Why 'Breaking Up' was good for NAB

The light at the end of the tunnel is starting to brighten for Cameron Clyne and National Australia Bank shareholders.

The UK legacy he inherited even as the financial crisis erupted has disfigured NAB’s results and coloured assessments of his tenure. But both the 'good' and the 'bad' banks NAB owns in the UK are beginning to quite sharply improve their performances (off ugly bases) in response to NAB’s major restructurings and promising signs of improvement in the UK economy.

It was the lessening of the drag from the UK, a continuing reduction in bad debts within the core Australian business bank, solid earnings growth in wholesale banking and, most notably, the stellar performance of NAB’s personal banking business – the floundering segment of NAB’s Australian business pre-Clyne – that underpinned NAB’s solid 9.3 per cent increase in cash earnings in the year to September.

The 'good' or ongoing part of NAB’s UK banking exposures lost $213 million last financial year. In the latest year it made $150 million, with the momentum in earnings surging in the second half as the external environment improved.

The 'bad bank', or the commercial real estate portfolio that Clyne separated from the ongoing UK business and put on the parent entity’s balance sheet, lost $375 million. But the losses in the second half were about 42 per cent lower than in the first half, and there has been definite improvement in the depressed UK commercial property market.

That portfolio, while still large at about $6.8 billion, is in run-off and was reduced by about $2.7 billion over the year. Should the UK economy and property markets continue to improve, the winding back of that portfolio could accelerate. This could allow Clyne  to have more options: not just for dealing with his bad bank, but perhaps in relation to the ongoing UK operations.

While the UK exposures are a blemish on NAB’s results and its returns on equity (a respectable 14.5 per cent in the latest result),  Clyne would be particularly satisfied with the performance of NAB’s personal banking business, which was rapidly becoming irrelevant in the market until the controversial "Breaking Up" campaign.

In the year to September it improved its cash earnings 17.5 per cent to $1.22 billion. The winding back of the price-driven promotion last year boosted the net interest margin, and strong cost control (the cost-to-income ratio improved from 51.5 per cent to 47.2 per cent) and above-system growth in mortgage lending all contributed to the result.

Since Clyne initiated the growth strategy within the personal banking business, it has generated 18 per cent compound annual growth in cash earnings and materially lifted its share of the mortgage market.

In conditions where demand for credit (particularly from business) is subdued, NAB’s core franchise – its business bank – lifted earnings a modest 3.3 per cent, largely as a result of reduced bad and doubtful debt charges.

Wholesale banking lifted its contribution 9.3 per cent to $1.2 billion, but NAB Wealth’s earnings were down 5 per cent and were impacted by some of the stresses that have been showing up in the insurance sector. The New Zealand bank put in a solid performance.

The result was affected to some degree by the major organisational restructure Clyne is implementing, and the costs of UK "conduct-related" charges. They were reflected in a 4.4 per cent (or $346 million) increase in costs despite a reduction of more than 1000 jobs over the year.

Amid reports that the Australian Prudential Regulation Authority has warned the major banks that, as systemically important banks, they face additional capital adequacy requirements and therefore should restrict dividend growth and capital returns, NAB has increased its final dividend by seven cents a share to 97 cents a share.

The group is already well-capitalised, with a capital adequacy ratio (on an APRA Basel III common equity tier one basis) of 8.43 per cent, an increase of 21 basis points on its position at the end of March and 53 basis points since September last year.

The Australian majors will, in the context of subdued demand for credit and their intense focus on costs, continue to generate substantial earnings and therefore capital. They ought to be able to both satisfy shareholders and the regulator, which appears anxious to protect the resilience and reputation of one of the world’s strongest banking systems by ensuring it is at the most conservative end of the industry’s capital and liquidity settings.