NAB finds breaking up hard to do

Weaker credit demand, with continued funding pressure, means NAB's trend of flatlining earnings but strengthening balance sheets will likely continue for some time.

Given that it had previously foreshadowed the disfigurement of its March half results caused by the decision to put its UK commercial property portfolio into run-off, National Australia Bank has produced quite a respectable result.

The group’s cash earnings were actually up 1.3 per cent between the September and March halves, despite the $204 million UK loss. That was primarily due to a very strong performance by NAB’s wholesale banking business, which added $251 million of earnings between September and March.

NAB’s decision to move first and hard in retaining a big slice of the Reserve Bank’s interest rate cut earlier this month – which left it retaining its boast of having the lowest standard home loan rate by only a sliver – was, however, put into perspective by the result.

NAB’s renewed competitiveness in retail banking and the "Breaking Up" campaign have been very successful, adding almost 200 basis points to its home loan market share over the past two years. That volume growth, driven primarily by price, has, however, come at a cost.

NAB’s personal banking business suffered a 7 per cent fall in earnings in the half, relative to the September half, although it was up 7.4 per cent against the March half last year. It lost 15 basis points of net interest margin between September and March and 20 basis points against the March half last year.

It was that squeeze on its net interest margin that caused NAB to retain 18 basis points of the RBA reduction. It would also no doubt have been mindful that the battle for deposits is heating up again and that underpricing its home loans would limit its ability to offer competitive rates on deposits.

NAB’s core business bank also experienced some pressure during the half, with earnings flatlining and its net interest margin down 10 basis points from the September half even though it increased its lending market share by 50 basis points. Earnings were, however, 7 per cent higher than for the same half last year and asset quality was stable.

Like its peers, NAB has been very focused on building its defences against any new threat emerging from the instability in Europe, the volatility and fragility of funding markets and the toughening regulatory regime.

It is now holding tier one capital of 10.2 per cent of risk-weighted assets and liquid assets of $90 billion. All four of the majors are building capital and liquidity as insurance against another meltdown in wholesale debt markets and in anticipation of the Basel III regulatory regime.

Given weak demand for credit, which has recovered modestly from its post-crisis lows, and the continued pressure on funding costs, that broad picture of flatlining earnings but strengthening balance sheets could be expected to continue for some time.

In NAB’s case, its UK exposures – it has nearly $10 billion of commercial property loans in run-off mode within a recessed UK economy while also under taking a costly restructuring of the remaining UK business – provide a particular reason for conservatism and introspection.

NAB reduced its costs by 70 basis points from the September half even as it grew its income 2.4 per cent. Like its peers, while the Australian economy remains low-growth, NAB is focused on lowering its cost structures to better reflect the structural change in the outlook for credit growth, from the mid-teens of the pre-crisis era to the low-to-mid single digit growth the banks now expect to be the new norm.

In the circumstances, while it slipped 20 basis points, NAB’s cash return on equity of 15 per cent was a solid result and one within the ballpark of its peers’ returns – Westpac generated a cash ROE of 15.1 per cent in the March half.

A combination of the sombre economic outlook and the creeping impact of the tougher prudential regime means mid-teens returns on capital, rather than the 20 per cent-plus returns enjoyed pre-crisis, is another of the likely new norms.