 15.4% compares very favourably with global peers. Customer deposits made up 66% of total funding at December 2016, stable on a year ago. The bank's superior credit rating and strong reputation in funding markets enable it to raise the remainder from securitisation, hybrids, and wholesale funding, of which approximately 35% of was sourced within Australia. The home loan book is high-quality. On Dec. 31, 2016, the average loan/valuation ratio for the Australian portfolio was 51%, based on current market values. About 77% of customers were ahead with their payments by an average of 35 monthly payments (including offset balances). An allowance for interest rate rises of 225 basis points is built into serviceability tests. Mortgagee-in-possession loans were just 0.05% of the portfolio.

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In first half fiscal 2017, the loan impairment expense rate was 0.17% of gross loans, stable on first half fiscal 2016 and down significantly from the previous peak of 0.81% in fiscal 2009, at the height of the credit crisis. We forecast a rise to a mid-cycle average of about 24 basis points by fiscal 2021. Economic Moat We assign a wide moat rating to Commonwealth Bank of Australia, mainly because of sustainable structural characteristics of the Australian and New Zealand banking industries, generating high returns on equity. The other three major banks also have wide moat ratings. In our opinion, cost advantage is the main source of the wide economic moats for Australia's four major banks. Intangible assets and switching costs provide important, but less prominent, moat sources. The wide moat rating recognises the structural competitive advantages Australia's four major banks possess. The four major banks dominate a regulated and rational oligopoly, bestowing structural advantages that are strong and durable. We believe the economic moats surrounding the major banks are sufficiently wide to ensure global sector-leading returns on equity for the foreseeable future. The four major banks control more than 90% of the business and consumer lending markets, plus the vast majority of bank deposits. Pricing is relatively rational. New Zealand is similar. The concentrated industry benefits from high barriers to entry across most segments, making it hard for new entrants to gain any sort of foothold, particularly in retail and business banking. Foreign banks have not made a serious dent in the domestic majors' market share, while the smaller regional banks compete on service and local brand recognition but face higher wholesale funding costs than the majors and are unable to undercut on price. They tend to follow the majors in pricing. Well-managed scale drives more scale. Commonwealth Bank leverages its large branch network to increase cross-sell, for example, of wealth management and insurance products. Commonwealth Bank's large scale generates substantial cost advantages over smaller banks and nonbanks. This enables Commonwealth Bank to price competitively, but still at levels that generate current returns on equity. As do the other majors, Commonwealth Bank has pricing power from brand strength, an intangible asset. Australians and New Zealanders have a cultural preference for large financial institutions with heritage brands because of perceived greater financial security. This preference exists even when the customer is a borrower. Management & Stewardship Commonwealth Bank of Australia has a long-term track record of maximising shareholder value and safeguarding capital. We therefore allocate an Exemplary stewardship rating to Australia's largest bank. Since the worst of the global financial crisis, the bank has steadily increased return on equity, but the AUD 5.1 billion of capital raised in 2015 to satisfy tougher regulatory requirements resulted in the return on equity declining in fiscal 2016 to 16.5%. Conservative management and a domestically focused growth strategy are long-term features. Strong risk management is an overarching feature of the bank's internal processes and procedures. Commonwealth Bank has committed to maintaining capital above regulatory minimums, and we expect surplus capital to be

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reinvested in the business and/or returned to shareholders via higher dividends, not wasted on expensive and dilutive acquisitions or risky expansion plans. In our opinion, CEO Ian Narev is an impressive executive, appointed in 2011, with a reputation for understanding the rapidly changing world of banking. He headed Commonwealth Bank's business and private banking division only from 2009 to 2011 and before that was group head of strategy and led the acquisition of Bankwest in 2008, as well as the investment in Aussie Home Loans. Before joining Commonwealth Bank, Narev was a partner of McKinsey & Company, the global consulting firm, and prior to that, he was a lawyer specialising in mergers and acquisitions. Banking is a specialised and risky business. It is clear that Narev is an excellent and farsighted leader in the changing world of banking, and he has impressed with his intellect and grasp of complex issues. The Commonwealth Bank board and management deserve the Exemplary stewardship rating because of the conservative, low-risk banking model, especially regarding loan underwriting standards, provisioning, and capital ratios, while positioning the bank to benefit from any upturn in key lending and wealth-management markets. The Core Banking Modernisation project was an outstanding success, reaching completion on time and within budget. Further investment in technology will drive meaningful, visible gains in product cross-sell, customer acquisition, retention, and revenue growth. Other investments need to support the key moat features of brand reputation and presence, while any further expansion in Asia should be modest and based on a long-term plan to gain valuable experience and contacts in the region. A small number of bolt-on acquisitions have been carried out in the past 10 years. The most recent major acquisition was completed in 2008, when Commonwealth Bank purchased Western Australian-based BankWest from Bank of Scotland for a bargain-basement price in the depths of the global financial crisis. The acquisition substantially contributed to Commonwealth Bank's competitive strengths, increasing distribution capability, scale, and cost-efficiency. The BankWest brand has been retained and adds to Commonwealth Bank's stable of valuable brands. It is very unlikely the competition regulator would allow such a takeover today, but BankWest was in trouble in 2008, and Commonwealth Bank took full advantage of its strong balance sheet to complete the acquisition. K

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