NAB Shares Drop On Competitive Pressures Impacting Interest Margins

Higher earnings but competitive pressures building

NAB has reported 17 percent higher cash earnings for the 6 months to 31 March 2023 of $4.07 million, compared to the first half of the prior financial year. However, the NAB’s Net Interest Margin for the March quarter has remained relatively flat at 1.77 percent and reflects the intense competition for customer deposits and residential mortgage home loans. However, higher wholesale funding costs and competitive pressures impacting the housing lending portfolio have crimped margin growth and this pressure is unlikely to reduce in the short-term. This explains today’s 5 percent share price decline despite the strong headline profit result. In a rapidly rising interest rate environment, bank lending margins generally increase because loan rates rise more quickly than deposit rates, but this hasn’t occurred in the current half-year.

Basic cash earnings per share of $1.30 are up 21 percent from $1.07 for the corresponding prior period, enabling a 5 percent higher interim fully franked dividend of 83 cents to be paid on 5 July.

NAB is prudentially sound

The bank remains exceptionally well-funded with over 80 percent of Gross Loans and Advances funded by customer deposits. Depositor funding is a key financial metric for NAB because customer deposits tend to be more ‘sticky’ than wholesale funds that can dissipate quickly when economic and financial market conditions deteriorate.

NAB has a prudentially sound balance sheet with a 12.21 percent Common Equity Tier 1 ratio, after providing for a collective lending provision coverage which is well above pre COVID-19 levels.

Liquidity is also strong at $202 billion, being $47 billion surplus to regulatory requirements. Moreover, NAB’s 2023 financial year term funding requirements are well advanced with $23 billion raised in the first half-year. An additional $59 billion contingent liquidity in the form of internal Mortgage-Backed Securities exists. This positions the bank well for the risks and volatility arising from the rapidly tightening monetary policy settings of the Reserve Bank.

NAB has a high-quality Australia housing book. The average Loan to Valuation ratio of 43 percent represents a healthy buffer against falling domestic house prices. The bank adopted a cautious approach to home lending in the half-year to March with home lending growth restricted to 0.6x of system growth.

This home lending system growth (market-share) has slowed to the lowest growth rate in home lending in the past 4 years and presently leaves NAB at 14.7 percent market share.

The business lending book (to SMEs) is also conservatively managed with 75 percent of the book fully secured. Business lending market share is currently 21.6 percent. Seventeen percent of the business lending book is exposed to discretionary expenditure like retail trade, tourism, hospitality and exertainment.

Interestingly NAB has increased its investigations and fraud team by 50 fulltime employees to more than 450 people, in response to the alarming increase in scams perpetrated on bank customers.

Outlook

Elevated inflation, rising interest rates and conflicts around the world and the prospect of a slower domestic and global economy ahead provides a degree of uncertainty not seen in recent times. The global economy is facing uncertainty regards the global inflation outlook and rising geopolitical tensions, which is having an impact on decision-making by business leaders in Australia. This is because Australia is essentially an ‘export‘ economy and the level of global economic growth is the primary determinant of Australia’s economic prosperity.  March was the second highest trade surplus on record at $15.3 billion, with export growth led by metal ores and minerals and rural goods exports. However, while Bankers can’t predict the future, they can prepare for it and NAB is well provisioned for the impact of higher interest and living costs on householders with a mortgage.

Six months ago, NAB reported that most of its customers are ahead on their mortgage repayments. This situation was in part due to customers paying down more of their mortgage loan while interest rate levels were at historic lows.

NAB appear confident about the capacity of the domestic economy to withstand current mortgage stress levels and softening business and consumer confidence levels.

Some insight into NAB’s strategic thinking is reflected in their assumptions relied on in estimating provisions for Expected Credit Losses. Future total Expected Credit Losses are estimated at $5.577 billion. Key economic assumptions based on NAB’s economic modelling when determining Expected Credit Losses include a base case for economic growth of 0.6 percent and 2.1 percent in the 2024 and 2025 financial years respectively, while for house prices year-on-year NAB expects house prices to fall on average by 4 percent in CY23 and increase by 0.4 percent and 6 percent in the 2024 and 2025 financial years respectively. NAB is forecasting unemployment to rise to 4.7 percent in the 2025 financial year.

Interestingly, NAB’s housing credit loss provisioning as at March 2023 increased by 12 percent compared to March 2022 while the provision for Expected Credit Losses on business loans at March 2023 was down 4.9 percent.

Population growth rebounding with increasing migration, and with business conditions expected to remain consistent with long-term averages, a well-capitalised NAB should deliver steady shareholder returns in an uncertain economic environment in the period ahead.