National Australia Bank Limited. (OTCPK:NABZY) Q4 2020 Earnings Conference Call November 5, 2020 6:30 PM ET

Company Participants

Sally Mihell – IR

Ross McEwan – CEO

Gary Lennon – CFO

Conference Call Participants

Richard Wiles – Morgan Stanley

Victor German – Macquarie

Jarrod Martin – Credit Suisse

Andrew Triggs – JP Morgan

Brendan Sproules – Citi

Andrew Lyons – Goldman Sachs

Jonathan Mott – UBS

Matthew Wilson – E&P

Ed Henning – CLSA

Brian Johnson – Jefferies

Operator

Thank you for standing by. And welcome to the National Australia Bank, 2020 Full Year Results Presentation. All participants are in a listen-only mode. There will be a presentation followed by a question and answer session. [Operator Instructions]

Sally Mihell

Thank you, operator. Good morning everyone and thank you for joining us for the audio webcast today and that’s full-year 2020 results. For those of you all don’t know, my name is Sally Mihell, and I’m the Head of Investor Relations at NAB.

Presenting today will be Ross McEwan, our group CEO; and Gary Lennon, our group CFO. We’re also joined by members of NABs executive team. At the end of the presentation we’ll open up the Q&A, just a reminder that you need to be on the phone line to ask a question.

I’d now like to hand over to Ross.

Ross McEwan

Thanks for joining us today for the results presentation. This has clearly been a very difficult year for our colleagues and for our customers in Australia and New Zealand and for people, globally.

Financial results for the year at September roughly, this challenging operating environment and for the first time in the generation, Australia is in a recession. Six months ago, we took the size of action to build balance sheet strength by rising capital and increasing after for the provisioning coverage.

This strength allows us to continue to be there for our customers wherever they are and the circumstances and conditions they are facing and what has become a multi-faceted economy. This includes the restaurants, spa’s and service industries and places like Melbourne CBD have been so hard hit and need our own guiding support.

And also includes suburban café’s and shops that have benefit from more people working from home together with pharma’s and other sectors that have proven resilience through the pandemic and want to grow with their backing.

It’s the largest business bank in Australia. We know how important business is, small and larger to the nation’s economic recovery. That’s why we are in engaging with their customer providing our service and the support appropriate for this circumstances.

As the economy transitions through 2021 and 2022, we are likely to see interest rates remain at a current very low levels in the medium term. In response to the RBA’s decision to reduce the cash rate to a record low 0.01% that is today an answerable cut fix rate home loan rates to record lows and reduced rates for small businesses.

The implications of low rates for NAB are clear, we need to be more efficient and resilient and execute well. A strategy refresh which we have found with the first half results builds on their progress over the past three years to be a simpler more streamlined business with clear accountability.

We’ve been getting on with it and we have more to do.

Turning to the next slide. As I mentioned, the financial results this year are clearly impacted by this challenging environment. The decline in cash earnings largely reflects the buildup of forward looking provisions for the expected deterioration and asset quality.

Underlying profit which declined 4.1% this year demonstrates the impact of revenue headwinds including low interest rates, subdued credit demand. Gary will spend more time on the key drivers of the good performance

The final dividend of $0.30 per share, it’s 48% of second half cash earnings including large notable icons. Together with the interim dividend of $0.30, this brings the total dividend for the full-year to $0.60 per share.

While this represents a 64% reduction compared to full-year ’19, reflects consideration of advisors, maintain the groups strong capital position. The uncertainty of — for COVID-19 impacts and approach revised dividend guidance.

The action we took at our first top results to rise capital links we have a strong balance sheet and a sized bank that can support customers. This strength is critical as the pandemic evolves and the pace of economic recovery differs depending upon location and sectors.

The success for completion of the 3 billion institutional placement and the 1.25 billion share purchase plan at 98 basis points where CET1 capital position in the second half. And our year in CET1 is a very strong an 11.47%. The style of MLC Wealth which we announced in August will fill at a fair of 35 basis points to a CET1 capital at completion.

Making our pro forma CET1 capital ratio to a 11.82%. We also took action this year the strength and our collective provisions we are now positioned at the top-end of peers. As I said early on the year, I don’t want anyone concerned about the strength of the bank and these steps are ensuring we’d stay strong through recovery and beyond.

Overhead for the economic activity will continue to improve with the benefit of the budget stimulus measures and the nation reopening for business and travel, the outlook remains uncertain again dependent on sectors location.

Over the past eight months, we have extended substantial support to customers including loan repayment that fills titling $60 billion. Anyway this has reduced monthly repayments on credit cards. Importantly, we have also stood out into business supporting our small-and-medium business customers through a new lending of over $2.4 billion per month during the crisis.

As our economy transitions from support to stimulus, access to borrowing will be critical. We are very aware of the important role we play and providing net support. And as I’ve said before, businesses will lead our economic recovery.

Our total loan deferral balance has reduced from over $60 billion to $19 billion in late October. While over 90% of customers who have exited deferrals therefore are expected to resume repayments. Customers and the more heavily impacted industries or regions are being provided with ongoing support and that is appropriate for them.

We are also conscious that some of their customers who they exited deferrals might end up requiring further support in the future. While this environment continues to present challenges, I am pleased to say that our colleagues adapted quickly to new ways or working.

I could not have been provider of health, I have continued to serve our customers while managing through the challenges themselves. At the same time, our colleague are more engaged with our employee engagement at 76 which is a strong increase in the equivalent score last years of 66 that topped 10 points.

In April, we announced the refresh of a longer-term strategy. This builds in the progress we made under our three year transformation that recognized that we need to go through this to create a simpler more streamlined business with clearer end-to-end accountabilities so we execute much better than we have in the past.

We need to be more efficient and resilient to grow returns in the current operating environment. Customers and colleagues that return takes to that refreshed strategy. And that’s why I outlined that their first half results have strategy refresh and to by four key areas.

We will focus on and be known for. Relationship lead easy to do business with safe and the final one being thinking long-term. At our first result, first half results, we have found a refreshed strategy and the key priorities despite the challenges of the current operating environment, we have made good progress.

Within five weeks we’re announcing our strategy refresh, we in later the new customer centric organization structure with clear end-to-end accountabilities to drive improved decision making.

Our senior leadership team comprising the top 100 colleagues across the bank is largely implies and focused on executing our key strategic priorities. And for the first time in the banks history, this team is 50% female and 50% male.

Our investment in colleagues includes the development of an industry leading education and accreditation program that will rise the standard of bank professionalism and provide a former qualification for all colleagues across the bank.

In addition, a single group-wide leadership program has been introduced to ensure all colleagues been up from great consistent leadership. In August, we announced sale the agreement to sell 100% of MLC Wealth to IOOF Holdings. This will enable us to focus on executing in our core banking businesses.

We’re also continuing to leverage our strong technology foundations. This has allowed us to accelerate the rollout of digital tools to make it easier for customers to deal with us.

Our strategy has identified clear opportunities to grow across our core businesses. As I outlined in April, these opportunities are not wholesale changes but they reflect the meaningful shift in our focus.

This does in private bank is our key differentiator where extending our market leadership by investing in our bankers and further leveraging the date to an inside capabilities we have developed in recent years.

Our personal bank is focusing on delivering simpler propositions and experiences underpinned by a single mortgage operation. Corporate & institutional focusing on more disciplined high return growth and the buildup of transactional banking and asset distribution capabilities.

And we entered, we’re continuing to shift our focus to resume and personal statements rewriting away from capital in terms of statements. And finally, UBank provides another opportunity for us to differentiate.

We will give it more focus as a customer acquisition agent. Let it be quite clear, we want to grow and we want to grow safely. We have a clear ambition to build our market share in our core businesses. To achieve this we need a relentless focus on execution across the organization.

And with our leadership team now largely in place, we have the right people in the right jobs. We’re giving them the right tools and letting them get all of it. Our investment spend in 2021 will be approximately $1.3 billion which is slightly lower than the spend from full-year ’20.

Our discretionary investment standards’ expected to account for approximately 30% of the total investment spend in full year ’21. One of the key changes made this year was to reduce the number of projects we are focused on a smaller group of co-strategic parties which are crucial to supporting our colleagues, serving our customers and ensuring the banks resilience.

These key priorities includes simplifying processes and policies with business and home lending, creating simpler transactional banking, further enhancing our data and analytics for customers and colleagues and growing UBank.

Regulatory and compliance spend will remain elevated in 2021 from proven automate at control environments. This is critical to ensure we get the basics right and importantly to help keep the banking customer safe from the growing threat of fraud, cybercrime and other criminal activity.

A number of the legacy issues we are dealing were occurred because their processes and control environment made us improvement. At the last of the three years investment in technology, a lot of thing delivered.

We have a more resilient and flexible technology environment that allows us to respond quickly and successfully to COVID-19. The key most turn in our technology strategy was the migration to the cloud of our business banking online customer platform NAB Connect.

The benefits to customers from improved resilience, performed, and reliability that can see can be seen in the strong improvement in customer Net Promoter Score. It’s part of our technology investment we’ve also taken significant steps to rise customer and colleague awareness of data security and protect their business from cyber threats.

This has been particularly relevant during the pandemic. And you can see on this slide, significant increase in attempted frauds on their bank and their customers.

Since June 2017, we’ve been based at approximately 300 million as part of a multiyear program to uplift their financial crime capabilities, we now have more than a 1000 people dedicated to managing financial crime risks.

This investment has enabled us to keep losses from fraud stable despite the surge in recent months. We’re taking a broader role and particularly in the community and customers from fraud and partnerships with the government regulators and other financial institutions.

This year, we participated in Clean Pipes an industry initiative to improve strategies online security and reduce our takes on customer information. COVID has led to a significant change in the way our customers engage with us.

Over 90% of our transactions are now digital. Many customers transacting trans positioning to tap and go in internet banking during COVID-19.

As you can see from the slide, we have launched a number of digital tools and customer innovations which support being easy to deal with from virtual checks, the mortgage appointment booking tool, partnerships with organizations such as Polemate [ph] ING [ph] to the launch of the simple home line and StraightUp credit card we are making progress.

We will judge a long-term success by four key measures. First being basic customer outcomes; secondly more engaged colleagues; third, date of returns to our shareholders through cash EPS growth; and finally getting this bank back to a double-digit cash return on equity.

Given the revenue headwinds we are facing cost and capital discipline will be fundamental to driving better results for shareholders. Our target is to achieve lower absolute cost over three to five years relative to the FY’20, cost base of 7.7 billion.

Improved shareholder outcomes can only be delivered by being basely customers and colleagues. This will be reflected in growing share and our target market segments. We will deliver on these measures by staying disciplined, focusing on what matters, and finally executing well that.

Gary, I’ll hand over to you to take the team through the results.

Gary Lennon

Excellent. Thank you, Ross. Let’s start with our usual high level overview of the results. As Ross mentioned, results this period reflected challenging environment including low interest rates and increased provisions for expected credit losses.

To provide a better sense of the underlying results, my comment exclude large notable items which I would address shortly. Over the year, cash earnings declined 26% and declined 9% over the second half.

In both cases, the key driver was high credit impairment charges. Underlying profit fell 4% over the year with costs up 2% and revenue lower mainly reflecting reduced free income. Over the second half, underlying profit increased from stronger revenue in markets and treasury.

Cash ROI declined over both periods with lower cash earnings and higher level of equity.

Turning to the next slide. Before getting into the detail the underlying results, I wanted to first address the large notable items reported this period which we’ve pre announced and provide an update on our customer related remediation program.

We have incurred additional customer related remediation charges in the second half ’20 up $266 million post tax. The bulk of wealth related and form part of discontinued operations. Banking related charges of $94 million post tax form part of large notable items in cash earnings.

Total provisions for customer remediation now stand at $1.9 billion, approximately $300 million lower than the first half ’20. Provision top ups this period have been more than offset by accelerated customer payments provides the service fees to salary planners with this program now substantially complete.

We are continuing to review wise further accelerate payments to customers. Besides customer remediation, there were two of the large notable items this period, payroll remediation or $90 million after tax related to provisions for the expected cost of remediating underpayments dating back to 2012.

And this charges of $94 million after tax for the impairment of property related assets that relates to plans to consolidate office space in Melbourne. For FY’21, any costs from the impairment will be offset ready cost benefits or from the impairment will be offset by additional lease cost as we transition in and out of buildings.

Turning to revenue. Which has increased 5.3% half of half. The key driver of growth has been markets and treasury income up $672 million and I’ll discuss this in more detail shortly. Excluding markets and treasury, net interest income was lower reflecting the impact of the low interest rate impairments and home lending competition.

Fees and commissions were also a drag down $86 million, will be at some drivers are likely to be temporary in nature. Merchant acquiring and cards income declined given lower transactions volume and fee income was low in CRB as several deals were postponed due to COVID-19 disruptions.

There’s also been an impact from COVID-19 related fee waivers.

Turning now to more detail on markets and treasury which consistent with the first half of ’20 has been a big swing factor this period. Total markets and treasury income increased $672 million half on half, $449 million relates to mark-to-market impacts on the high quality liquid portfolios and includes a full reversal of the $160 million losses for the first half ’20.

In addition, trading revenue and rates and FX has been stronger. While, mark-to-market impacts have created a lot of volatility between the first half and second half, on the full-year basis, markets and treasury income is only up 2.8% year-on-year.

And at $1.8 billion is broadly in line with historical outcomes.

Turning now to margins, net interest margin declined 1 basis point over the half. Markets and Treasury had a 2 basis point benefit over the period including a 4 basis point drag from higher liquids. Excluding these items NIM fell 3 basis points. The impact of the low interest rate environment net of re-pricing was largely consistent with our guidance of negative 5 basis points. This shows up in deposits down 8 basis points and capital down 2 basis points partly offset by home lending — home loan re-pricing, which is a key driver of lending margin up and net 3 basis points.

In addition to the low rate impact, home loan competition is the other main drag this period partly offsetting the impact of re-pricing in the lending margin. On the positive side, we have benefited from lower wholesale funding costs, particularly lower short-term wholesale rates, combined with a continued shift of customer preferences to echo deposits and away from more expensive term deposits.

Looking to FY’21, we expect a similar impact from the low rate environment estimated at approximately 6 basis points. Net of the full period impact the prior period re-pricing. We also expect home lending competition and higher liquidity to remain headwinds. Partly offsetting these headwinds, there are likely to be modest tailwind from deposit mix and wholesale funding.

Turning to expenses, expense growth over the year was 2% and 4.9% over the half. In terms of year-on-year, productivity of $348 million was achieved. The main drivers have been reduced third-party spend as well as benefits from automation and digitization, particularly in the personal bank. Over the three years from FY’17 productivity totaled $1.2 billion against our target of greater than $1 billion. Notwithstanding this, the challenges of this year meant that much of the focus diverted away from additional productivity initiatives to enabling staff to operate in a working from home environment, as well as delaying restructuring activities until Q4. We also need to reinvest some savings to build up resources in our customer support and workout teams.

The $141 million of restructuring costs relates to our strategy refresh with these costs now going directly through our P&L, rather than being absorbed by a restructuring provision. The net increase across D&A and investment spend in this period is $135 million. We continue to strengthen the compliance and control framework, including spend on cyber security and financial crime. The other component increase to $103 million that relates to numerous items, larger components, higher customer service and compliance related costs, higher regulatory fees, and an increase in annual leave costs partially offset by lower variable remuneration.

Turning now to credit impairment charges, which increased $1.6 billion in the second half of ‘20 and now represents 54 basis points of GLAs, $573 million relates to the underlying charge up 8 basis points to 19 basis points of GLAs. And it’s mostly due to the net impact of rewriting of performing exposures. In terms of forward looking provisions, there has been a further EA top up this period of $661 million and target sector FLAs for COVID-19 impacted sectors have increased by $363 million. This has resulted in higher collective provisions, which now stands at $5.5 billion. Collective provisions as a ratio of credit risk weighted assets have increased 35 basis points over the second half of ‘20 to now be 1.56%. I will discuss the components of the uplift in more detail shortly.

Turning to underlying asset quality, so far we’ve only seen a modest deterioration in the ratio of 90 days past due and impaired assets to GLAs up 6 basis points over the second half of ‘20. This is mostly due to the increased Australian mortgage delinquencies where customers are not part of the deferral program. However, what’s loaned are much higher, with the ratio increasing 155 basis points over second half of ’20. The key driver is re-grading of performing customers in industries heavily impacted by COVID-19, including aviation.

The next slide takes you through our process for determining expected credit losses which provisions are required to cover. I’ll focus here on the collective provision aspects. It starts with an underlying collecting provision using model outcomes based on point-in-time data. We call this our baseline this captures actual deterioration currently being experienced. In second half of ‘20 our underlying CP increased $155 million. The relatively small uplift reflects the early stages of the downturn and material levels of support and liquidity in the system.

Next, we consider the economic adjustment. This is a forward view of additional stress across the portfolio from the baseline. According to three scenarios, which we then probability weighted. These scenarios are forward-looking at macroeconomic data, based on forward-looking macroeconomic data, and expected impacts on probability of defaults and loss given defaults. With a probability weighted outcome is higher over the period and EA top-up is required and vice versa. In second half of ‘20, we topped up the EA by $661 million.

And finally, we consider target sector FLAs. These capture forward looking stress incremental to the EA top-up and are particular to sectors and geographies. In second half of ‘20, these increased $367 million.

The next slide provides some details behind the underlying drivers of our higher estimates of expected credit losses in second half of ‘20. There has been a modest deterioration in our economic assumptions, and the expected shape of the downturn and recovery has changed with a deeper trough and a slower recovery. We’ve also adjusted our PD and LGD assumptions to reflect the uneven impact of this downturn across customers. While the overall trend is looking slightly better, we expect the range of outcomes has widened with some customers doing better and some worse. We also recognize, they remained significant uncertainty in the outlook, and in particular, the transition from support to stimulus. As support is removed and stimulus measures increase, the customer impact will be varied and difficult to predict. Nevertheless, given the scale of the recently announced stimulus, we have now included some weighting to our upside scenario.

The next slide provides some detail on the increase in our collective provision target sector FLAs are referred earlier to the uneven nature of how this downturn is impacting customers, and that for those customers most impacted by COVID-19, the outlook has deteriorated. This view has been informed by granular review of our exposures to those sectors most at risk. As a result, we’ve increased total target sector FLAs by $367 million in the second half of ‘20. This reflects both a top-up to our existing FLA for commercial property, plus the addition of new FLAs for both aviation and tourism hospitality and entertainment. At the same time, we’ve released some about Agri FLA given the easing of drought conditions across most of Australia. Now Australian mortgage FLA has also reduced as a majority of these risks are now covered by the EA top-up, the total coverage of this sector has increased over second half of ‘20.

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Turning now to deferrals and starting with the timelines. Balances are rapidly declining as large cohorts of the deferrals expire. Balances as at the 23, October have declined to $14 billion, with a further $10 billion expiring by the end of November. Just over half of the accounts on deferral at September have advised, their intention is to resume the payments at expiry and 38% of elected to resume repayments before expiring. Deferral extensions are being considered by analysis team on a case-by-case basis. And so far 2% of deferral accounts have been granted an extension with balance have approximately $500 million. Unsurprisingly, Victoria represent a disproportion amount of the remaining deferrals, the Federal extension requests and referrals to NAB Assist. 5% of deferral accounts have been referred to NAB Assist to determine specific solutions. Of those accounts, the dynamic LVRs are higher than for the total book at 63% and 9% of these accounts have a dynamic LVR greater than 90%.

Turning to business deferrals, similar to mortgages, business deferrals are now declining rapidly. Balances have reduced the $5 billion at the 27, October with a further $4 billion expiring by the end of November. All those balances on the federal app, this September 76%, have advised our intention is to resume repayments at expiry and 16% have elected to regime repayments before expiring. The Federal extension to being considered by our SPS and NAB Assist teams on a case-by-case basis, and so far of the circa $800 million referred around 30% have been granted an extension. Again as with home loans, Victoria represents a significant share of referrals more than half and 30% of the remaining balance.

Now turning to capital, now CET1 ratio has increased 108 basis points during the second half of ‘20. This reflects a combination of impacts. We have the benefit of our capital rising early in the year, which added 98 basis points. Organic capital generation has been strong at 29 basis points. This includes a lower risk-weighted asset outcome reflecting a range of impacts which I’ll discuss shortly. The impact of FX and money and mark-to-market on higher quality liquids portfolio has added a total of 32 basis points this period, more than reversing the increase of 21 basis points in first half of ‘20. AVA has been a drag of 14 basis points this period. This includes higher deferred tax assets relating to the increased income credit provisions combined with some movement in hedge accounting reserves over the period. Both impacts are expected to reverse over time. The completion of the MLC Wealth — expected mid calendar year 2021, is expected to add approximately 35 basis points to CET1, increasing the pro forma CET1 ratio to 11.8%.

The final dividend of $0.30 has been held flat with the interim, reflecting the strong capital position, continued uncertainty over the outlook of COVID-19 impacts and APRA’s revised guidance.

Turning to the next slide with more detail on credit risk weighted assets, which declined 10.6 billion over the half. The increase in credit risk weighted assets from credit quality and portfolio mix has been $1.8 billion. This reflects the net impact of rewriting activity, with reviews completed for over 85% of the total CRB book and approximately 70% of the larger business and private customers. In the case of smaller businesses and personal customers we use behavioral modeling, which is updated regularly. Non-retail downgrades have been largely as expected at $17.4 billion, including an overlay held for expected deterioration in SME asset quality. These primarily relate to customers in highly impacted sectors. However, this has been partly offset by $8.2 billion of non-retail upgrades again highlighting the uneven nature of this downturn. These customers are doing better in the current environment and have been able to strengthen their balancing.

Retail credit risk weighted assets also declined, particularly mortgages supported by deferrals and high household savings. The other key driver of decline in credit risk weighted assets in this period has been derivatives and translation FX down $12.2 billion and it’s more than offset the increase in the first half of ‘20 of 9 billion. While there’s still a high degree of uncertainty experienced to-date indicates the high end of our previous range is increasingly unlikely. Mainly due to the higher levels of support and stimulus and the unexpected non-retail upgrades. As a result, we’ve reduced the high end of our range from 190 basis points to approximately 140 basis points, while keeping the low end unchanged at 80 basis points. Outcomes to-date suggests credit risk-weighted asset migration is trending towards the lower end of this range.

Turning to funding and liquidity, liquidity has remained very strong with significant surpluses above regulatory minimums benefiting from continued strong deposit flows. LCR increased over half to 139%. In terms of funding, NSFR also increased over the half 227%. We have fully drawn down the TFF initial allowance of $14.3 billion in the second half of ‘20. Our intention is to utilize the TFF to support lending and refinancing of wholesale funding maturities. Term maturities for FY‘21 at $25 billion compared with the supplementary and additional TFF allowances estimated at approximately $13.8 billion. In addition, we expect to issue approximately $5 billion of Tier 2 capital in FY’21 to meet [Indiscernible] loss absorbing capacity requirements by 2024.

Before closing, I’d like to summarize a few items worth considering for our FY’21 outlook. Our expectations for the revenue environment to remain challenging in FY’21. As already mentioned, the impact of low interest rates is expected to be a drag of approximately 6 basis points on equity margin. Credit growth is expected to remain subdued. Given the impact of uncertainty on the confidence and investment decisions, combined with increased line amortization from low interest rates. We are responding to these environmental challenges in a number of ways in FY’21. As Ross has said, we’re investing to drive growth in our target market segments. We are managing costs and investments in a disciplined way. In FY’21, we are targeting expense growth limits and to 0% to 2%. As we balanced discretionary investment spend to support our fresh strategic agenda and to build growth momentum, while managing costs tightly. We expect asset quality to deteriorate in FY’21, but have strengthened provisions in expectations and the completion of the MLC sale is expected to add 35 basis points to CET1.

And now on that note, I will hand back to you, Ross.

Ross McEwan

Thanks very much Gary. 2020 has been a year of taking action to build balance sheet strength, keeping the bank safe and support for our customers. This will continue to be a core priority in 2021. At the same time, we see clear opportunity through the year end into 2022 for NAB and for Australia and New Zealand more broadly. There is no other place in the world I would like to live now than right here in Australia is one of these two countries we operate. We’ve handled as far as better than most other developed nations, both in economic and health terms. And we’re best placed to rebound because of that. Governments have acted quickly and decisively. The income and cash flow support that they have provided has been critical. And as we shift from support to stimulus, both decisions and reforms are being made to ensure Australia and New Zealand are strong global players as we emerge from this pandemic.

With restrictions lifting and borders reopening, we are seeing an increase in activity. And when international travel regimes we know people will want to come and live here in Australia. This will be a business led recovery. And as Australia and New Zealand’s biggest business bank, we are ready to play our part. This is a good bank with a clear plan that we are executing to be better for customers and for our colleagues. We believe we are making the right long-term decisions. We have the balance sheet strength and we are looking to grow.

Thanks again for joining us today. I look forward to meeting you in person sometime, which will be nice. And now Sally, I’ll hand back to you to start the questions.

Sally Mihell

Thanks, Ross. I’ll hand over to the operator to moderate the Q&A. Just to reminder to everyone to limit your questions to no more than two. Thank you, operator.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] The first question today comes from Richard Wiles from Morgan Stanley. Please go ahead.

Richard Wiles

Good morning, Ross. Good morning, Gary, a couple of questions please. First one relates to the provisioning. You’ve gone from having an overlay which was lower than growth at the first half to one that is now at the top end. Do you think you just taking a conservative approach? Or have you previously underestimated the risk? And could you comment specifically on what credit quality trends you’re seeing in the commercial real estate portfolio?

Phil Chronican

Thanks, Richard. So a couple of comments there in terms of what we’re seeing in the underlying portfolio, similar to experience across much of the sector, are not a lot as yet. And that’s really because of what Ross and I both mentioned, of the degree of support that’s in the system. And we think it’s going to be I think we all believe it’s going to be an interesting period, as that support starts to get taken away. And there’s the transition the stimulus. So we haven’t really seen any deterioration across the broader portfolio, including commercial real estate today. So it’s been pretty stable.

In terms of the increase in provisioning, and like we said, right at the start of this, that, that we’re all going to learn as we go through this and trends are going to become more obvious. And certainly, some of our economic assumptions of the half, in hindsight have proven to be a bit more optimistic about the in out of recovery, and in the speed of the recovery, we now look at it and it’s a lot more obvious that this recovery is going to take longer than what we originally thought. It’s becoming clear. And this is particularly influencing our thinking around aviation that international borders by all likelihood are going to be closed longer. Certainly the internal borders in Australia to be closed, as long as they have been that was unexpected today. So there’s some difference in trends.

Probably the biggest difference, which we’re really seeing Ross has sort of touched on or the bit is what we’re describing as the uneven nature of this downturn and how we really do have some of our customer base, in fact, are doing particularly well and thriving in this environment, as he plays to that customer base and you can, Ross sort of sided if you’re a suburb and cafe, then you’re probably doing a lot better than you are in the CBD, we see the agri sectors doing really well and flying. But increasingly, there’s the other side of that where sectors are really struggling and as you get more granular, it’s not even clear cut by sector, by geography, even within sectors and within geography gets customers that are doing well and not so well. And that is really important that we’ve dug into this provisioning question and thought about provisioning because as you will know, Richard, you don’t lose money on what’s happening on the average of the portfolio, you lose money or what’s happening to the tails of the portfolio and with this an evenness, we have a dispersion where there’s probably going to be more in the tails and that does get somewhat mass when you look at averages. And that’s helped informed, the fact when we ran our models, et cetera, that that we needed to top up our EA and we needed to top up our FLA. And, we’ve probably had a little sprinkle of conservatism with that as well. But that helps. So we’re feeling very pleased about strong capital, strong liquidity strong provisioning. I hope that helps Richard.

Richard Wiles

And could ask a second question please on your target for double-digit cash ROI. Ross, you mentioned at the outset that you expect interest rates to stay low in the medium-term. So I assume your ROI target doesn’t rely on any increase in interest rates. Could you comment more specifically on whether you think you can stop the margin decline beyond their FY’21 when you clearly expecting it to full? And whether your assumption for double-digit ROI assumes that your Common Equity Tier 1 ratio gets back down to 10.5%?

Ross McEwan

Start at the back end of that and we do have a higher CET1 ratio for very obvious reasons, I wonder if this bank to be safe and secure, and nobody to worry about it, we would run with higher knowing that we would have impacts on it over the period of time. So I think you’re right making the assumption over the next few years that we’ll come back to a more normalized level. So that is one factor.

The second thing is we are going to have a very, very competitive market with low interest rates, that’s not going to go away, we just need to be much, much better in this marketplace and how we operate our costs, as we’ve discussed, need to come down. I don’t see that happening this year. And that’s why we’ve given you the 0% to 2% this year, but they have to cast coming down over the three to five. And we’ve given you the bench of the $7.7 billion for the exit out of 2020. We need to use technology and much better efficiencies in this business to get our costs down and we’re working on that right now. The work that’s been done over the last three years has been very helpful. They’re some of the foundations have been put in place, which are very helpful for this bank. And we’re starting to see some of the fruits of that as well. But we’ve got a big investment portfolio of Spain this year, $1.3 billion. But, we’re going to be targeting growth in the core parts of that market. And so we want to see growth. And I want to see costs come down over the three to five years. Capital, we’re running elevated levels right now and will maintain those while there is uncertainty in this marketplace.

Richard Wiles

Thanks, Ross.

Operator

Thank you. The next question comes from Victor German from Macquarie. Please go ahead.

Victor German

Good morning. Thank you for the opportunity. I was hoping to ask two questions as well. One on revenue one on costs, I might start with revenue one. And with respect to mortgage growth, it appears that you’ve struggled lately to grow that part of the business. I’ve noticed that your economist is looking for a fairly subdued outcome next year in terms of volume growth. If that actually sort of surprises on upside relative to that expectation, do you think that you can regain market share and grow broadly in line with market? And do you think you need to sacrifice more margins in order to do that?

Phil Chronican

First, on our mortgage growth, I take our loss of market share early on my over the last six months, as we went through the COVID. I said to the team, these are times when we should be very cautious. We dropped out what was 3,000 or 4,000 cash back that was going on in the marketplace. And that damaged our market share growth in 2020. So I take that on board this to myself. Let me be quite clear, we’re already starting to grow again, we will be competitive, and we’ve got a machine now that is starting to come together quite nicely. We don’t have the difficulties we had some time ago on the back end about business. We’ve now seen the broker community assist us rated up as one of the top two players of the big banks for service delivery. And that’s what we’re going to play on we will be a much more difficult competitor on this marketplace going forward.

So yes, will then create growth, I believe it will. You’ve seen us with competitive rates at yesterday, showing that we’re a player in this marketplace and we want to grow. This is one of the core markets for us. And we’re now building one over changing not four or five other things. So, yes, I think that will give you a clear signal, what will happen the margins will, it’s a competitive market. And margins we hope to hold on to I think we are one of the most disciplined banks on margin in the last year, as you’ve seen as the other results come in.

Victor German

Thank you. Now that makes a lot of sense. And just on costs. I’d be interested in your observation and also Gary’s in terms of the appropriate investment standards within a couple of your competitors and peers talk about much higher investment spend in the short-term. Are you comfortable with $1.3 billion? What do you think is the appropriate number? And maybe, Gary, if you can also give us a sense for amortization expense we have noticed that your amortization period is still five years, it appears that it’s much higher than what peers are doing. And the charges coming through the P&L is lower. In your zero to two cost guidance. Are you anticipating that that number will increase? Thank you.

Gary Lennon

Yes, so I will start on the 1.3, I think 1.3 for this year is fine. It’s more around what you do with the money rather than how much you’ve got. We were spending a lot more on this in the last three years. I think we can do just as well by delivering better and focused on a smaller number of programs, we talked about that at the half year, I started, I think we had 467 programs work going on this place. I’ve got 19 that I care about, 19 my executive care about, we’ve funded them. And we’ll look to get delivery against those. And I think that’ll give us a better result. So I’m less worried about the amount. And I think 1.3 is plenty. Once you get over that level, it’s pretty hard to know how you spend it. And you get all sorts of strange things going on the business. So I’m very comfortable with 1.3, believe we can do what we need within that. And, again, get ourselves in a good competitive position with costs coming down over the longer term, medium-to-longer term.

Ross McEwan

Victor, I’ll to that a couple of things. So as we started in ‘17, uplifting our investments been so we’ve had quite an elevated investment spend for a number of years and some of the competitors saying that elevating their investments being now might be just a timing issue that we kick that off a bit earlier. Let’s look at certainly how we view it and how we feel about it. And a lot of the core infrastructure technology fundamentals that we now have in place, which others may still be required to build. On the useful life metric, which is just a calculation, but it’s a couple of things to point out there. Victor is, firstly, it is a bit distorted this period, because of policy change. So a lot of — we did that policy change at the half year where we would just expense, the low value project. So this is €5 million and under, we just go straight to expense and it’s often that those lower value projects had a shorter life.

So nearly by default, so it’s not essentially a lengthening of the average life. It’s really that policy change that’s driving the lengthening. But there’s still an element of merit in your question in the direction. And so there will be an uptick and we do expect — continuing to expect for a while, probably next year or maybe the year after a bit of an uptick in amortization costs and just to give you a sense of around about €70 million for ‘21 is that up uplifting amortization costs over issues baseline.

Victor German

Thank you. Thank you, Ross, and Gary.

Operator

Thank you. The next question comes from Jarrod Martin from Credit Suisse. Please go ahead.

Ross McEwan

Hi, Jarrod.

Jarrod Martin

Thanks, Ross. Thanks, Gary. A couple of questions. So first of all, just to follow up on the on the cost one. So if you take the midpoint of your guidance for next year are up 1%, that there doesn’t look like a significant hurdle in terms of getting to your medium-term aspiration of lower than the $7.7 billion. So inferring into that, is there a bit of an expense build for a couple of views, before we start to track towards that $7.7 billion, is that the way to look at it? And then I have a follow up on mortgages.

Ross McEwan

I think that’ll be fair. But that expense build was in 2020 and 2021. After I would expect to see it coming down. We did have additional expenses in the second half of this year as we hit it into COVID. We also remember, restructured the bank walked through the middle of the year into the latter part of this year. So there are some restructuring charges that we’ve just put through the business. We didn’t put them under the line like other players, we gave them to you as a cost. It’s a cost of doing business. And there’ll be a continued cost of doing business. So you put them into the business, but there was some there. And we’ve taken some costs to sheer relate to COVID of getting pretty much all of our colleagues working from home and because of supporting customers through this.

We also have some elevated costs going into 2021, with additional people going into NAB Assist, which is our vehicle for helping customers are having a bit of difficulty, and also into SBS, and we’re building more capability and greater numbers in our business bank and in our private bank with committed 55 or 550 new heads into that area for this year. So there are costs. And we’ll have obviously come out of other parts of the business together at a zero growth longer term. But I’m happy to expend money on the business where I see growth. And you’re starting to see that it’s coming through now in the areas we like.

So yes, you’re saying 2021 for slightly different reasons to ‘20 sorry ‘20 increases more to do with private and restructuring. ‘21 has more to do with putting bankers back into places where we should never have taken them out of and starting to grow a private banking. We used to be the best private bank in Australia. We are going to be the best private bank in Australia in the next few years. So we’ve got the right tools, we just need to put them in the right place and get onto the job and be good for customers that cost you money.

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Gary Lennon

And Ross, I’ll add to that enjoyment. Now what we’re essentially viewing this, you’ve got to take a disciplined but balanced approach to how we’re dealing with cost at one level if cost was the only objective, it would be relatively straightforward. But if you’re wanting to grow the business, if you want to respond to how our customers are responding to us and wanting more self service more digitalization, you have to continue to invest and play into that and there is major change and trend change along those lines. So we want to make sure we’re getting that balance, right of investing the right amount continuing to invest whilst also driving the productivity. So that would hopefully lend that sort of model shape for modest cost increases for a couple of years, and then the ability to bring it back.

Once we’ve sort of through that other points of interest there is we do expect the radian compliance spend to continue to be higher for 21. Hopefully, that starts to moderate down over ‘22 and beyond. And that will help change the mix of where we’re expanding now more towards productivity and business growth. And finally, it’s really where Victor was at before then there will be some headwinds associated with the investments we’ve done in the past and amortization coming through. So, trying to get that balance right across that whole package and we think it is the right three to five year target, to get to lower absolute cost in a pretty tough environment. And we think we’ve got a balanced and sensible pathway to get there.

Ross McEwan

Yes, the other area that probably hasn’t been recognized that strongly, but as quite an expense for any bank is in the area of fighting against fraud, cyber, and obviously KYC. But, we’re seeing and we’ve been quite clear about this throughout the year. And then our results today, the attacks on banks or any organization that has customer data, payment data is very accelerated. So we’re having to spend money on those areas to keep our customers and the bank safe. I don’t see that going away. But every bank is going to be experiencing that. That’s why you probably started to see some difficulties, everyone says you want to get cost out, but it’s how you get the cost that we are taken from otherwise, you end up with explosions and areas of fraud on behalf of the banking customers and cyber. So a number of areas and that is a balance of giving very clear signals. And in the three to five years, we’ll be back to a cost base of 7.7 at least.

Jarrod Martin

Thank you and a second question on mortgages and be interested in your perspective on this Ross given your U.K. experience, we now have fixed rate mortgages that are substantially below and pricing below variable rate mortgages, 100 basis points plus and expectation of low rates for longer are we likely to see a permanent shift in the mortgage mix of the Australian market to move to predominantly fixed rate mortgages? And what that means for competition because what I’ve seen in the U.K., how competitive mortgages and fixed rate mortgages have sub 1.5% rates in the U.K., and margins are crunched? And also what it means from as far as the financial system perspective that the transmission mechanism for the RBA rate cuts is obviously a lot less effective under a fixed rate mortgage regime.

Ross McEwan

That looks a good observation see on the transmission mechanism, because you transmission mechanism, because once you get rates at sub 2%, and they are fixed for four years, any changes, they don’t have any impact at all. But the reality is, this market is moving to more towards fixed rates for certainty was about 10% of the book, I think you’ll see quite quickly getting to 30% of the book. We’re seeing that on the flows today. But I’d like to debug something just around the variable rate. I mean, you can get a standard variable, right for €2.69 million from us. So if you’ve got up from another bank at a higher rate than that, bring it across. But you can get a standard variable at 2.69. But you’re right, the fixed rates at 1.98 for four years, is becoming a pretty big proposition for customers. And we are seeing that trend going across. It’s going to be a competitive marketplace. That’s why we’ve decided to go for one mortgage engine and one factory and take the costs out and we have to streamline things. You’ve got to use this digitalization a lot more. And that’s what we’re doing. We’re investing heavily, both on this side of the business.

But don’t forget, we’re also heavily investing in our business bank processing capability as well. And that’s where we’re going to spend a lot of money over the next couple of years because margins will come out of this business, and we want to hold the profitability. But yep, we understand the market. We understand that you’ve got to be competitive. We want to be strong in this market. And I’m clearly signaling we’re going to be I sort of know how this market works right from the U.K., and from Australia. And as I said, we backed out for about three to six months thinking the market might have been a bit more sensible. It wasn’t. We’re back and getting market share again, and we’ll make sure it’s profitable.

Jarrod Martin

Thanks, Ross. Thanks, Gary.

Operator

Thank you. The next question comes from Andrew Triggs from JP Morgan. Please go ahead.

Andrew Triggs

Good morning Ross and Gary. Question on the business bank, for most of the last few years, the business bank has delivered relatively stable in obviously, this period saw the impact of right, the RBA rate cuts. But, following this sort of final rate cut, if it is, is it proves to be that would you expect to see reemergence of resilient NIMs in that division? What are you seeing in terms of growth, from asset write-off rule changes as well within the business bank? And finally, on the deposit base, I’ve seen more of your deposit basics with business banking customers, then retail customers, at least compared to your peers, is the distribution of that interest rate. The interest rate distribution on that book, similar to the retail book, I equally comfortable at taking out deposits spread savings in the business deposit book as you are in the retail deposit book.

Ross McEwan

Yes, to the last one, we’ve got quite a stable deposits in the business bank, it’s been stable for a long, long period of time, I don’t really see that as changing. And we’ve had quite reasonably stable NIM in the business book itself, there’s pressure there, there’s good competition in that marketplace, what we’ve found is that we just need to be much better at the processing in and freeing our bankers up. And thus the investment in that market to actually get our bankers was more time out in the marketplace has been the issue for this bank. And why I think it hasn’t grown as it should have. We’ve also been in the last 6 to 12 months very consumed with looking after existing customers, and not hunting the market for new growth. Because that customers number of them have been in pain and we’ve had to have the focus of our bankers on looking after customers who have gone to the federal get him in the right position. But it’s a pretty stable NIM story that I’ll get Gary to speak on, see if there’s anything different and same with the deposit book. But it’s a good competitive marketplace here in Australia. And again, this is high NIM for us. We’ve got great expertise here. And we’re going to build it.

Gary Lennon

Yes, was probably the two other things to add. And Andrew, you were going to an interesting place or an appropriate place. So in particular, business and private are impacted by the low rate environment. So that comes through hitting deposit flows, but also how we allocate capital return. So it comes through that deposit and what we call capital benefit, which is impacted that overall margin rather than the customer margin, so it would have been more that low rate impact rather than the margins we’re actually seeing at the customer level. And your observation around the deposit base look given the changes where rates are going, I think there’s more work to do in re-pricing those deposits down. I know the team, the team is focused on that it can be painful for those customers and the rates that you get.

But, the low rate environment, that’s it, we also get some offset just through that, that shift away from term deposits into there’s a lot more on demand deposits, which we are getting benefit from, and actually working hard to ensure as much of that as possible, is sticky money rather than money that has come in and flies out. So we do see that as an opportunity to really work hard with that money that’s come in and sitting in transactional accounts, how do we make that situation more permanent at those types of levels, and that’s something that Andrew is focused on in future periods.

Andrew Triggs

And Gary, the question around volume growth, that look like business lending volumes are fairly stable, which is probably a good outcome given what the system is doing. But what you’re seeing on the ground there, I know that your economists forecast is sort of the reverse of what respects with respect to housing this business system growth, what makes you confident you can be great in the system for business lending?

Gary Lennon

Yes well, we all know you get 10 economists in the room they will come up with different views on the same study that they’ll all say they’re not wrong. Their models are right. Just their assumptions are wrong. In terms of the business lending, yes, look, it’s turned out to be a difficult environment force me lending. And, and we thought it was a bit of a disappointing result, albeit it was slightly up. But then when we’re seeing out our peers results, it’s not looking as bad on a peer relative basis. But as Ross has said, where we’re looking to grow in that space and see opportunities, and its early days, but the start into 2021 has been pretty solid so there’s some green shoots there. And we’ll continue to press hard as I’ve already mentioned agri and rural is looking strong. In more recent is, which we think has been the right decision, we really pulled back from agri, so we’ve been pretty sensible on that. So that’s subdued some of the headlines. But, we do see plenty of opportunities to grow. And we’re going to be quite competitive and aggressive in pushing that growth. And Ross has already announced with Andrew, we’re going to be putting more 500 plus bankers into that platform to really get momentum back into that important core part of our business.

Ross McEwan

Yes.

Andrew Triggs

Thank you.

Ross McEwan

We are seeing, it’s very early on but they are saying both competence coming back. And just the sheer fact that Victoria is opened up one week. Let’s put some life back into the Melbourne and Victoria market long way to recover from where we’ve gone down to. But, we’re up here, we’ve been concentrating, as I said, very importantly, on existing customers. And we’ve taken our focus away from growth. Now we’re back on the job of both. And we, we like this market. This is ours. This is homeland for NAB. Thank you.

Andrew Triggs

Thanks Ross.

Operator

Thank you. The next question comes from Brendan Sproules from Citi. Please go ahead.

Brendan Sproules

Good morning. Thanks for taking my questions. Ross, I just got a question on new bank. You’ve outlined today that you want to spend some more money in that particular franchise as a digital attacker, I was wondering if you could outline what sort of differentiated proposition that you imagined new bank can provide. And then just a second question on the fixed rate mortgages pretty much following on from what Jarrod was asking. I mean, if we do get to a situation where 30% of the mortgage market is fixed rate as you mentioned, what happens when the TFS is removed, I would suggest to you, you kind of strike quite different in that sense in that we’re quite short of deposits relative to the U.K., just how you imagine that playing out place.

Ross McEwan

Instead of the back end of the UK, remember had a very similar scheme on the TFS, funding for lending scheme up there was at the cash rate at 25 basis points. So it actually ended, Austria has found itself in a very similar position to the U.K. on that same basis. And remember, the U.K. still is a very fixed rate market as opposed to a variable. And, banks still make good money out of that, as long as — had a very good process and a good distribution. So I think the 30% could be more of the extended ends up as we would have suspected more than 30%. But I wouldn’t fear that, because there are some things that I got in favor for bank at that point of time, particularly if it’s on for two, three or four years, five years, you do not have to deal with the administration of it every year. But margin, you’ve got to be better at playing in that market.

On your bank, we do see an opportunity for you bank. And we started this as part of our review. We think there’s it’s held onto quite a nice niche of customer service delivery on and how customers think about it. Over the last 12 years, we haven’t really invested that well into it over the last probably five years. And our view is if we invest a bit of money in here, there is a group of customers that would be attracted to your new bank brand and mainly in the more use market. I notice other players doing other things to try and get into that market sitting under our noses. We have a brand here 600,000 clients that we can talk towards that, we think it’s worth with the investment on behalf of shareholders. So we’ll be more towards the use case.

And also you’ve got to be ready to use the advantages of open banking. And that’s something we’ll concentrate on both of the big red star and new bank to get ourselves ready for using that data to actually put better propositions to customers. So we’ve been working on new bank at the moment getting its plans, prepared to invest in it. But it’ll go after a different group; probably the rich style will go after different group of customers.

Brendan Sproules

Thank you.

Operator

Thank you. The next question comes Andrew Lyons from Goldman Sachs, please go ahead.

Andrew Lyons

Thanks and good morning. Just two questions on margins and then a follow up on asset quality. Just on margins firstly, you’ve spoken to a 6 basis point impact from lower rates in FY ’21 then also spoken about further competitive pressures offset by modest funding cost improvements. Bringing this altogether do you think pressures can be fully offset by the improvement in funding cost and so NIM decline next year can be contained as 6 bit. Is the 6 bit sort of right impact the best case outcome for the NIM and maybe you should then discuss any other offset that might exist?

And then secondly, just on asset quality a follow-up to Richard’s question on provision and certainly understanding bank conservatives here, but can you explain the consistency between the significant top-up we’re seeing this half in [Indiscernible] against your unchanged assessment of your low end price cyclical capital expectation and fairly possible reduction in the high end price cyclical capital expectation?

Gary Lennon

The first one on the 6 basis points guidance that we’ve given. There’s going to be a lot of variables there and sort of going to be what is going to be. Hence now clearly, if it continues where it was a continued trend out of more expensive term deposits to that deposits that can help funding costs. The amounts from RBA during the rate around TFF will continue to help. So, I expect that bills always and cash costs will continue to be low. So they’ve pretty decent benefit, but probably not a huge amount of upside from what we’re already seeing going through.

And then, the flip side about competitive pressures, I think it will be intense, you’ve heard from Ross, there’s areas where we’re all going to compete. We saw it yesterday with the announcement in terms of competiting pretty fiercely on the fixed cost. My expectation is that all the banks will be looking to growing mortgages, we’ve got new players as well. So I think that’s the combination of all that and we will maintain as best as possible our discipline around this which I think would demonstrate what we’ve done.

We will continue to improve that processes and our service proposition, so it’s not just about price. So, we will focus on all the things we should focus on, but I do think the reality is that competitive pressure is going to be tough, I doubt whether the funding cost will out way it. But that’s the sort of time of question.

Ross McEwan

On the essay quality questioning Gary?

Gary Lennon

On the essay quality, I’m trying doing the comparisons between what we’ve done on collective provisions and the overlays and how you compare that with risk weighted assets. Well, probably the biggest difference is, on the risk weighted asset you do get benefits from the upgrades. So with the uneven brand that we’re seeing the dispersion, on credit provisioning when you see that dispersion and there is more credit that are drifting towards the tails and that draws increased provisioning. When you have risk weighted asset position where this dispersions you do get downgrades but it does somewhat get impacted by upgrades.

So it is a different dynamic and you do get offsets in risk weighted asset, but you don’t get necessarily on credit provisions particularly once you get the credit losses. So that part of how you actually reconcile between [Indiscernible] and on the credit provisioning that the down side scenario is bit more severe than the down side scenario that we’ve got on risk weighted assets. So this is slightly different in terms of the scenario.

Andrew Lyons

That helps, thank you.

Operator

Thank you. The next question comes from Jonathan Mott from UBS, please go ahead.

Jonathan Mott

Thank you. Got a question on slide 38, which is corporate and institutional bank. If you look there in the top right corner, you can see that the NIM ex-market started to rise pretty well from a hunching 59 bips to 172. Now this is different to every other institutional bank you’re seeing anywhere in the world that you’re getting NIM expansion in this environment. So can you explain firstly, why you’re getting NIM expansion which is obviously bursting the group NIM, and why this isn’t unsustainable?

And second question if I could, just relates more to, within the mortgage businesses, if you look at where you’re actually losing market share. In the business and profit bank, you saw you’re housing book full by full point, 6% year-on-year and in the personal bank reinvest this 4.4. Now this goes to Ross what you’re talking then your core customers that you want to cave. It actually looks if anything that systems close to zero in this space, you’re losing a lot of share, it’s not paper or refinancing for full grant in your core product bank I would have thought. I think this is purely that you’re just not taking enough risk, do you think that is the case that you’ve gone too far to day risk and you’re actually doing – detect more risk in this space?

Ross McEwan

I will start with the final one and then Gary on the first one. It’s been good discipline and actually in our ability. I think it’s a whole combination of things in business and private bank, part of that is around risk. I think part of that was around the model we were running, more difficult for our bankers. Part of that was like a focus on that particularly part of the marketplace. So I think, there wasn’t one factor, there was number of factors that we’re working out right through which hinds the business model that we’re operating with and we’ve reduced that outright now. So there’s a number of things that I think we just made too difficult both for our bankers and our customers and we’re changing that pretty much now.

Gary Lennon

I don’t think it was around pricing?

Ross McEwan

I think it was just around the model we were running in our business and private banking. And Andrew and his senior team are certainly changing that. And we’re investing quite a bit of money on prices of [Indiscernible]. And again, remembering we ran four or five different price of getting a mortgage into this business, we’re running now one mortgage factory that will have one way of doing which will make it simplier for our bankers as well.

Gary Lennon

It will be one bank.

Jonathan Mott

It will be one core system across the private bank and the retail bank.

Gary Lennon

And the business bank for mortgages, we’re running one factory. In the past we ran four or five of these things. So one, cost up, two, complexity up, three, confusion up and four, different model in the place. So good discipline is going to give us good results in this part of the market. So that’s we are I think, difficulty that came with particularly mortgages and the business bank. Remembering two, we had taken what I think was the best private bank in Australia and we can hardly find it. We’re now regenerating that, will put on something like 35 to 40 on private bankers and we look to grow that business with — you do some very good business with the business customers at the top end. So again, four parts I think we would bid ourselves down. We will be more — will be different that going forward.

Jonathan Mott

Yes, the question on the NIM and the institution?

Gary Lennon

So Jon, thanks for that. Few things going on here and quite a significant differentiative from other CRD businesses as well. But, the first one, a dive in this team with especially disciplined around pricing particularly of that higher point of anxiety across this period, so there was a lot of re-pricing going across the book in the first half and that’s played through into the second half of the year and provided some benefit.

Now, in terms of pricing, I think stabilized and might be somewhat tougher to retain all of those re-prices going forward that we hope to retain certainly a chunk of it. The second important factor, probably the more important factor, within CRB business we’ve a custody business and that has, significant part of that business is by quality deposits and there have been significant inflow of high quality deposits into that business and they own sort of decent returns or have been earning decent returns as the cash rate comes down, those returns will start to moderate overtime. But for the second half back of that trend just more of the custody’s businesses customers migrating to cash that were benefiting the margin in CIB.

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Phil Chronican

I think a very good discipline within a business of looking at longer term with customers where you get the returns and what returns you get rather than just seeing the dollars come in the door. I think that in the corporate institutional bank you have to be incredibly disciplined otherwise you can put a lot of capital at risk for minimum returns. I think David and the team have been very disciplined particularly as some of the corporate customers have been re-rated both up and down if you don’t move the pricing over time when they’re rated down your returns go down to the floor and I think there is been a lack of discipline in many banks around the world in this very market and I’m pleased that David and the team are being very disciplined about it. Very clear focus and that’s part of the strategy.

Ross McEwan

Probably the final point on that is that there has been a bit of distribution that’s done some low returning assets that helps at the margin on the margin. So that business will continue to do it. So I think John, I think that’s been a high point for the margin but I expect it would sort of come off a bit from there but still be a bit elevated from where it was.

Unidentified Analyst

Thank you.

Operator

Thank you. The next question comes from Matthew Wilson from E&P. Please go ahead.

Matthew Wilson

Good morning. Yes good morning Ross. Good morning Gary and team. Two questions if I may. Firstly to you Ross you have actually ran a bank in this extreme central banking policy environment. So you’ve got credibility in this space. Can you talk about the efficacy of the policy? What you learned from running a bank in that environment and the keys to success in that environment? And then secondly your economists’ forecasts on housing growth look at that ridiculous given where the RBA the government policy given stimulus rates the level of new lending commitments what’s your economist saying that perhaps the government and the RBA isn’t saying because that’s the lever that they’re aggressively pulling?

Ross McEwan

Yes. Well I’d never fight against the economist he’s probably going to be right but we’ll wait and see he could be wrong as well but I’ll leave you that one with Gary but one of the big lessons I learned up in the UK was capital returns are vital and you can keep trying capital of things and not get a return you’ve actually got to get a return out of the capital you put into the marketplace and it becomes more difficult in a low interest rate environment. Costs become vital. We haven’t seen for 30 years a difficult time in Australia.

So we’re quietly seeing one now with low interest rate environment it’s going to stay around for a long period of time. It makes running a bank more difficult. So you have to concentrate on costs, efficiency, straight through processing make it easy for customers let them do it themselves but also you’ve got to look at the capital and that’s why they comment around the corporate institutional bank and the measures that David and the team have put in place and looked at pretty much every customer over the long term do we make any money and if not have the conversations.

And I think a lot of cases people get sucked into having the big brands as their customers you make no money. So I think there is a big discipline piece in running a bank in this environment and we’ve now got it in our corporate institutional. We’ll drop that through into our top end of our business banking operations as well and right across every part of the bank and I think that’s something 30 years of having a good time in Australia with growth. All of a sudden it’s not here. You’ve got to manage it quite differently and you’ve got to be disciplined about where you find the growth as well. So that’s the lesson. I did seven and a half years of just grinding up in the UK and it doesn’t go away and I don’t think this is going away either. So we have to get used to it.

Gary Lennon

Matt its Gary here. Well, let’s say it’s been a contentious topic internally Alan’s forecast and we pride ourselves at Alan’s independent. He can form his own views and that the two things Matt that Alan is looking at and concerned of is unemployment which you’d expect and the impact of unemployment and secondly the impact of borders shut on immigration. So they’re the macro factors he’s concerned about. Now I’m not saying it’s right well I think we all hope that that would be a little bit underdone. I’d like to see a bit more mortgage momentum than that it’s possible that Alan’s right it’s possible that Alan’s not. So we’re not totally dug in behind that in terms of all the decisions that we make.

Matthew Wilson

Okay. And can I just squeeze in one on liquidity there’s obviously clearly huge amounts in the system. You can see that with the LCR you can see with the NSFR and your deposit growth where board money’s going, etcetera. We really need this — or is there some other agenda here given the removal of the CLF and the fact that you’re going to have to hone more government bonds going forward given the level of government debt in this country?

Ross McEwan

Yes. I don’t know the reserve bank’s been explicit with that but I would agree with you. That’s the plan is that there’s a lot of incentivizing for banks to be topping up their physical liquids which means us going in and buying government bonds which is sort of handy because the government will be issuing lots of government bonds. So we’re issuing from that there will be a good solid underpinning of demand for government bonds and one little of argument that’s quite a smart strategy. In terms of the TFF look I think it will be a really helpful tool amongst others and we focus on it as we have senior maturities then we will replace that with TFF and so you do get a funding benefit.

One of the biggest dilemmas on how we manage our funding book going forward because they’re it’s great to get the TFF they do does create a concentration on maturity dates in three years time that you have to manage and that is not a big problem if you believe all of the inflow and deposits are going to stay. So you do have to make some sort of assessments about the inflow into cash accounts, call accounts how much of that is really going to be sticky money over the medium term and how much of that money is going to if things pick up just sitting there ready to be deployed to other areas and that will help determine then what other steps that you need to make in terms of other issuance to cover the maturity dates of the TFF.

So it’s quite a complex equation Matt to manage our way through this over the next three years and it’s exactly that the situation they found in the UK with the same scheme where there was a lot of difficult management required around the cliffs that were created by the maturity dates of the TFF equivalent in the UK.

Gary Lennon

Particularly for those that took big tranches of it in comparison to the size of the book and you’ve got to look after and that’s why our treasury function are already thinking about three to four years out how do you read refinance. I think without worry something.

Matthew Wilson

Thanks so much.

Operator

Thank you. The next question comes from Ed Henning from CLSA. Please go ahead.

Ed Henning

Hi, thanks for taking my questions. Look earlier you’ve touched on before the investment spending and it’s been coming down from 1.6 to 1.35 to 1.3. Can this fall further to help get your absolute cost target or is 1.3 a stable level you see investment spend going forward?

Ross McEwan

Look I’ll pick that one up it. Look it was elevated for three years as we went through the transformation program that Andrew was running a lot of that went into our technology areas and to KYC AML a lot of areas that I think have been fundamental to the position a good position we’ve been in over the last six months of getting through COVID and having our technology working incredibly well from off-site but our view at the moment is 1.3 is the right span for this year and here there’s quite a bit still of spend on non-discretionary spend relating to controls in the business and relating to regulatory spend and the likes. We do see that coming off over a period of time not in the next year or two but we’d certainly like to see that come off and more spent on discretionary i.e. growth of the business spend.

So I think 1.3 is look we’re comfortable with the spend. Of course if you ask my executives I’d like to spend twice that amount of money if I gave it to them but the reality is you’ve got to get a return out of it and also the discipline of actually delivering against it and I think we’ve got a very good balance here now in the business. We’ve got 19 major programs of work that we’re working through and funding, un-funding for the longer term as well. So I’m pretty comfortable with it. Could it come down? Yes but we don’t want to see a lot of the work completed over the next probably a year or two years.

Gary Lennon

I think that’s good if over the next couple of years that rigging compliance impose started to come down then that could be a catalyst bring it down a bit.

Ed Henning

Okay. That’s great and just the second one if we move beyond the app restrictions on dividends and the COVID impacts where do you see the medium-term payout ratio supporting your growth ambitions and your 10% ROE target?

Ross McEwan

Yes. Look we haven’t said that other than to say we’re a dividend stock and we’ve reduced the dividend payout from the last year to make sure we stay in a very strong capital position but over time we’d like to see that come back up. We haven’t had a discussion as a board recent time about what that payout ratio will be but over the next probably 12 months we will. I would like to see us come through the next 12 months before we get too excited about increase in dividend but over time it has to go and it’s got to go up. That’s the form of stock we are.

Ed Henning

All right. Thank you.

Ross McEwan

But at this point comfortable where we are until we get through the out workings of COVID and then we’ll be doing the review.

Gary Lennon

I think the way to think about without giving any numbers but we would like to build it up over time assuming performance improves and then ultimately get to a sustainable position where we’re still generating capital on an organic basis at that level of dividend payout so that’s the and so you can come up with your own numbers about well what level that is and that will give you a bit of a sense probably what we’ll start thinking about.

Ross McEwan

Thanks Gary.

Ed Henning

I appreciate that. Thank you.

Operator

Thank you. The next question comes from Brian Johnson from Jefferies. Please go ahead.

Brian Johnson

Good day. First of all Ross it’s rare that I congratulate someone in difficult times of actually at least having a pathway for future improvements so well done on that front.

Ross McEwan

Thank you.

Brian Johnson

Well, it’s to be commended because I think you’ve had a great markets result and you’ve pumped up your balance sheet provisioning which is really quite sensible. Two questions if I may. First one is if I go back to slide 24 from the last first half result and I compare that to basically slide 30 at the first half result you said rising capital density your base low end was 80 basis points and your high end was 180 over the next two years when we move through to this result on slide 30 I can see that the deterioration over two years under the key scenarios is still 80, two years out even though we’re six months in and the high end is 140 but when I look above I can see that there is been 40 basis points consumed over the short term. Can you kind of reconcile those numbers for us please?

Ross McEwan

No, I’m going to give that straight to you though. Thanks Brian and yes and as I went through on the as we’re seeing things play out and run various models now that we’ve brought that 140, 180 top end down to 140.

Brian Johnson

Is that just the 40 basis points that’s been consumed Gary though?

Gary Lennon

No. So it’s, that’s the equivalent range from the previous disclosure based on what we now know. So the way to think about it is the 40 that you see is part of the 80. So we’ve already so we set those at March to date we’ve seen 40 come through of that 80. That is the best think about it.

Brian Johnson

So we’re six months into two years and in the future the low end is another 40 basis points and the high end is basically a 100 is that the way I should read it?

Gary Lennon

Yes. That’s the way you should read it with one catalyst or one catalyst.

Brian Johnson

Okay. Well Gary I feel like taking away my compliment because I think you could have expressed that even more clearly in those slides. Now the second question that I had is —

Gary Lennon

Brian I’ve just got to add one point which again I’ve taken the note. We’ll express more clearly so we’re on board on that is that what we have seen that surprised us which I’ve talked about already is that there has been upgrades this period and that’s 40, that 40 of deterioration is the gross downgrades. There is been some offsetting upgrades. What we don’t know yet about those but we’ve kept the range at 80 to 140 because we don’t know whether those upgrades we’ve seen today is that a temporary aberration once support gets taken away will those upgrades go off but it’s just a bit of asterisks if you like to that 40 but now that you’ve got it that’s the way to think about it, 40 against 80, 140 range.

Brian Johnson

And Gary how do I reconcile the credit risk weighted asset increase? Is that from the levels where it was six months ago the 37 billion and the 65 or is that from where it is now?

Gary Lennon

That was from March. Yes.

Brian Johnson

Okay. So you’ve given us the September figures, but the 37 billion and the 65 is from where it was at March.

Gary Lennon

Yes and I’d take on board that could be a bit confusing.

Brian Johnson

Gary, we are in 100% agreeance on that okay on to the next question if I may and Ross this is probably one for you is that if I do some mucking around and I go into the actual profit release and I have a look on page 70 I can see that in this half year you had $539 million of new impaired assets emerge in quite a troubling economy. When I go back and have a look at the half before it was 553 and even half before it was 807 when I actually have a look at that rate of decay in your book and I compare it as relative to gross loans and advances relative to each of the other major banks it is markedly lower. That’s despite the fact that proportionally you have less housing.

Now I had thought that’s because the formation of bad loans coming through from your SME skewed book is just so much lower than Insto which is just totally the opposite of the conventional wisdom but could you just explain to us why over the longer term NAB’s rate of formation of impaired assets seems to be so much lower than your peers? So that was page 70 of the result 9 which is asset quality on page 70 of the result.

Gary Lennon

So Ross, want to have a go for start and you might want to make comments because certainly the reason why we’re not seeing the level of impairments increases is what we talked about earlier and we have been I think we’ve all been somewhat surprised but not totally surprised and this goes back to the level of support in the system that we’re not really seeing the true pressure yet on our SME portfolio and we’re not really seeing the new impaired flow through that we thought we would have thought had been flowing through.

Now, I actually would have thought that’s a bit of a sector-wide dynamic but that’s why our new impaired are quite low this period when you probably expect them to be a lot higher. The whole proposition of is this going to impact SMEs more than institutional and corporate customers I think it’s still too early to call that as to whether that is going to end up being the case or not and to-date I think the top end of town that has fared particularly well their ability to access funding and equity has been, it’s been particularly good.

So they’ve been able to get through it so far but you don’t, as we all know, you don’t need too many impairments at the top end to create some pretty significant pain whereas at the SME end a lot of this has been masked to date with the level of support in the system and if anything because of the amount of liquidity in cash all of our models are saying our SME portfolio is improving not deteriorating in a lot of respects. So it’s just an interesting time currently that I think the next 6 to 12 months will give a clearer picture about where those impaired will actually be.

Brian Johnson

Gary sorry, I apologize obviously didn’t ask that question very well. What I’m more interested in is even pre-COVID this has certainly been the case for three or four years why is NAB’s formation of impaired assets so much lower as a portion of your loan portfolio than the other banks? Now we know you’ve got less housing that you would think that would actually make it higher. You’ve got more SME lending you would think that would actually make it higher if you followed the traditional literature but in Australia your impaired asset formation is so much lower. Ross have you got any thoughts as to why that might be?

Ross McEwan

No. It’s something actually right and then you pick up on this okay well now I know what you’re talking about the piece that I think we need to examine is what part of our business book is actually secured or semi-secured compared to others as well because a fair portion of our SME book is either secured or semi-secured. So that may give us a tilt as well because if we’ve got a high percentage and I don’t know whether we have or not if we do well actually would be a better outcome for us than others would wear I’d also go to Gary —

Gary Lennon

Yes. I’d take you to slide 82 if you can Brian in the pack that might give a bit of a view of this and there is some other data points will point to as well around commercial real estate but from a macro risk setting risk appetite perspective we’ve been working for a long time to see on that chart there that back in 09 we had 27% of the portfolio had a probability of default greater than 2% and we have been actively trying to reshape that portfolio over many years to minimize that greater than 2% and as we went into COVID that was down you see with a low point of 11.

So it’s more than halves what it previously was and that has been a very conscious longer term strategy that Sean’s put in place with the business for a number of years with David Gaul’s help of course and so that’s why I think you’ve seen that trend over a number of years and that’s why our impairments statistics did improve rapidly.

You’ll also see our proportion of our portfolio for commercial real estate, [Indiscernible] might about 17% it was at its height the GFC and it’s now about 10% of GLAs. So that’s a massive shift in de-risking the portfolio. It costs you on the growth side. It costs you on the revenue side but we think it’s the right way to reset it and Brian what you’ve called out is the benefit on the other side of those costs of de-risking the portfolio in a sensible gradual way over what has been essentially a decade. Does that help you now?

Brian Johnson

It just seems to me you’ve got a higher stickier margin and you’ve got structured lower loan losses. So it’s just a very valuable business but that could be, I could be wrong. Thank you.

Ross McEwan

And it is around the restructuring that’s happened over a long period of time on the portfolios.

Operator

Thank you. At this time we’re showing no further questions.

Ross McEwan

Thanks very much. So I’ll just make a couple of closing comments. First off, thanks very much for joining us on the call. Good set of questions as well. Thanks Gary and the team for putting the session together and look 2020 was a year for us of building balance sheet strength. You’ve seen our capital. You’ve seen our liquidity. You’re seeing now the impairment provisioning. It’s very-very strong for this bank and that’s what we wanted to achieve in 2020. We want to hold on to that next year. I’ve said very clearly there is no better place to be operating out of than Australia and New Zealand. We are the business biggest business bank in these markets and it’s our job to step into these markets and help the recovery.

The government has done an outstanding job to-date on building helping businesses and individuals get through and now we need to build on that strength that we have a very clear strategy and we just have to have the discipline now of delivering against that and growing safely in this marketplace. So thanks for joining us today. I’m sure we’ll get an opportunity to chat over the next few weeks and it looks like the Victorian economy is starting to get moving again which is also very good for our business. So good to catch up today. Thanks all.

Operator

Thank you. That does conclude our conference for today. Thank you for your participation. You may now disconnect.



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