Nationwide Building Society (NBS) Earnings Call Transcript & Summary

Good morning, and thank you for joining us today for Nationwide Building Society's First Half Year Results of the '21/'22 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 Products and Marketing Officer; Muir Mathieson, our Director of Treasury; and Robert Gardner, our Chief Economist. As we look back on more than 18 months of the pandemic, I think it's fair to say that it's been a test of character for us all as individuals and organizations. As you know, Nationwide's character is defined by our mutuality, which means we are owned by our members and run in their long-term interests. We prioritized the needs of our members during the pandemic. We kept lending, and we're true to our core purpose and the needs of our members and communities. Today's very strong financial results show the benefits of running a business that is strongly aligned with our members' interests. For background, over the last 5 years, our goal has been to bring mutuality to life, grow our business and use our success to deliver on our social purpose in the toughest of times. For a perspective, it took us almost 100 years to attract our first 1.5 million members. By comparison, it took only the last 5 years to grow our membership by the same amount. Our membership is now 16.3 million. We've grown our mortgage book by 20% and our deposit base by around 28% over the last 5 years. That's GBP 32 billion and GBP 39 billion, respectively. We've achieved our long-term target of a 10% share of current account market. Beyond commercial success, we are committed to delivering outstanding service, great value and a society that is financially strong and resilient. We believe that the quality of our service helps attract people to Nationwide, so we work hard to maintain our members' trust in our service and satisfaction. Consumer expectations rise constantly. So we're greatly encouraged to have been able to keep our #1 ranking for satisfaction over 9 years running, extending our lead relative to our peer group. As a member-owned mutual, our members share in our success through preferential rates and incentives that we offer compared with our competitors. In the last 5 years, that benefit has amounted to almost GBP 3 billion. Turning to our finances. We are stronger than ever, and our credit ratings are higher than they were 5 years ago. This long-term track record of strong performance shows the strength and resilience of our mutual model and is a validation of our strategy and purpose: building society, nationwide. Building society, nationwide is underpinned by 5 strategic cornerstones, which outline our priorities. Building thriving membership describes how we'll help our members manage their money by homes and save for the future. We design propositions to meet their changing needs. For example, our Helping Hand mortgage is helping more first-time buyers onto the housing ladder, while our Start to Save account is designed to encourage saving. Building legendary service describes our commitment to giving members the best service we can, in branch, online and over the phone. We've been enhancing our service by protecting our members from online fraud with the launch of our Scam Checker service and by maintaining our branch service while our competitors retreat from the High Street. Members want a building society that is safe and secure over the long term, and our built-to-last cornerstone describes how we'll maintain our financial strength, underpinned by strong capital and a low-risk business model. Providing a healthy and fulfilling work environment is where everyone can be themselves and thrive are key priorities that are captured in our building pride cornerstone. Our final cornerstone, building a national treasure, expresses our social purpose, our desire to make a positive contribution to our communities, including helping to solve the housing crisis, elevating the green agenda and promoting tolerance and respect. This social purpose has been a golden thread throughout our history, and we want it to remain at the core of who we are and what we do. That's why last year, we made 5 mutual good commitments, which we've hardened into firm targets. Many of you will be familiar with these from our recent ESG Investor webinar. The targets are all aligned with our strategy and purpose and linked to the UN Sustainable Development Goals. We will report back on our progress towards these commitments, at least annually. And on the next slide, you can see the first steps we've taken to achieve them. Rather than talking to you through each of these, as COP26 has just concluded, I'll focus on our green commitments and show our broad approach, which is to engage our business, membership and external partners to achieve these goals. Our strategy already does not include lending or investing in businesses that have a negative impact on society and the environment, such as the fossil foot -- fuels industry. While we are not a carbon-intensive business, we do have a direct impact, and that can and is being managed. We are already carbon neutral for Scope 1 and Scope 2 emissions, and we've committed nationwide to net zero by 2050. The remaining challenge for us as a building society and as the U.K.'s second largest mortgage lender is to help lead the greening of U.K. homes, which account for about 20% of carbon emissions. We've launched Green Lending, offered loans at preferential rates for green home improvements to homebuyers and landlords. We've committed that 50% of homes in our mortgage portfolio will be EPC or better by 2030. Of course, we can't tackle societal issues like climate change alone, so we work closely with our partners as well. We've convened a cross-industry action group to recommend ways to improve the sustainability of our housing stock, and we stand ready to support the government to deliver a national retrofitting strategy. We do, however, remain concerned about the economic implications for both homeowners and renters of decarbonizing our homes. We're deeply concerned that policy choices do not result in the cost of eliminating emissions falling on the people who can least afford to pay. Now I'd like to turn to our business performance. Members continue to choose Nationwide in preference to competition. And as a result, our product volumes were strong. We continue to grow our mortgage and deposit balances and current accounts during the last 6 months. Our already substantial mortgage book grew by over GBP 3 billion. And overall, our market share of mortgages remain broadly flat. Within that, our buy to let share rose, and our residential share was slightly down. We continue to help people onto the housing ladder by, for example, lending at 95% LTV and launching a new Helping Hand mortgage. Altogether, we helped 30,000 first-time buyers buy their first home during the half. Deposit balances grew, as did our market share of deposits. These were both helped by members holding more cash in their current accounts and putting more into savings. We also had a very, very successful ISA season, opening 30% of all ISAs in our peer group. Our stock and share of current accounts also rose, helped by our decision to restart our switching incentive. We paused that earlier in the pandemic so that we could concentrate on serving our existing members rather than seeking new ones. Turning now to our KPIs. As a building society, owned by our members, we believe our primary purpose is to deliver outstanding service, great value and a society that is financially strong and resilient. That's why our KPIs track these 3 metrics. On service, I am pleased that we were able to extend our significant satisfaction lead over our peer group. In the all sector, UKCSI, however, that's the customer service index, in common with many other High Street providers, our satisfaction suffered from the disruption to branch services caused by the pandemic and the lower interest rates. So although our score was 5 points ahead of the all sector average, unfortunately, this was not enough to meet our target of being in the top 5 in this reporting period. We measure value in 2 ways: member financial benefit and the number of members who have 2 or more products with us. Member financial benefit continues to be impacted by the pandemic-induced ultra-low interest rate environment, but stabilized in the half. As I mentioned earlier, we delivered almost GBP 3 billion of member financial benefits in the last 5 years, and we are finding new ways to reward members beyond rate. Our member price drawer is one example. Others include our Start to Save and PayDay SaveDay campaigns designed to encourage a savings habit. The number of committed members, those who have 2 or more products with us, reached 3.6 million. So we are actually currently ahead of our long-range target. Our final KPI, our UK leverage ratio is a measure of our financial strength. At 5.5%, it is comfortably ahead of our target of at least 4.5%. Before I hand over to Chris, this last slide summarizes our financial performance, which I hope you will agree is encouraging. We made decisions early in the pandemic to stand by our members and protect the long-term financial health of the Society, and this allowed us to support our members and to deliver the very strong half year performance you can see on this slide. Profits were GBP 850 million. Our UK leverage ratio and liquidity position strengthened further. This financial strength means that we're well placed to support the Society's future growth. It also allows us to choose, for example, to invest in our business, products and service and to build an even stronger society in the future. Now Chris will take you through the numbers in more detail.

Thank you, Joe. Good morning, everyone. At the beginning of the pandemic, we focused on protecting the Society's financial strength so that we can support our members through this very uncertain period. During the first half of this year, we have seen profits improve, reflecting increased mortgage income as well as a reduction in IFRS 9 expected credit losses as the economic outlook has improved. We have continued to strengthen our balance sheet and now have a leverage ratio of 5.5% and a 12-month average LCR of 173%. So turning to our financial performance. Underlying profits are GBP 850 million compared with GBP 305 million a year ago. Total income was 26% higher, largely reflecting improved mortgage volumes and higher new business mortgage margins during 2020, which increased due to the macroeconomic uncertainty. Other income increased by GBP 133 million, supported by gains from our investment portfolio and the nonrepeat of last year's liability management exercise. Operational costs are GBP 8 million lower, with reduced business as usual costs and restructuring costs offset by increased investment spend and a charge related to historic APP fraud cases. We expect total cost for the full year to be GBP 30 million lower than last year. Asset quality remains strong with stable arrears and forbearance levels during the period. The impairment release of GBP 34 million reflects house price growth and improvements in the economic outlook. The charge for other provisions was GBP 53 million compared to GBP 26 million in the prior year, reflecting ongoing remediation of legacy member processes. Member financial benefit was stable at GBP 145 million, but is tracking below our annual target. The balance sheet is 12% higher than at the same date last year and reflects a rise in liquidity and an increase of GBP 3.2 billion in lending balances. Liquidity increased by GBP 27.9 billion as we continued our prudent approach through this ongoing period of uncertainty. During the period, we made a further GBP 5.3 billion of TFSME drawings alongside the wholesale issuances of GBP 1 billion across our long-term funding programs. Deposit growth of GBP 7.1 billion reflects ongoing current account inflow and a strong performance in our traditional deposit franchise. Our market share of deposits increased to 9.6% compared to 9.4% at the year-end. Our cost of retail funding, including current accounts, stabilized during the period and now stands at 25 basis points. Capital ratios remained strong. The CET1 ratio increased to 37.7% and the UK leverage ratio increased to 5.5%. Income increased compared to the same period last year as a result of higher mortgage margins on the business written in 2020 and lower savings rates as a consequence of the base rate cut in March 2020, with higher levels of liquidity contributing a reduction of 2 basis points to our net interest margin. The underlying net interest margin is broadly stable compared to the second half of last year. During the period, the increased margin on mortgage new business outweighed the continued runoff of the closed book. In the second half of the year, book margins will be broadly stable. But as we look forward into '22, '23, we expect margins to moderate as the impact of mortgage competition feeds through into the overall book. Mortgage new business margins are now at pre-pandemic levels, reflecting the reduction in economic uncertainty and the strong liquidity position of the sector. Deposit pricing remains low due to the low base rate environment and the sharp rise in retail deposits relative to lending, which in part reflects the increase in household savings seen during the pandemic. Savings flows have moderated in recent months as the economy has started to normalize. This trend is likely to continue in the near term, especially given the squeeze on household incomes from rising inflation. We expect deposit pricing to remain subdued because of the substantial liquidity in the sector. The cost base reduced by GBP 8 million as we continue to drive efficiencies into the business and invest for the future. Costs, excluding restructuring and one-off items, are broadly flat, reflecting lower business as usual run costs being offset by an increased investment spend in the period. While restructuring costs were lower than the same period last year, we do expect them to increase in the second half of the year as we continue to make changes to drive future efficiencies. We expect total costs for the year to be GBP 30 million lower than the prior year. We continue to make progress on driving further cost efficiencies and expect the '22, '23 costs to be 3% to 5% lower than '21, '22. The cost of risk has fallen below pre-pandemic levels as a consequence of the improving economic outlook. The underlying cost of risk, excluding expected loss provision releases, remains at 6 basis points. Despite payment holidays ending during the period, asset quality metrics improved. Mortgage 3 months plus arrears fell by 6 basis points to [ 37 ] and unsecured 3 months plus by 21 basis points to [ 112 ]. Overall, forbearance levels across all portfolios also remained stable as members resumed payments at the end of the payment holiday period. Average stock LTV reduced to 53% over the period, reflecting the strong housing market. Economic prospects have improved since the year-end and the risks are more balanced. Nevertheless, the outlook remains highly uncertain, and this is reflected in our economic scenarios, which continue to trace a wide range of potential outcomes. Our central scenario, which remains 40% weighted, assumes a modest rise in unemployment in the near term as government support winds down and a small decline in house prices before recovering as the economy's momentum post-pandemic. Our upside scenario, which is 30% weighted, assumes the recent resilience of the labor market is maintained with house prices recording steady gains in the years ahead. Broader inflation pressures are assumed to dissipate in the years ahead as interest rates rise and the economy normalizes. The weight attached to our downside scenarios has been reduced, but at 30% remains substantial. While the outlook has improved, we remain cautious given the uncertainties that still lie ahead. Total provisions for expected credit losses have reduced by GBP 68 million to GBP 784 million. Mortgage coverage ratios have reduced by 3 basis points compared to the year-end but remain elevated compared to pre-pandemic levels. In assessing expected credit losses, we continue to make a number of adjustments to reflect the uncertainty as to how the current economic conditions will translate into future arrears performance. Arrears levels have remained 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 73 million to reflect the risk that arrears have been temporarily suppressed. Whilst payment deferrals across all portfolios have come to an end, there remains an increased risk of default for those members who took advantage of a payment deferral. We continue to hold and expect a loss provision of GBP 57 million for this risk. And finally, we adjust mortgage collateral values where we have increased the modeled expected loss by GBP 30 million to reflect the crystallization of idiosyncratic risk that is likely to occur on repossession in a stressed and uncertain economic environment. We remain strongly capitalized. The UK leverage ratio increased to 5.5%, driven by retained profits in the period. Our CET1 ratio has increased to 37.7%, again, driven by retained earnings. The PRA have confirmed that they will reverse the favorable benefit from software intangibles from the 1st of Jan '22. Without this benefit, our CET1 and UK leverage ratio would be 36.9% and 5.3%, respectively. Our capital resources are in excess of regulatory requirements, with substantial buffers across risk-based, leverage and MREL frameworks. The Society holds surplus capital of GBP 4.7 billion to the UK leverage ratio requirements and GBP 10.1 billion to the CET1 requirements. The UK leverage ratio is expected to remain our Tier 1 binding constraint after taking into account known changes to the risk-based framework expected in the future years. In Jan '22, we expect our CET1 ratio to reduce to the low to mid-20% as a result of the introduction of hybrid through-the-cycle modeling approach for IRB accredited firms, the introduction of mortgage risk weight floors and the reversal of the software intangible treatment already mentioned. The implementation of hybrid IRB models is expected to reduce volatility in RWAs during stress periods and in stress test. Following these changes, we expect to maintain a significant surplus to MDA. Our liquidity and funding ratios support our financial strength with a 12-month average liquidity coverage ratio of 173%. As noted earlier, we took advantage of a further GBP 5.3 billion of TFSME funding with total drawings of GBP 21.7 billion. We will continue our strategic approach to wholesale funding and expect to remain active across a range of currencies, in secured and unsecured formats. We will optimize for maturities beyond TFS repayment window whilst taking opportunities to prefund where appropriate and ensuring that our issuance plans take into account rating agency's requirements, including Moody's Loss Given Failure. Now let me hand you back to Joe.

Thank you, Chris. And I'm sure that you'll have some questions for us. So I'll just quickly summarize how we see the last 6 months. Our results have shown the resilience of our mutual business model, which has delivered a very strong financial performance and enabled us to stand behind our members at a time of continued great uncertainty. As a mutual, all of that profit is put to work for the direct and indirect benefit of our members. I'm very grateful to our members for their loyalty and to our employees for their fortitude and commitment. It is this that has driven these strong results. And it's this that has enabled us to show leadership in a number of areas. We've designed innovative propositions to help our members achieve their financial goals. We've taken a lead on what the future of work might look like and how our colleagues will work in the future. And we've worked hard to use our influence and strength for good by supporting the climate agenda, working with our partners and policymakers to help solve the housing crisis and promoting respect and tolerance between communities. You don't need me to tell you there's still a lot of uncertainty about the future, but what I hope these rounded results demonstrate is that with our thriving membership and financial strength, Nationwide Building Society is well placed to continue to support our members and communities whatever the future holds. Thank you for listening. Now we'd be very happy to answer your questions.

Thank you, Joe, and everybody. So first of all, thank you for those people who have already submitted questions. If anyone else does have any, then please do send them through. So the first question from [ Omar ] relates to mortgage margins. Open book mortgage margin is 175 basis points. And if we look at some of the bank's commentary, application margins are somewhat out of that. Can we say anything more about application margin levels in September? And also, when we think of group NIM, are there any particular offsets that would mitigate some of the mortgage margin pressure?

Thanks, [ Omar ]. As you said, a really interesting question. So let me give you a few data points. So you can see on our Slide 15, we talk about the open book margin of 175. The inflection point where new business fell below that was towards the end of June. Our current pipeline, so end of October pipeline, has got a margin of 1.3%. And clearly, we will see that complete over the coming months. But the application flow, as of beginning of this week, is at 90 basis points. That's been relatively volatile as we've seen movements in the swap curve, but yet current application flow at 90 basis points versus 130 in the pipeline. I think it's worth also calling out we've got a couple of disclosures in the -- both the RNS and the investor deck on sensitivities to interest rates. In a rising rate environment, we do see an improvement in NIM. And clearly, in a declining rate environment, it is the opposite. Just a couple of words on basis of preparation on that. Those numbers that we present assume 100% pass-through of any rate rise to all components of the balance sheet. Clearly, on the downside, we do not go below 0 on retail savings. So there is a small offset to declining mortgage margins. And in our judgment, at the moment, mortgage pricing effectively reflects a higher base rate environment because it's the structural hedge runs off the back of 5-year swap curve. Hopefully, that's covered all the points. I'll kind of leave you to put that in your various spreadsheets.

Thank you, Chris. Yes, there were a couple of follow-up questions actually in terms of where we expect new business mortgage margins to settle over time. But I think you pretty much covered that in the answer already.

At 90 basis points, there's still a good marginal return on capital. They clearly can go lower. But I think in a rising rate environment. It's more about the total earnings than it is the return on capital at the margin.

Brilliant. Thank you. So then we had a question in from [ Hardya ] and a couple of other people actually on a similar theme, really just asking if we can talk about what we expect for competition in the deposit market, particularly in the face of a potentially rising rate environment. And how we expect to manage our interest rates on savings and borrowing in the event of base rate rise?

Great. Okay. Very important question. I think, Sara, if you could talk to that?

Yes. If I talk to the deposit question, and it is a really interesting and obviously live question. We had a bit of a dress rehearsal for it or for the rate rise that didn't happen a couple of weeks ago. I think it's important to take a step back though and understand how we think about pricing and proposition more broadly around savings. Because the way our members choose us and why they choose us for a sort of different savings products, there is really considerably depending on the amount of money they have, the kind of savings habits they have or have not. And therefore, although pricing is clearly really important, it's only part of the mix. So that's why we look at understanding really where the value beyond rate as well as the value within rate to make sure that we get that balance correct. So for example, for people who haven't been saving, I'll start to say products that we had out there for quite a large amount of the year, was really successful and encouraging that savings habit. But that was often driven by the price draw mechanic. It wasn't really about the rates when you don't have very much to save even if the rate doubled or tripled, it doesn't really make any real difference in your pocket. And of course, that's very different at the other end for members who are serious savers, rely on the income and hence, why we had such a strong ISA performance, taking 30% of the ISA market this year because we had very attractive rates for savers for whom that mattered. So as we start to face into that competition, that segmented approach is really important. But -- and as we partly look at the way that, that flows through, that then determines the pass-through rate that we think is the most sustainable and best interest for all the membership.

Thank you.

Thank you, Sara. Okay. So next question from [ John Atian ] relates to other income. And he's really just inquiring how sustainable is the level of fees and commissions we've seen during this half going forward?

So let's -- there is a one-off investment rise in one of our fintech holdings of the order of GBP 25 million. If you discount that, the rest of it is sustainable.

Thank you, Chris. Okay. So then on to the next question and moving on to capital. It's a question again from [ Hardya ]. He is really just asking around the move through the cycle, the sort of through-cycle hybrid IRB model and what we expect from capital requirements? And obviously, there are a number of moving parts in that sphere. So we could say a bit more about that?