The ‘new’ NAB looks quite good

From the murky clouds of distraction and confusion generated by Andrew Thorburn’s whirlwind of activity last year the “new” National Australia Bank is emerging. It actually looks quite good.

Stripped of the disfiguring impacts of the distancing of NAB from its 30-year engagement in UK banking earlier this year, NAB’s cash earnings of $3.31 billion in the March half, a 6.5 per cent increase on the same half last year, represent a very strong performance given the subdued context in which the now Australasia-centric group operates.

Relative to the sluggish performance of Westpac and the upheaval at ANZ as Shayne Elliott re-positions that bank into more conservative settings, the underlying NAB performance is better than respectable and offers some confidence in the near term, at least, that the group can maintain its dividend.

The statutory net loss of $1.74bn largely reflects the already-known cost of exiting the UK, albeit with an additional $801 million drawdown of the capped $2.2bn of provisions for conduct costs that the UK authorities insisted on as the price of that disengagement.

The departure from the UK isn’t, however, all red ink from the perspective of NAB shareholders, since they were given 75 per cent of the shares in CYBG Plc when it was deterged from NAB. Since its UK listing in early February its shares are up 24 per cent and it now has a market capitalisation of just under $4bn.

It has always been recognised that beneath the sea of red ink that poured out of the UK in recent years was the domestic but somewhat neglected core of a solid financial institution and the first-half result provides a better insight into what the new NAB looks like and what it might become.

Thorburn, having largely pared the group back to that core (the completion of the sale of 80 per cent of its capital-intensive life insurance business to Japan’s Nippon Life is the major unfinished structural business), has put a lot of effort and investment into revitalising NAB’s sector-leading business franchise, which had been somewhat neglected in recent years because of the distractions elsewhere.

That franchise dominates NAB’s Australian banking business, which lifted cash earnings 5 per cent in the half to $2.7bn. Business banking customer revenue was up 4 per cent on the previous corresponding half and the net interest margin of the unit was three basis points higher than in the September half.

There was a slightly jarring note in that business banking expenses grew faster than revenue — they were up 6 per cent — but there is an element of renovation costs in the increased expenses.

Encouragingly, given the discernible rise in charges for bad and doubtful debts reported by its peers, NAB’s charge for impairments was, at $375m, lower than a year earlier ($399m), albeit slightly higher than in the September half ($349m).

Within the business bank itself the charge was $341m, 7 per cent lower than in the same half previously, even though NAB shares with the other majors exposures to several large failed or troubled corporates. Those big single-name exposures were reflected in a sharp uplift in the proportion of specific provisions relative to its impaired assets, from 30.3 per cent at 30 September to 36.4 per cent at 31 March.

That’s encouraging, given that there have been some concerns that NAB’s new-found aggression as it sought to rekindle growth within what had been a stagnating business would result in a dilution of credit standards and ultimately asset quality.

NAB is, of course, more exposed than its peers to any significant increase in stress in the economy, particularly within the small and medium-sized business sector so its asset quality and its pricing for risk, as reflected in its net interest margin, will continue to be scrutinised closely.

When Thorburn was appointed CEO in 2014 the two burning issues he was confronted with were extricating NAB from the UK (and its far more modest and successful presence in the US) and generating acceptable returns from NAB’s historically underperforming wealth management businesses.

Under Andrew Hagger NAB Wealth’s performance has been improving strongly and that stronger performance has continued ahead of the completion of the deal with Nippon Life, which will greatly improve the unit’s returns on capital and enable its processes and technology platform to be re-engineered and simplified.

NAB Wealth improved its cash earnings by 11.7 per cent to $249m, with higher net income and lower expenses.

NAB’s relatively small retail banking business also performed well, increasing its customer revenues 10.2 per cent, albeit with a far more modest growth rate between September and March, and growing its net interest margin 12 basis points between September and March.

The “other” key unit within the pared-down group is its large New Zealand business.

It has been impacted by the problems being experienced in the NZ dairy industry, with its cash earnings down 3 per cent in local currency terms (4.6 per cent in Australian dollars) to $NZ404 million ($373m) after bad and doubtful debt charges increased by 83 per cent, or $NZ38 million ($35m) and its net interest margin fell 11 basis points between the September and March halves.

While Thorburn’s frenetic remaking of NAB remains a work-in-progress, the early signs are encouraging.

Along with all the other major banks, NAB raised a very big lump of new capital last year -- $5.5bn — in response to changes in their regulatory capital requirements, although in NAB’s case there was an extra element to provide for the UK demerger.

Despite the size of that equity raising its return on equity has held up quite well. At 14.1 per cent it is well down on the 15.8 per cent it generated in the March half last year, ahead of the raising in May, but only slightly lower than the September half’s 14.3 per cent.

Its ROE compares well with Westpac’s 14.2 per cent, given that Thorburn only recently, post-demerger, had reasonably clear air to operate in, and more than favourably with ANZ’s 9.7 per cent.

It is also (like the other Australian majors) well-capitalised, with a common equity tier one ratio of 9.7 per cent, which is above its target range of 8.75 per cent to 9.25 per cent, and therefore well-placed to deal with either further regulatory capital imposts or a deterioration in the external environment.

The big difference between today and a year ago, of course, is that NAB now only has to concern itself with the environment in its home markets of Australia and New Zealand.

While it still has an interest in what unfolds in the UK, both because its shareholders have an exposure and because it might eventually be able to repatriate whatever’s left, if any, of the pile of cash and capital it was forced to leave behind to cover its potential conduct liabilities, the UK is now an interesting sidelight rather than a returns and earnings-depressing front-of-mind challenge.