Nationwide Building Society (NBS) Earnings Call Transcript & Summary

Hello, and welcome to the Nationwide Building Society 2020 (sic) [2021] Full Year Results Conference. My name is Lydia, and I will be your coordinator for today's event. Please note, this conference is being recorded. [Operator Instructions] I will now hand you over to your host, Joe Garner, to begin today's conference. Thank you.

Hello, and thank you for joining us for Nationwide Building Society's results for the 2020, 2021 financial year. My name is Joe Garner. I'm the Society's Chief Executive. Also on the call with me are Chris Rhodes, our Chief Financial Officer; Sara Bennison, our Chief Product and Marketing Officer; Muir Mathieson, our Director of Treasury; and Robert Gardner, our Chief Economist. This week, in this country, at least, it does start to feel like we are emerging from the shadows of the pandemic. That makes it all too easy to forget the terrible situation that we faced only a year ago. Today, we can meet with family and friends, even go to the cinema and contemplate the possibility of a summer holiday. But when we talk about the past year, it's important to remember what we've been through. What it was like before mass testing, before vaccine, we had no real idea of what the future held and this acute uncertainty drove our decisions and choices in the early part of pandemic. Our decisions in the last year were also guided by something that COVID has not changed, Nationwide mutuality, our values and social purpose. While purpose and responsibility have become buzzwords for businesses large and small, they have been central to Nationwide since we were founded in 1884. Our social purpose and mutual status means we have always run our business for the benefit of our members, our employees and our communities. To take just a handful of examples from the past, we actively supported the expansion of the housing market in the critical post-war period, we championed free ATMs. We were early adopters of the national living wage. We founded the national -- the Nationwide Foundation. We've never financed fossil fuel industries and we never will. Just over 30 years ago, our members endorsed our social purpose by voting to maintain our mutuality at a time when others would be mutualizing. Our founding ethos still runs strong and guides how we do business today. It's why we are actively finding ways to keep our branches open rather than retreating from the High Street. Why we are helping tackle the housing and environmental crisis by building 239 green homes in Swindon. It's why we're bringing forward new mortgage propositions to give buyers a helping hand onto the housing ladder. And it's why we're supporting good landlords to help those renting into high-quality homes. Our social purpose underpins the society strategy of Building Society nationwide, which is highlighted on the next few slides. This is about providing outstanding service and long-term value to members underpinned by a financially strong and secure society. It's about supporting our employees and creating a fulfilling work environment and it's about putting weight behind campaigns for fairness and equality in all areas of life through good quality homes to respect for the environment. We've continued to do all these things during the pandemic, adapting rapidly and balancing the demand for the pandemic with the needs of our members and communities. At the half year, I mentioned that we would go a step further to make a number of commitments to help build a stronger, kinder, greener society. On this slide, you can see our mutual good commitment which are aligned to the UN Sustainable Development Goals and the targets we've set ourselves. As you can see, although these targets are new, they've always been embedded in our core purpose. These commitments are about helping people provide good quality, sustainable homes for all, giving people the know-how to manage their money confidently and helping communities and people to survive. These are all things that are important to us as a mutual and where we think we can make a difference. We're able to make commitments like these because of our continued success in supporting our members and growing our membership over many years. Now I'd like to talk about our performance during the last year. Despite the pandemic, we've had another successful year. In the early days, we shifted our priorities quickly to protect the health and safety of our colleagues and our members and the financial strength of the society. Around 13,000 of our employees moved to homeworking, we moved many of our services online at speed, and we introduced the now familiar distancing and hygiene measures so we could keep all of our operations going and continue to serve our members in branches. We went into the pandemic financially strong, and we also took rapid decisions to maintain that strength against a deeply uncertain future. By protecting the financial strength, we were able to support our members in ways they needed throughout the year. We put together a comprehensive financial support package for members in financial difficulty, including a pause on repossessions. Chris will talk to you shortly about the impact and outcome of the different types of payment holidays. Our members still wanted to move house, save and manage their money, and we continued to support them with new products and competitive rates. We remained open with more than 90% of branches open throughout. We've adapted many of our processes and retrained many colleagues to support our members and made sure they had every opportunity to engage with them. We have supported the most vulnerable with a dedicated helpline, video appointments and cash deliveries. In 2020, we were delighted to be recognized as Which's Best Banking Brand for the fourth year running. We also invested heavily in new digital tools, including e-signatures and online decision in principle for our mortgages. We've extended our branch promise until 2023 to support our members, [ high street ] and the communities in rebuilding after the pandemic. As well as supporting our 16.3 million members with flexibility and humanity over the last year, we've also achieved a very strong business performance. Our mortgage gross lending was fractionally lower as a result of 2 months when the housing market was closed, followed by a strong rebound. After the first lockdown, we made a priority of bringing higher LTV mortgages back into the market to support first-time buyers while lending prudently. More recently, we launched our Helping Hand mortgage, making us the first major lender to offer mortgages at 5.5x salary. We also recently became the largest mortgage provider to reintroduce 95% LTV without government support, offering new market-leading mortgages to first-time buyers and home movers. Overall, growth in our buy to let lending offset the decline in prime lending. And as you'll see in Chris's presentation, mortgage lending at improved margin was the primary driver of our income growth this year. And although margins improved, borrowers are still paying less for their mortgage on average than before the pandemic. Although our share of deposits were slightly lower, our stock of deposits rose significantly. Although the main driver was the fact that many members reduced spending over the course of the year, we also saw strong deposit inflows later in the year as we found new ways to deliver mutual value to our members through new propositions. These included our Start to Save account, Member Exclusive Fixed Rate ISA with linked cash incentives and prize draws. We continued to be a net gainer of current accounts in the year despite withdrawing our switching initiatives -- incentives after we'd achieved our target of a 10% share of all current accounts. Despite this very strong performance in this exceptional year, we did fall slightly short on a number of our long-term key performance indicators. Our KPIs measure the things our members value: excellent service, good value, a stable and secure society. During a year in which many members could not experience our in-branch services, it was perhaps not surprising that our lead narrowed, although we remain first amongst our peer groups for the ninth year running. Our member financial benefit fell below our target for the first time after 4 years, in which we significantly exceeded it, but we expect to recover to a degree in the future. We don't believe the pandemic has changed what members want from us, so we'll not be changing our KPIs, but we have rephased one target in light of the disruption caused by the pandemic. The strength of our business performance and finances is clear on this page. Our profitability recovered strongly and while profit is not our prime motive, it is obviously important to the resilience of the society and our ability to stand by our members in challenging times. Our U.K. leverage ratio also improved as did our liquidity coverage ratio. Now I'm going to hand you over to Chris, who will take you through the financials in more detail. Chris?

Thank you, Joe, and good afternoon, everybody. Despite the very uncertain operating environment, we ended our financial year in a position of improved financial strength, with increased [Audio Gap] lower costs. We supported our members with our home support package and mortgage [Audio Gap] in the second half of the year, [Audio Gap] support our members with better savings rate, which have generated strong flows. We have strengthened our balance sheet and now have a U.K. leverage ratio of 5.4%, and a 12-month average LCR of 159%. So turning to our financial performance. Underlying profits are 68% higher at GBP 790 million, compared with GBP 469 million a year ago. Statutory profit is GBP 33 million higher, largely due to below-the-line hedging items. Total income was 8% higher, given improving new business mortgage margins, the benefit of our hedging activity and the lower cost of retail funding. Our operational costs are GBP 94 million lower, reflecting rephased investment spend and lower business as usual run costs, partially offset by restructuring costs that help us position the business for the future. We expect costs to fall further next year, but at a lower rate than we have seen in the last 12 months as we continue to modernize our technology estate. Asset quality remains strong, with a very small increase in arrears level during the period. The impairment charge for the year was GBP 190 million, GBP 19 million lower than the same period last year, but still elevated relative to pre-pandemic levels. I will come back to these numbers and the approach we have adopted in more detail later in the presentation. The charge for other provisions was GBP 87 million compared to GBP 56 million in the prior year. This reflects ongoing remediation of legacy member processes. Member financial benefit was GBP 265 million compared to GBP 735 million last year, largely reflecting the impact of reduced savings rates following the reduction of the bank base rate in March 2020. We expect member financial benefit to be closer to our target of GBP 400 million over the next 12 months. 3% balance sheet growth reflects a rising liquidity and an increase of GBP 1.6 billion in retail lending balances, with a decline in other lending balances of GBP 1 billion as a consequence of the reduction in the housing association loan book. Liquidity increased by GBP 8.4 billion as we continue our approach of maintaining a prudent liquidity position through the cycle. During the year, we repaid all of our TFS drawings and complete -- and have completed all of our drawings from TFSME by the end of April. Deposit growth of GBP 10.6 billion reflects strong current account inflow, as our members spent less during the pandemic, together with a strong inflow into savings accounts in the second half of the year. Our cost of retail funding, included in current accounts, reduced by 59 basis points in the year. And our differential now stands at 10 basis points better than the market average deposit rate. Capital ratios remain strong. The CET ratio increased -- CET1 ratio increased to 36.4%. The U.K. leverage ratio increased to 5.4%. During the year, income increased as a result of higher mortgage new business margin, lower savings rate and the impact of our hedging activity, together with a lower cost of holding liquidity. The society runs a rolling structural hedging program to hedge an appropriate proportion of current account balances and reserves. This program is based on a 2.5-year duration which has remained unchanged during the period. In addition, we have hedged some of our savings balances that are currently deemed to be floored to protect income in a reducing interest rate environment. The benefit of this savings hedging more than offset the drag from the structural hedge program. The cost of holding liquidity has also reduced as we have continued our strategy of diversifying investments into high-quality G7 government bonds. During the year, increased margin on mortgage new business outweighed the continued runoff of the closed back book. As we look forward into '21, '22, we expect a broadly stable position as mortgage new business margins continue to reduce from their peak. But are expected to remain higher than pre-pandemic level. Over time, we do expect mortgage margins to return closer to pre-pandemic levels. But the timing of this remains very uncertain. Deposit pricing remains low due to the low base rate environment, and we expect this position to continue even as we return to offering more competitive products. The market share and unpredictability of future pricing strategy of national savings and investments continues to pose a risk for the overall behavior of the savings market. The cost base reduced by GBP 94 million as we continue to drive efficiencies in the business. We have continued to invest in modernizing our technology estate, improving our resilient payment systems and digital capabilities. Costs, excluding restructuring provisions, fell by GBP 182 million as we optimized our investment in the business and made efficiencies in other parts of our operation. However, in the year, we had a GBP 72 million increase in restructuring costs as we position the business for reduced operating costs in the future. Restructuring costs will remain elevated as we seek to make changes to the business that will drive efficiencies in the future. We do expect costs to fall further next year but at a lower rate than we have seen in the last 12 months, as we continue to modernize our technology estate and drive improved efficiency. Our continued focus on low-risk assets provides resilience against economic uncertainty. This year's cost of risk remains elevated at 9 basis points compared to 10 basis points last year. This is largely driven by modeled IFRS 9 economic scenarios, together with adjustments that reflect suppressed arrears levels as a consequence of COVID-19 support measures. In addition, a GBP 23 million charge has been taken to reflect the impact on the valuation of flat on the presence of unsuitable cladding and the potential costs of remediation work. Asset quality metrics are broadly stable, with a very small increase in 3 months arrears levels during the year. The increase in the 3-month arrears percentage for unsecured is as a result of reduced balances rather than an increase in the number of accounts in arrears. Average LTV of new business reduced during the year as a result of a prudent risk management during the pandemic and the average stock LTV reduced over the period, reflecting the strong housing market. As we look forward, there is clearly significant uncertainty and this is reflected in our economic scenarios, which continue to trace a wide range of potential outcomes. On a weighted average basis, our scenarios are consistent with a significant rise in unemployment towards the end of 2021, with a peak unemployment rate around 1% higher than the Bank of England's February projection before falling back in 2023 and beyond. The path of house prices is particularly uncertain, given the scope of shifting consumer preferences as a result of the pandemic as well as the wider economic uncertainties. These scenarios reflect our best view of the outlook as at the balance sheet date and do not, therefore, reflect the more positive news flow over the last few weeks. Government support has been crucial in limiting the impact on households and businesses, and we don't know how the economy will perform as that support is withdrawn. We remain cautious about the outlook, given the challenges that lie ahead. IFRS 9 staging and provisions reflect continued uncertainty and the wide range of possible economic outcomes. Total provisions for expected credit losses have increased by GBP 666 million to GBP 852 million, with increasing coverage ratios across all retail portfolios. In assessing the expected credit losses, we have made a number of adjustments to reflect the impact of the uncertain economic environment and the impact of government support schemes on the macroeconomic variables our models rely on. Our credit loss models use changes in GDP as an early-stage predictor of future unemployment levels. The link between GDP and unemployment has changed due to the nature of the economic shock and government support. And we now judge peak unemployment will occur 15 months after the fall in GDP, longer than the previously modeled correlation. We have adjusted the way GDP impacts our model provisions to recognize this delay and better reflect our best view of the likely outcome. Had we not made the adjustment, the model outcome would have implied a GBP 25 million reduction in provisions. Whilst active payment deferrals across all portfolios have fallen to only 13,000, there remains an increased risk of default for those members that took advantage of a payment deferral. And we have recognized an incremental GBP 35 million charge, taking our balance sheet provision to GBP 74 million. Arrears levels remain low and in our judgment, some of this is due to the impact of government support schemes, particularly furlough. We have retained a provision of GBP 57 million to reflect the risk that arrears have been temporarily suppressed. The final adjustment links to mortgage collateral value, where we have increased the expected loss by GBP 33 million to reflect the crystallization of idiosyncratic risk that is likely to occur in a stressed and uncertain economic environment. I'm sure the next 2 slides will be of particular interest. And I'm going to summarize them quite slowly in terms of what they're telling us. So to summarize and starting with mortgages, you can see that the total number of payment holidays granted was 256,000. This has declined to 9,000 representing only 3.5% of the original population. 214,900 are paying in full and 21,000 accounts are closed. Of the balance, 7,800 are in arrears with no concession and a further 3,300 have some form of concession. While some of the previously performing accounts that have emerged from payment deferrals, emerged from payment deferrals in arrears are now classed as nonperforming. 88% of loans currently 3 months plus in arrears were in arrears prior to their payment deferral being granted. The next slide shows the same data for the unsecured portfolio, with total payment deferrals of 67,000, with just 3,700 outstanding. Of the expired deferrals, 5,500 are in arrears and 1,500 are forborne. We remain strongly capitalized. The U.K. leverage ratio increased to 5.4%, predominantly driven by retained profit and the AT1 issuance. Our CET1 ratio has increased to 36.4% again driven by retained earnings. The reduction in lending risk-weighted assets and other movements reflect reduced retail unsecured balances together with the smaller commercial book and favorable regulatory changes on RWA calculation. We expect the PRA to reverse the favorable benefit from software intangibles which if implemented today, would reduce our CET1 and U.K. leverage ratio to 35.4% and 5.2%, respectively. Our capital resources are in excess of regulatory requirements with substantial [ growth ] across risk base, leverage and MREL frameworks. Society holds surplus capital of GBP 4.4 billion to the U.K. leverage requirement and GBP 7.8 billion to the CET1 requirement. The U.K. leverage ratio is expected to remain our Tier 1 binding constraint regardless of known changes to the risk-based framework expected in future years. Over the next 12 months, we expect our CET1 ratio to reduce as a result of the impact of hybrid IRB model, the potential introduction of mortgage risk-weight [ floors ] and the reversal of the software intangibles treatment already mentioned. The implementation of hybrid model is expected to reduce volatility in risk-weighted assets during a stress period and in stress [ tests ]. Following these changes, we expect to maintain a significant surplus to MDA. Our liquidity and funding ratio supports our financial strength with a year-end liquidity ratio of 165% and an average throughout the year of 159%. We fully repaid all GBP 17 billion of TFS funding mainly with drawings from TFSME, from which we have final drawings of GBP 21.7 billion by the end of April. We aim to remain active in wholesale funding markets in both secured and unsecured formats across a range of currencies. Our plans assume we retain our prudent approach to wholesale funding, optimizing maturities beyond the TFSME redemptions window, as demonstrated by the recent 20-year euro-covered bond. We may also take opportunities to prefund '22, '23 requirement if conditions are favorable towards the end of the financial year. And we will continue to ensure our issuance plan, taking into account of Moody's Loss Given Failure requirement. Now let me hand you back to Joe.

Thank you, Chris. Before we take your questions, let me quickly summarize where we are today and how we see the immediate future. We're emerging from a difficult year, and hopefully, the darker days of the pandemic are behind us. We've demonstrated the resilience of the Building Society model in the last year and the strength of our long-term strategy, building society nationwide. More than anything, our performance over the last 12 months is a credit to the dedication and hard work of our employees and the loyal support of our members. We've learned a lot over this time as COVID is accelerating changes that were already underway, including the digital transition and flexible working. The fact that we've been locked up in our homes over the last year has also changed the way we think about our homes and finances. Research that we released this week shows that we've become more cautious, saving more and spending less. This presents a significant opportunity for us to support people to invest in greening their homes, spending safely and in such a way that supports local communities. Although we're not out of the woods yet, these strong results, coupled with our financial strength and our social purpose, mean that we can continue to support and serve our members and communities to help them rebuild post-pandemic. Now I'll hand to [ Charlie ] to help facilitate your questions.

Thank you very much, Joe. Thank you for everyone who's sent in questions so far. Please do log any more that you might have. So the first question we have, Joe, actually comes from 2 people: Lee Street, and Rohith Chandra-Rajan. And it's one on the outlook for mortgage margins. I guess, particularly given that, obviously, spreads have been compressed a little bit in recent months, but obviously, there's more higher LTV mortgages available. So any thoughts on the outlook for the next year or 2?

Okay. I think I'm going to turn to Chris to answer that. Chris?

Yes. I guess, look, a couple of observations. Maybe starting with the market in the round, we expect the market to remain healthy in terms of total volumes. Mortgage margins have fallen from the peak. So the peak spot margin would have been [ 220 ] to [ 240 ] over SONIA. As of today, it's reduced to about [ 170 ]. Our judgment is margins will continue to reduce a little bit over the next 12 months but remain somewhat higher than they were pre-pandemic. And what that means for the society overall, and you will see in the second half of the year, we exited at a 1.26% margin. Our view is for the next 12 months, that our margin will be broadly stable. I think we've got a healthy mortgage market. We've got good volumes. I think pricing, as I said, will continue to decline a little bit, but remain elevated in terms of pricing relative to where it was pre-pandemic.

Thank you, Chris. And so the next question is also from Rohith, but a few other people have lodged it as well. And this one's around the outlook for house prices, particularly across the -- our sort of upside and central scenario, where we have sustained growth in the upside, but sort of a dip in our central scenario. So any comments on house price outlook?

So if I just make a comment from what we're seeing from our members and then hand to Robert to provide a bit more perspective on it. What we've really seen is there's a degree of structural change that what people want from their home has changed and in conjunction with the way working patterns are changing, that's driving a lot of movement in the market. And that structural change we expect to continue. Of course, the facilitating of that is through amazingly priced mortgages across the whole market, and we expect that to continue. And therefore, the stamp duty holiday is only, I think, going to have a relatively small impact on it. And whilst house prices will always go up and down in the short term, personally, I remain pretty optimistic about the longer-term outlook. But Robert, would you like to comment a little bit more specifically on the scenarios?

Yes. Sure. As Joe said, the range of outcomes is potentially very large, partly because we don't know what the economic circumstance is going to be. That's clearly still very uncertain. But also on top of that, there are these shifting preferences, which could continue to impact the market and again, create additional uncertainty. So just for example, in April, we did a survey and around 25% of homeowners said they were either in the process of moving or considering moving as a result of the pandemic, and around 3/4 of the people that said that -- said that would have been the case whether or not the stamp duty holiday had been extended. So you can see that these preferences are really important to driving activity at the moment, and we don't know the extent to what that will continue or over what time period. In terms of the scenarios, in particular, you asked about the upside and the downside, if you look over the 5 years as a whole, again, that does trace out -- just those 2 scenarios trace out quite a wide range of potential outcomes. So in the upside, we're assuming over the period as a whole, we're talking about 3.7% growth per annum. So at the end of the period, that would mean that house prices end at around about 25% more than that, above where they were before the pandemic struck at the end of 2019. In the central case, prices are about 12% or so above the 2019 level if that makes sense.

Thanks, Rob. So the next question is in relation to our mortgage market share. A question from Alastair Ryan. What's our appetite for market share gain, given mortgage spreads are robust, and we've got plenty of liquidity?

So I'll have a go, and then I'll just see if anyone wants to build on it. We don't chase a market share number. I think we have -- we've definitely got appetite to lend. And I think you've seen that there's a wonderful sweet spot between us meeting our core purpose of lending to the first-time buyers and also the returns that have been available in that segment. And we'll continue to be guided by that but we'll set our economic returns, our risk appetite and in a way, then the market share will land to a degree where it lands. But I think that we certainly do have appetite to -- and we would like to do a bit more. I don't know if there's any additional concern.

So maybe a bit of context, Joe, I mean, clearly, last year, we prioritized our resource to make sure we were lending appropriately and prudently and make sure we used our underwriters in the right way. There is scope for us to write a bigger market share this year, bearing in mind the market circumstances. I think our volumes this year on the basis of how we are trading at the moment will be a touch higher than they were last year.

Thank you both very much. So still on the mortgage theme, again, another question from Rohith. In terms of mortgage arrears, obviously been low and stable and really strong compared to the market. Any thoughts on the outlook for arrears going forward?

So, I think that's a really tough question in a sense of I don't think we really know what is going to happen post the runoff of support schemes in the autumn. We have made the post model adjustments to our expected loss charge that I've set out. If the -- if unemployment rises and follows the weighted scenario inherent within our MES, then you would expect arrears to rise, clearly, difficult to say exactly to what extent. I mean clearly, you look at our payment holidays and the performance as they stand today, you would not be expecting a material rise in arrears. But we have got an expected loss charge in the balance sheet that is -- does assume some rise in arrears. But I think the path is so uncertain. I'm not going to give anything other than they're likely to go up a little bit.

I think one thing that does feel a bit more optimistic than what we thought sort of 8, 10 months ago, is that about 8, 10 months ago, I think we all assumed that furlough would come to an end and then at some time after that, the economy might start to recover. I think the way that things have played out with the extension on furlough, personally, I think more people will roll off furlough into employment than we might have thought a little while ago and just got [ filled ] looking around the place. The labor market feels fairly tight. So I guess, personally, I feel a little bit more optimistic. But as Chris says, it's hugely uncertain.

Thank you, both, for that one. So then just changing topics slightly. I've got a question in on structural hedging from Aman Rakkar. Can you give more details on your structural hedge in terms of notional and yield? And how has that changed over the last 12 months? And do you expect any changes going forward, noting you've only hedged half of the current account growth this year?

So Charlie, I'm going to ask Muir to talk about the intricacies of the structural hedge?

Yes. With pleasure, Chris, and thanks, Aman, for the question. So we have put extra disclosure in our release this time around. Slide 35 in the appendices gives a greater breakdown of our structural hedging. And on that Slide 35, you will see 3 different elements to our balance sheet hedges, where we hedge both our reserves, our current accounts and we do have hedging in place for our floored savings accounts. And the dynamics across these 3 has been slightly different during the year. In relation to the reserves hedging and the current account hedging, you'd be unsurprised to hear with rates lower that we have earned slightly less than those hedges this year. However, the hedging that we have in place for our floored savings accounts has protected our margin, as you can see on Slide 35. In terms of the quantums, we broadly -- we have kept our reserves hedging program, exactly the same as before. In relation to the current accounts, you'll see that current account balances have grown strongly this year, as you've already heard, and you'll see it in totality, a GBP 9 billion increase in balances. Whereas we've only increased structural hedging by GBP 5 billion. So we haven't fully hedged the growth in current accounts as we are retaining a little bit of optionality in case more of those current account balances are transitory and that balance does get spent during the year. And we keep that under close review and assessments and in terms of your -- the final part of the question, no, we are not planning on changing our structural hedging going forward. We believe in having stability in our structural hedges and a programmatic approach and not chopping and changing it all of the time.

Thank you for that, Muir. And so now just moving over, we have a question in from [ John Cronin ] on member financial benefits. So in the context of enhancing member financial benefit back to closer to our sort of target levels this year, are we likely to increase the availability of market-leading mortgage products? And can we also comment on the outlook for savings rates?

Okay. So just to preface this, of course, member financial benefit is really an outcome because it's how our extra compares with the market. And so it depends -- a large chunk is out of our hands. It depends what the market does. But the action on member financial benefit is going to be more on the savings side. And maybe I could ask Sara to talk to what's been happening and how we're thinking about this.