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Edited Transcript of NANW.L earnings conference call or presentation 22-Nov-19 9:30am GMT

Half Year 2020 Nationwide Building Society Earnings Call

SWINDON Nov 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Nationwide Building Society earnings conference call or presentation Friday, November 22, 2019 at 9:30:00am GMT

TEXT version of Transcript


Corporate Participants


* Chris S. Rhodes

Nationwide Building Society - CFO & Executive Director

* Joe D. Garner

Nationwide Building Society - CEO & Director

* P. Andy Townsend

Nationwide Building Society - Divisional Director of Treasury

* Robert Gardner

Nationwide Building Society - Chief Economist




Joe D. Garner, Nationwide Building Society - CEO & Director [1]


Good morning, and welcome to Nationwide Building Society's results for the first half of the 2019-'20 financial year. I'm Joe Garner, Chief Executive; and with me on the call is today is Chris Rhodes, our Chief Financial Officer. Chris is an Executive Director at Nationwide and took over from Mark Rennison when Mark retired last month. We also have with us Tony Prestedge, our Deputy Chief Executive; Sara Bennison, our Chief Marketing Officer; our Chief Economist, Robert Gardner; and Andy Townsend, Society Treasurer.

I'm going to take you through the key performance highlights, Chris will then drive into the detail, and then we'll take your questions.

Nationwide is a member-owned building society and as you can see on this slide, we've grown very strongly over the last few years with membership at a record high of almost 16 million members. Our primary purpose is building society nationwide, which describes our desire to contribute positively to the financial lives of our members and our wider communities. We run our society in the interest of our current and future members, and our results today reflect that very clearly.

Although our business has grown, our profits are lower for 3 reasons. Firstly, because we've made a number of conscious decisions to prioritize our members interests over higher short-term profitability. For example, we have continued to offer very good value mortgage and savings rates in a persistently low interest rate environment. Our GBP 365 million in member financial benefit in the first half of the year, substantially exceeded our half year threshold of GBP 200 million. This is a tangible benefit to our members and has contributed to lower net interest income and a narrower margin, which has inevitably constrained our profits.

However, second, we are investing in the future of the society. We announced last year, a significant increase in investments in our technology estate and digital future. More recently, we pledged to keep a branch in every town where we have one today until at least May 2021. Decisions like these are a real value to our members but they do carry a cost, which is contributed to lower profits.

The third reason profit is down is that we did take a higher provision for PPI as previously announced as the claims peaked ahead of the FCA -- or inquires peaked ahead of the FCA deadline. As a building society, we do not have shareholders in a traditional sense and therefore, we are able to make decisions that put the needs of our members ahead of short-term profit. We believe this is the right thing to do, and we'll continue to balance rewarding our members with investing in the society and financial strength.

We track our performance against 3 measures, which are important to our members, great service, good value and financial strength. We want to encourage more members to do more with us by combining good value, great service and a convenience of seamless branch and digital services. We grew our committed membership, who are those members who have 2 or more products with us by 100,000 people to 3.5 million during the half. We continue to work hard at providing excellent service at a time when service expectations are increasing because we believe that service attracts members to Nationwide and keeps them with us.

We're pleased to have maintained our service lead over our peer group for over 7 years, and to be named which is Banking Brand of the Year for the third year running. However, we are acutely aware of how fast service expectations enabled by technology are changing, and we've embarked on an ambitious investment program to make sure that society continues to meet members' needs today and in the future.

Our investment will enhance our IT systems and infrastructure, and enable us to meet rapidly growing demand. For example, in just 3 years, mobile logins have increased by over 300% and point-of-sales transactions have nearly doubled. We'll continue to digitize our services, allowing us to bring new services to our members more quickly and easily than before. We're building a completely new platform for our small business current account, which will be launched in 2020.

Technology is also accelerating innovation, we have secured premises for 2 new in-house technology hubs in London and in Swindon. And these will, in time, reduce our reliance on third parties as we build our own capabilities. We're also using our investment to partner with fintechs to develop entirely new ways for people to manage their finances better. And through our open banking for good initiative, we're partnering with fintechs to use open banking technology in new ways to help people who are financially vulnerable to make better decisions around their finances. Our investment is not confined to tech spend. We know that members continue to value our high street presence, and we're also investing in our network. We've refurbished 28 branches in last 6 months, taking our total number of branches refurbished since 2017 to 150. We've also made our branch pledge, as I mentioned earlier.

Our third KPI is on financial strength. Our finances remain strong, our leverage ratio stands at 4.6% underpinned by a conservative risk profile. We've also delivered over GBP 300 million in sustainable cost savings in starting our efficiency program in 2017. And in the half year, we've kept our costs broadly flat, excluding the tech investment that I mentioned earlier, and that's while still growing our business.

Turning now to our trading performance in our 3 bedrock relationships, current accounts, mortgages and savings. We achieved particularly strong growth in each of these areas in the first half of last year, and the pace of growth has returned to a more moderate level in the last 6 months. Current account openings were robust with 389,000 new accounts opening despite unprecedented consumer choice. Our market share of main, standard and packaged current accounts continues to grow, and we're particularly pleased to attract well above our market share of current account switches, many of whom are bringing their main current accounts to us.

Helping people into homes of their own continues to be at the heart of what we do, mortgage lending was robust with new lending of over GBP 16 billion in a subdued housing market. We continue to innovate to meet members' needs by, for example, becoming the first high street provider to offer a comprehensive range of retirement mortgages to help people make the most of their assets in later life.

Deposits grew by GBP 2.5 billion as we continue to prioritize competitive savings rates for our members, with average rates 50% higher than the market average. We've also recently launched a PayDay SaveDay campaign to encourage people to regularly save in a low rate environment across our membership and wider community.

Now let me hand you over to Chris to take you through the numbers in more detail


Chris S. Rhodes, Nationwide Building Society - CFO & Executive Director [2]


Thank you, Joe. Good morning, everyone. Whilst I'm new to the CFO chair, I've known many of you for a long time and I'd have to say it is great to be talking to you this morning about the numbers. So as you've heard, we continue to make good progress against our strategic objectives with continued growth in our membership, leading service performance and a solid performance in our core markets. During the period, we continue to invest in our IT estate in line with the announcements we made last year.

So turning to our financial performance. In line with our expectations after allowing for the additional PPI charge we announced in September last year, underlying profits in September, underlying profits are 33% lower at GBP 307 million compared with GBP 460 million a year ago.

Statutory profit is down by a further GBP 54 million, largely as a result of below the line hedge accounting gains not being repeated this half-year. Total income was 3% lower reflecting the net impact of lower margins, offsetting a 1% growth in lending balances. Operational cost, excluding the additional technology-related items, depreciation and our investment in Nationwide for business, we're broadly flat. We remain on track to deliver GBP 500 million of sustainable saves by 2023.

Asset quality remains strong and arrears levels reduced during the period. Impairment increased by GBP 12 million, reflecting book growth and a slight deterioration in the economic outlook, which is reflected in our provisioning assumptions.

The charge for other provisions was GBP 52 million compared with a release of GBP 15 million in the prior year, this largely reflects an increase in PPI provisions already announced together with provisions for CMA Directions. Member financial benefit was of GBP 365 million compared to GBP 330 million in the same period last year, illustrating the extent to which we are maintaining our commitment to long-term good value for our members. 5% balance sheet growth reflects a rise in liquidity and an increase of GBP 3.1 billion in mortgage balances, with a decline in other lending balances as the runoff of our CRE book offsets growth in unsecured lending balances. Liquidity balances increased by GBP 6 million due to increased wholesale funding. Other assets also increased by GBP 3 billion, reflecting an inflow of collateral as the market value of our hedging portfolio, which supports our funding our member balances increased.

Deposit growth of GBP 2.5 billion reflects ongoing current account growth and stable other deposits in a competitive market. Our cost of retail funding reduced by 3 basis points in the 6 months, maintaining a 33 basis point differential to the market.

Capital ratios remain strong. The CET ratio declined very slightly to 31.5% as growth in RWAs and other movements, largely pensions, offset retained profits for the period. The U.K. leverage ratio reduced to 4.6% reflecting the net AT1 redemption.

As communicated at the year-end, margins continue to reduce as a result of competitive lending rates and back book runoff, including our BMR balances. The reduction in the retail cost of funds has offset the decline in mortgage margins, in addition, net interest has been reduced further as additional wholesale funding has been raised to increase our liquidity and to fund our MREL requirements.

In the second half of the year, we expect the decline in margins to moderate as new deal margins stabilize and the high levels of liquidity are maintained. Although the market remains competitive, new business margins have stabilized as fall-in swap rates were not fully passed through to mortgage pricing. The impact of low interest rates on the current account structural hedge continues to place downward pressure on current account profitability, which will offset some of the benefit of improved mortgage pricing. The outlook for the medium term remains unchanged, and that we continue to expect downward pressure on margins due to the runoff of close books and ongoing price competition in our core markets.

After allowing for the increased levels of investment, the cost base is broadly flat, and we expect this trend to continue for the full year maintaining the trend over the last few years. We remain on track to deliver our technology investment for the incremental GBP 1.3 billion we announced last year with total investment during the period, '18, '19 through to '23, '24 being no higher than the GBP 4.1 billion previously announced. The income statement impact of this investment will vary in and between accounting periods depending on the nature of the programs of work that are undertaken.

Impairment charges are in line with the recent experience and expectation. Asset quality metrics are very stable with a slight decline in arrears levels during the last 6 months, underpinned by the fundamentals of low interest rates and high employment. IFRS 9 staging across both mortgages and unsecured credit remains stable. Provision coverage is stable with a secured coverage ratio of 11 basis points and an unsecured ratio of 900 basis points.

We have used 4 economic scenarios in deriving IFRS 9 provisions, including 2 downside scenarios. One assuming a mild recession with moderate house price falls and a more severe scenario, encompassing a deeper recession with more significant falls in house prices.

In aggregate, we have applied a 45% probability to our downside scenarios compared to 30% at the year-end. The impact of all scenarios on our provisions, relative to the modeled central case is GBP 137 million, the majority of which relates to the severe downside. We believe our scenarios capture the range of plausible economic outcomes over the medium term. In particular, they allow for a range of outcomes contemplated by the Bank of England in its analysis of possible Brexit consequences. The customer redress charge has been driven principally by a surge in a number of PPI inquiries in the run-up to end of August deadline. The charge recognized in H1 is based on inquiries processed to date, which show a conversion rate of inquiries to claims of 9%.

Overall, our PPI volumes remain low compared to the rest of the industry, with total volumes accounting for circa 1% of industry volumes. Other movements in provisions for redress include previously announced CMA directions in respect of prenotification of charges.

Our CET1 ratio has reduced slightly to 31.5% with retained earnings being offset by higher RWAs and other move -- asset movements largely pensions. Intangible software assets, which are a capital deduction continue to grow as a consequence of our investment in technology. Our capital resources are in excess of regulatory requirements across CET1, leverage and MREL frameworks with leverage remaining our binding constraint. From an MREL perspective, we already meet future regulatory requirements and expect to manage ongoing maturities and new issuance to maintain this position. In terms of our capital outlook over the medium term, our position will be affected by a new IRB modeling standards for residential mortgages and the progressive implementation of standardized floors from 2022. We currently expect new through-the-cycle IRB models to be effective from the first half of 2020, reducing our CET1 ratio by approximately 1/3 to low 20s.

Further down the line, our IRB model outputs will be overridden by standardized floors under current proposals, resulting in a further reduction. In aggregate, on a pro forma basis, we expect the combined impact to reduce our CET1 ratio by around half to the mid-teens. Given the strength of our current position and long transition period, our plans would indicate that organic profitability will allow us to maintain a CET1 ratio in excess of regulatory expectations through transition. We expect leverage to remain our binding constraint subject to no material shifts in our asset mix.

Our liquidity and funding ratios are in excess of regulatory requirements. Our half year liquidity ratio of 140% was lower than last year-end, remains elevated. We remain active in the wholesale funding markets across a range of platforms and currencies. Our plans assume we retain our prudent approach to funding, retaining higher levels of liquidity for as long as market uncertainties remain.

Our credit ratings have remained stable during the half year, and negative outlooks for Moody's and a rating watch negative for Fitch relate to a technical loss given failure assessment and sector-wide Brexit uncertainty, respectively.

Nationwide prides itself on being a responsible and sustainable business, and we have strengthened our governance in this area in the last 6 months, including publishing our first responsible business report and becoming a signatory to the UN Global Compact.

Overall, we continue to make good progress with a solid trading performance, delivery of long-term value for our members underpinned by a strong balance sheet.

Let me now hand you over to Robert to take you through the economic outlook.


Robert Gardner, Nationwide Building Society - Chief Economist [3]


Thanks, Chris. Good morning, everyone. There's been a lot of noise in the economic data in 2019, in part due to the inventory adjustments in the run-up to and immediately after the Brexit deadline at the end of Q1. Nevertheless, the underlying piece of U.K. economic activity appears to have slowed from an already mediocre performance in 2018. Overall, the U.K. economy grew by 1.4% in 2018, its weakest performance since 2009, and it looks likely to be around 1.2% this year.

Loss of momentum is centered around business investment and trade and reflects the impact of heightened uncertainty surrounding Brexit as well as the impact of weaker global growth. By contrast, household spending has remained fairly solid, thanks to healthy employment conditions and gains in real earnings, though, in recent months, there have been tentative signs that the labor market may be weakening in response to slower economic growth.

The outlook remains highly uncertain, but our central forecast assumes that the U.K. economy will remain subdued with annual growth of around 1% over the next 12 to 18 months before picking up modestly as Brexit uncertainty lifts and as global growth regains some momentum. This may mean a small rise in employment rate from current lows with interest rates remaining close to current levels over the next few years.

In the housing market, activities remained broadly stable in recent quarters albeit at subdued levels with mortgage approvals for house purchase remaining close to the average prevailing over the past 2 years. Solid labor market conditions and low borrowing costs appear to be offset in the drag from the uncertain economic outlook.

After remaining fairly stable at 2% to 3% for March of 2018, annual house price growth has been below 1% in each of the past 11 months as shown on this last side. In terms of regional trends, annual price declines have largely been confined to London and the Southeast of England. And the prices in the capital have been declining in annual terms since early 2017, but they're still only 5% below their all-time highs and are still much further above the 2007 levels in other U.K. regions.

If the U.K. economy continues to grow with a modest pace, with the unemployment rate and borrowing cost remaining close to current levels, U.K. house price growth is likely to be broadly flat over the next 12 months before edging higher as the broader economy gathers momentum.

Over the long term, we expect house prices to rise broadly in line with average incomes, assuming that the economy grows in line with our expectations and housebuilding keeps pace with household formation.

Turning to trends in our core markets. Total mortgage market growth lending was relatively stable over the past year, though there was continued variation across borrower types, as you can see on this slide. I should make clear here that my comments refer to total market developments and not just to Nationwide's lending.

First-time buyer numbers continue to increase towards 2007 levels, thanks to healthy labor market conditions and low borrowing costs while continued low mortgage rates provided support for owner-occupier remortgage activity. By contrast, buy-to-let purchases remain subdued following changes to tax and underwriting standards in recent years, though buy-to-let remortgaging has proved more resilient.

In terms of the savings market, annual growth in household deposit market has averaged around 4% in recent quarters, which is slightly higher than the 3.5% prevalent over the previous 2 years, reflecting continued modest rates of credit growth and household saving. In the years ahead, we expect mortgage lending and deposit growth to continue to grow at a steady pace, similar to recent trends before strengthening gradually in line with developments in the broader economy.

And now I'll pass you back to Joe for some concluding comments.


Joe D. Garner, Nationwide Building Society - CEO & Director [4]


Thank you. So looking ahead, it's clear that the U.K.'s growth has slowed as a result of weaker global growth and Brexit uncertainties, however, household spending has remained relatively solid and the housing market broadly stable albeit at subdued levels. However, our members will still want to buy homes and save for the future and manage their finances efficiently. We're operating from a position of strength with capital ratios well above all known, current and future regulatory requirements. This means we can continue to prioritize the long-term health of the society and serve the needs of our members both current and future.

Thank you very much, now I'll turn to Alex for your questions.


Questions and Answers


Unidentified Company Representative, [1]


Thank you, Joe. We have had a number of question come in. The first question from Lee Street of Citi. It's a 4-part question. Where do you see NIM bottoming out? What is the lowest level you could envisage the NIM hitting in the next 3 years? Can you provide guidance in terms of new mortgage pricing, the closed mortgage book runoff and funding costs? That was part one.

How should we think about your appetite towards M&A? Do you see a scenario where the mix of your loan book could materially shift in the next 3 years? Could you give us some guidance as to your funding plans for the coming year?


Joe D. Garner, Nationwide Building Society - CEO & Director [2]


Okay, thank you for that. I think that's -- I'll make that 6 or 7-part question but maybe if I can turn to Chris for the majority of that and see how far into the crystal ball we can actually go or not.


Chris S. Rhodes, Nationwide Building Society - CFO & Executive Director [3]


So Lee, let me kind of unpack this year's margin decline and then talk about the future as far as we can see it. So the 11 basis point decline in margin in this half year compared to last half year elevated liquidity, the rundown of the CRE book, that's about 3 basis points. Gross mortgage pricing, about 10. And then as you can see from the chart we put up earlier, we get a 2 basis point benefit from funding cost in the round lower retail offset by higher wholesale, particularly including MREL.

Now within all that, we have seen some stability in mortgage pricing and, again, you can see that from the chart in the last couple of periods, actually relative stability in mortgage pricing. And when we look to the full year, I'd be giving you guidance that the rate of fall is going to moderate, and I'm talking broadly about 2 basis points of fall in margin between now and the end of the year.

Once I start to look out beyond that, Lee, I think there is still a downward pressure. But if I give you a couple of caveats, then I would say we are close to the bottom, not at the bottom, we are close to the bottom. And the reason why I say that, and therefore, these are the caveats, relatively stability in new mortgage pricing. If we assume that continues, and we assume we don't get base rate cuts, and we ultimately get an upward sloping yield curve rather than a downward sloping yield curve from some point in the middle of next year, then we are within a few basis points of the bottom of the cycle. But as you can see, Lee, there's quite a few caveats in there. In terms of new mortgage pricing, we are seeing, I'd say, broad stability, about 120 basis points for prime across the blended portfolio, about 170 basis points for buy-to-let. And it's those rates that I'm assuming carry on into the future when I've given you that forecast.

So I think that's probably all I've got to say on margin. If we take this -- I think what was the last question, Joe?


Joe D. Garner, Nationwide Building Society - CEO & Director [4]


Well, just to comment on M&A. And then the last bit was about the possible shift in loan book mix. But M&A, I think it would be normal to speculate that after 10 years of low base rates and sustained margin pressure, consolidation would be one sort of obvious outcome in that, sort of, environment. So we obviously stay open-minded, there's nothing around that is particularly interesting to us currently, but we do stay actively open-minded and watch closely because I think that is -- would be a very logical outcome from sustained conditions that we see out there.


Chris S. Rhodes, Nationwide Building Society - CFO & Executive Director [5]


So asset mix, Lee, no major change to be expected. We've got the rundown of the CRE, that will be somewhat replaced by unsecured lending but no dramatic change in the balance sheet there. We will still fundamentally be focused on resi property, probably a little bit more buy-to-let and a little bit less prime, but no fundamental shift in asset mix.

And then I think the final question was about funding. So if I look to the 2021 financial year, we've about GBP 11.5 billion of maturities, including TFS. We've talked about maintaining elevated levels of liquidity, I kind of want to be a quarter ahead of those maturities. So across, I think, all funding platforms, schemes, currencies you could expect us to issue circa GBP 11 billion in the next 12 months or so. Andy, do you want to add anything to that?


P. Andy Townsend, Nationwide Building Society - Divisional Director of Treasury [6]


Yes. Lee, just a couple of things. One is that probably our issuance of coming will reflect the fact that we haven't been very active in the secured lending markets for some time now. So you can probably see or expect to see the issuance slightly skewed towards a securitization and/or covered bonds, which of course segues into the fact that from next year, we'll start to see the repayments of TFS. So we've got GBP 17 billion drawings across a couple of financial years for us, so well within our usual funding norms, if you like. And of course, that's a fairly natural construct whereby the TFS, which of course is secured against mortgage lending will be in quite large part replaced by secured external market funding.

I think you made an observation in your quick note this morning that you wouldn't be expecting a further additional Tier 1 supply any time soon. I think it's fair to say that's a reasonable assumption.


Unidentified Company Representative, [7]


Okay. So we have two questions from Rohith Chandra, Bank of America. On mortgage lending, after a strong second half in 2018-'19, the gross lending market share has fallen to its lowest for a number of years in the first half of this year, how do you expect this to evolve in the second half? And why do you think mortgage new business pricing will be stable, there has been some noted decline in spreads in recent months.


Chris S. Rhodes, Nationwide Building Society - CFO & Executive Director [8]


So I think as we look at mortgage lending, we -- in terms of our share, we continually balance the need of our savings members and our borrowing members, and we seek to achieve a good balance between both sides of the balance sheet as competition in low loan-to-value mortgages steps up the margins decline. Actually, it's a much more balanced opportunity to continue to reward savers and not chase volume, purely for the sake of volume.


Joe D. Garner, Nationwide Building Society - CEO & Director [9]


So I'll just underline that. I'd say that we're there to optimize both the profitability and what we can pay our savers. If the market's there, we'll take it; if it's not, we won't. And we will not chase unprofitable market share.


Chris S. Rhodes, Nationwide Building Society - CFO & Executive Director [10]


Alex, in that context that I talked about, our pricing and our margins stabilizing. So as swaps fell materially, the full impact of that was not passed through to mortgage pricing and that's underpinned the stability in gross mortgage pricing over the last few months. We expect that to continue and the reason why I expect that to continue is the downward sloping yield curve is hurting everyone's structural hedge. Some of the other guys are clearly more exposed to that than we are. And I think there is a balance between mortgage pricing and what's going on with the structural hedge, which gives us a view that there is slightly more stability in mortgage pricing than it has been the case.


Unidentified Company Representative, [11]


And we've got one last question from James Hyde at PGIM. Are you concerned that despite modest balance sheet growth, the leverage ratio has fallen close to your target?


Chris S. Rhodes, Nationwide Building Society - CFO & Executive Director [12]


So broadly, no. I mean we have a target, we're ahead of the target, the net AT1 issuance was to maintain that position. The vast majority of the fallen, clearly not all of it but the vast majority of the fall in leverage is down to the redemption, a bit of movement on pensions, which is fundamentally about the shape of interest rates. So no, I'm not worried.


Unidentified Company Representative, [13]


Thank you. No further questions.


Joe D. Garner, Nationwide Building Society - CEO & Director [14]


Great. Okay, so thank you very much for your interest. As you know the team are available anytime for any follow-up questions. And just to reiterate, I think what we are really encouraged by is the continued strength in what matters to our members, underpinned by really strong capital ratios and thus the ability to focus on success over the long term. Thank you very much.