Nationwide Building Society (NBS) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us for Nationwide Building Society's Interim Results Call. I'm Debbie Crosbie, Chief Executive. And with me on the call today are Chris Rhodes, our Chief Financial Officer; Muir Mathieson, our Treasurer; Robert Gardner, Nationwide's Chief Economist. So I'm going to run through the highlights of the period and provide a brief strategy update before handing to Chris who'll take you through the numbers for the 6 months to 30th of September. I'm going to keep it brief so that we'll get plenty of time to respond to any questions that you have. So Nationwide has again delivered a strong financial performance, and our mutual model means that we can continue to support our 16 million members through the current economic uncertainty. We've reported profits of GBP 980 million due to growth in income, driven mainly by rising interest rates. This has meant that we can further strengthen our capital and leverage positions. We continue to deliver competitive products, high-quality services and great customer experiences. We've remained #1 for satisfaction amongst our peer group. We successfully grew our mortgage and deposit balances, and we continue to attract new current account members, demonstrating the impact of leading on value and service. Chris will take us through the financial highlights in more detail shortly. But first of all, I thought I would touch very briefly on our cost of living support and our [ Strategy Refresh ]. We've responded proactively to the cost of living crisis by extending our Branch Promise until 2024 to provide practical in-person support for our members, and we've also launched our new dedicated cost of living telephone help line, which does the same. We've also been very careful to make sure that we deliver real value and reward to our members, and we're doing this with tailored and competitive products, particularly for savings, mortgages and current accounts. We've maintained our mortgage lending through the recent disruption and recently moved our switcher rates to below 5% for our current members. We were able to pay this level of support because our mutual model provides us with opportunities that aren't available to many other financial services providers in the U.K. Mutuality will remain core to our [ Refresh Strategy ]. It's central to delivering a distinctive experience for our members today and in the future. This also means we can secure change for the good of society with our social investment activity, our community charity boards and the partnership that we have with Shelter. Our mutual purpose is at the heart of our strategy. We want Nationwide to be considered the #1 choice for personal financial services, and we will build member value, service excellence and operational excellence around that. We also want to build upon our reputation for great customer service. [ Branches ] will continue to be part of our approach. We're also going to develop our digital capability so that members benefit from round-the-clock convenience as well as access to personal support when they need it most. Over the strategy period, we will grow sustainably by attracting more members and deepening the relationships that we have with existing members. Service excellence will go hand in hand with our operational excellence, delivering simple, streamlined and flexible member experiences, grounded in resilient controls that protect our members and their money. So I'm now going to hand over to Chris, who's going to take you through the numbers.

Thank you, Debbie. Good morning, everyone. Over the last 6 months, we have been focused on supporting our members with great value products and investment in services that ensure they can get the advice and support they need through these challenging times. During the first half of this year, we have seen profits increase as a consequence of Bank of England base rate rises. Provisions for expected credit losses are elevated due to the uncertain economic environment with coverage levels just below those seen at the height of the COVID pandemic. We have continued to strengthen our balance sheet and now have a leverage ratio of 5.8% and a 12-month average LCR of 179%. So turning to our financial performance. Underlying profits are GBP 980 million compared with GBP 850 million a year ago. Statutory profit is GBP 11 million lower than underlying profit due to below-the-line hedging items. Total income was 16% higher, largely reflecting improved savings margins following base rate rises. Other income reduced by GBP 53 million due to the nonrepeat of investment gains seen in the first half of last year. Operational costs are GBP 58 million higher as a consequence of higher inflation and investment in services to support our members. We expect total cost growth in the second half of the year to moderate. Asset quality remains strong with stable arrears and forbearance levels during the period. The impairment charge of GBP 108 million reflects the deterioration in the economic outlook as well as an increase in model adjustments to recognize the impact on borrower affordability of rising inflation and interest rates. The charge for other provisions was GBP 19 million compared to GBP 53 million in the prior year, reflecting ongoing remediation of legacy member process. Member financial benefit improved to GBP 320 million for the half year and is now tracking above our GBP 400 million annual target. The balance sheet is 3% larger than the year-end, reflecting an increase of GBP 5.5 billion in mortgage balances and a GBP 3.3 billion increase in liquidity, partially offset by a reduction in other assets. Deposit growth of GBP 3.2 billion reflects ongoing current account inflows on a good performance in our traditional deposit franchise. Our stock market share of deposits was 9.3%. Our cost of retail funding, including current accounts improved during the period as a consequence of the base rate rises. Our average remember deposit pay rate is 91 basis points. This is 45 basis points higher than the market average deposit rate compared to 10 basis points 12 months ago, reflecting our higher pass-through of base rate changes. Capital ratios remained strong. The CET1 ratio increased to 25.5% and the leverage ratio increased to 5.8%. Income increased compared to the same period last year as a result of higher retail savings margins and the timing benefit of base rate changes. Approximately 50% of the change in base rate has been passed through to our retail deposit rate -- deposit base, including current accounts and approximately 60% when looking at retail variable savings. This compares to a market average for total deposits of approximately 20%. The mortgage market continues to be highly competitive, placing downward pressure on net interest income. During the period, the margin on the mortgage book reduced to 151 basis points, reflecting ongoing competition for both Prime and Buy-To-Let mortgages. Mortgage margins are now below prepandemic levels. Completions in the first 6 months of the year recorded a margin of 101 basis points, whereas the current new business margins are 114 basis points. And the pipeline of new business expected to complete over the coming months has a margin of 68 basis points. In the second half of the year, mortgage book margins are expected to decline at a similar pace to H1. Deposit margins improved by 48 basis points during the period as a consequence of base rate rises. We expect this margin moderation to continue into '23, '24 with ongoing mortgage competition. Costs, excluding restructuring, increased by GBP 58 million, of which GBP 29 million reflects inflationary impacts, including a GBP 15 million cost of living payment for colleagues alongside incremental investment in member-facing services. Restructuring costs increased by GBP 23 million, reflecting decisions we have made to reduce our property estate, which will reduce future running costs. These have been offset by a reduction in historic fraud losses. The cost of risk in the half year has increased to 5 basis points, an annualized equivalent of 10 basis points, reflecting the increasing economic uncertainty and the affordability challenges presented by higher inflation and interest rates. This compares to an annualized cost of risk before the pandemic of 6 basis points. We have included model adjustments in our expected credit loss assessment to reflect risks that we do not believe are captured adequately in our core models. Firstly, arrears levels remained low, and some of this is judged to be temporary as a consequence of support provided during the pandemic. We retain a GBP 51 million provision for this risk. The increase in inflation to levels not seen for 30 years creates a risk that may not be adequately captured in our IFRS 9 models. As a consequence, we continue to hold a model adjustment to reflect the impact of rising inflation on those borrowers most exposed to the cost of living challenge. This has been refreshed to include higher inflation and higher wage growth but we have also looked at payment shock and included an expected credit loss of GBP 16 million for those accounts rolling off fixed rates in the next 2 years. This total provision is now GBP 124 million. We also continue to hold a provision of GBP 26 million for cladding risk. Arrears and forbearance levels remained stable and below prepandemic levels. Mortgage 3 months plus arrears fell slightly to 32 basis points compared to the industry average of 72 basis points. 3 months arrears on the unsecured portfolio rose slightly to 128 basis points but remained below the 132 basis points recorded in December 2019. Based on the economic outlook and continued cost of living pressure on borrowers, we expect arrears to rise in the coming months. The average stock LTV reduced to 51% over the period, reflecting the strong housing market. As part of our assessment of expected credit losses, we have looked at upcoming fixed rate mortgage maturities and use the model adjustment to reflect the risks associated with possible payment shocks. We thought you might like these charts. They show that over the next 12 and 24 months 22% and 43%, respectively, of the total book will roll off from a fixed rate. The average pay rate for maturities over the next 2 years on the Prime book is around 2%. Whilst these mortgages were originally stressed to a pay rate of circa 6%, we do assume there will be an increase in the 12-month probability of default as they mature. Assuming they move on to a new fixed rate of 6%, the probability of default increases somewhere around 27 basis points to 88 basis points. As described earlier, this results in an additional expected credit loss of GBP 16 million, reflective of the low LTV of these accounts. Only 5% of these Prime accounts have an LTV greater than 80% with only 0.4% above 90% LTV. We only offer buy-to-let mortgages up to 80% loan to value. The economic outlook continues to be uncertain and has deteriorated since the year-end. This is reflected in our economic scenarios, which continue to cover a wide range of potential outcomes. Our base case scenario is 45% weighted and assumes a small rise in unemployment and broadly stable house prices. We attach an aggregate 45% probability to our 2 downside scenarios, which include material falls in house prices as well as growth in unemployment. The upside scenario, which is 10% weighted, is aligned to a rising rate environment with a gradually improving labor market and rising house prices. The weighted average house price assumption across all 4 scenarios is a decline of 8% by the end of 2024. We estimate that a further fall of 5% in house prices compared to our weighted average would increase the expected credit losses by around GBP 20 million. We remain cautious about the outlook given the uncertainties that lie ahead. Total provisions for expected credit losses have increased by GBP 68 million to GBP 814 million since the year-end. Coverage ratio since the year-end have increased by 4 basis to mortgages and have remained stable at 11.4% for unsecured. Coverage levels remain elevated and just below the level seen at the height of the pandemic. The increase in Stage 2 residential mortgage balances is largely due to a rising interest -- largely due to rising interest rates in the economic scenarios with the buy-to-let portfolio stage allocation being particularly sensitive to interest rate changes. Rising interest rates also resulted in an increased probability of default for buy-to-let loans in Stage 1 which led to higher model-driven provisions and hence, higher coverage. We are comfortable with the asset quality of our buy-to-let portfolio given the LTV profile and the high interest coverage ratios. We remain strongly capitalized. The U.K. leverage ratio increased to 5.8% and the CET1 ratio increased to 25.5%, driven by retained profits in the period. 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 5.4 billion to the leverage requirement and GBP 7.7 billion to risk-based requirements. The leverage ratio is expected to remain our Tier 1 binding constraint. Based on our current understanding of Basel 3.1, our CET1 ratio would be 20% on a fully loaded pro forma basis. I have previously talked about our desire to manage our surplus CET1 capital more flexibly through the ability to repurchase CCDS periodically at our discretion. I am pleased to confirm that we are actively exploring implementing a facility that would enable us to do so. And we have made an application to the PRA for general prior permission, which is one of the prerequisites. Subject to this permission and completion of internal governance, we are targeting having such a facility available to us from early 2023. Our liquidity and funding ratios support our financial strength with a 12-month average liquidity coverage ratio of 179% at the half year. We aim to remain active in wholesale funding markets in both secured and unsecured formats across a range of currencies with an expected total issuance of GBP 8 billion to GBP 10 billion equivalent per annum. Our plans assume we retain our prudent approach to wholesale funding by targeting maturities beyond the TFSME redemption window. As TFSME drawings mature, we expect to optimize our LCR in the range of 135% to 145%. We continue to ensure our issuance plans reflect credit rating agency requirements for loss-absorbing capacity. Thank you. We'll be now happy to take your questions.

Thank you, Chris, and good morning, everyone. We've already had some questions. [Operator Instructions] So our first question is from Lee Street and there are 2 parts to it. So firstly, really helpful to hear plans for CCDS, but given the very high capital ratios for Chris, interested in whether you have a maximum leverage ratio target. And for Debbie, could you please share your thoughts on M&A, including consolidating smaller building societies?

So in terms of a maximum leverage ratio, no, we don't, but let me explain how we look about our capital position. We aim via stress testing to the Bank of England stress test as well as our own stress test to keep a CET1 or total capital level above MDA threshold at the absolute peak of the stress and that becomes our binding capital management strategy. The leverage ratio is the number that flows from that, albeit we are clearly sitting on excess at the moment. And you can see the strength of our performance in both SS or the Solvency Stress Test of '21 and the ACS of '19.

Okay. So I'd just reiterate that our immediate focus is on the strategic pillars that I've outlined, which is essentially making sure that we deliver member value and absolutely focused on doing the best job we can with the society that we have today. However, in the future, there's no question that new capabilities can bring value. My thoughts are that M&A and financial services doesn't often deliver the value that expected, so we would set a very high bar before we would do anything and it must be something that would deliver a capability that was really about driving longer-term value. But right now, I just want to reiterate, we're very focused on the society that we have today and making sure that we do the best job we can for our members.

Thank you. We've got a question from Alvaro probably for Chris, around the volume dynamics in the mortgage market during October and November, please.

Okay. So right just trying to unpack this. But buy-to-let has seen the biggest impact. Buy-to-let volumes are probably down 75%. Clearly, purchase business in Prime is down, but switcher business, i.e., folks booking future deals as they expect to roll off their fixed rate is up. That's what we've seen during the most recent period increase in switches, falloff in purchases, but actually the Prime market is still relatively good. 75% fall in buy-to-let. The expectation is that will continue for the rest of the year as well.

And then we've got some questions from Alastair about the margins in the mortgage market. So I think that the outlook you described, Chris, he's interested to understand what it would mean for the net interest margin outlook.

So in terms of net interest margin outlook for this year, there's clearly downward pressure from mortgages, but ongoing -- potentially ongoing benefit from base rate rises. You will see that our core scenario is for a 4% cash rate in early 2023. If that were to transpire, using our assumptions on pass-through, the margin in the next 12 months would be broadly stable as the decline in mortgage book margins is offset by the ongoing benefit of base rate changes.

We've had a few questions coming in on what you said about CCDS. So Muir, I'm wondering if you could provide any clarification regarding the size of a potential purchase.

Thanks, Sara. So as Chris mentioned, we, as a mutual, are able to apply for a general prior permission, and we have applied for that with the PRA. The size of that general prior permission is for 2% of our CET1 resources, which as at 30th of September equated to GBP 259 million. Now I will, of course, emphasize that we would not necessarily use the whole of that prior permission but then we could go up to GBP 259 million. And that prior permission is in place for a 12-month period.

And there's a follow-up question on CCDs, Muir. Can you provide some guidance on when you expect this facility to be available? And will it be an ongoing facility? Or will it be time bound?

So as Chris mentioned earlier, our hope would be that we can conclude internal governance, and we hope that we would get regulatory approval by the end of this calendar year and hence be in a position should we choose to do anything with this permission to launch in early 2023. In terms of would it be a continuous operation? No is the short answer to that. As some of the people on this call will be aware we have to operate under Section 9A of the Building Societies Act, we cannot be a market maker, so we cannot be a market maker in CCDS. So if we do choose to use this facility and exercise it CCDS buybacks then in practice what we would expect to do would implement a small number of discrete and time-limited exercises.

Thank you, Muir. A question for Robert, please. Your base case mezz looks relatively benign compared to those published by peers. Why are you so confident in the outlook for the housing market?

So I'd say the outlook is very uncertain, and that's reflected in the probabilities that Chris described earlier, where we do have significant weight attached to the downside scenarios as well. In terms of the central scenario, that does envisage a still a significant slowdown in activity and house price growth going towards 0. So it already does envisage a significant slowdown. But I think there is a significant chance of a relatively soft landing given that -- and the labor market does expected to soften -- is softening from a very robust position. And the labor market has been rock and resilient to wave of shocks in recent years. Household balance sheets are also in very strong positions. If you look at net wealth relative to assets relative disposal income is still very high. Household is retaining a significant buffer of liquid assets. And also, they do still have significant protection from interest rate changes in the short term with over 85% of Prime mortgage balances on fixed rates. And obviously, the impact of affordability testing has helped to ensure that households are refinancing and are in a better position to deal with any increases in that going relative to previous periods. And also fundamentally, there's still a constraint in the housing supply in the U.K., which will also help to provide support for prices as well. So as I said, I think, there is still a good chance that we do manage to achieve a relatively soft landing but the risks are also clearly skewed to the downside, and that's also reflected across our scenarios.

I guess I'd also point you towards the coverage levels. So if you were to benchmark the unsecured coverage levels, you'd see we sit at the top end. If you look at the coverage level of 13 basis points across the portfolio, mortgage portfolio, we're bang in the middle of the pack. And clearly, we've got an arrears position that sits below half the industry average. So I think we remain with all the mixture of scenarios that we process really comfortable with the overall level of coverage.

A similar question. Can you provide a sensitivity of RWA inflation in the context of significant fall in house prices?

Wow. Okay. So probably not in a sense that you will have noticed from previous stress tests a significant volatility in risk-weighted assets, driven by the point-in-time models. The step down in our CET1 ratio earlier on -- at the end of last financial year was driven by the move to our hybrid models. We're still waiting approval from the PRA on the hybrid models, but they will dramatically dampen the volatility of risk-weighted asset growth during a stress. We've yet to run those models or the -- effectively, the hybrid adjustment through the current stress test. So all I can guide you to is a lot less volatility than you've seen before and all indications would be at the height of the stress, the risk-weighted asset inflation would be lower with the hybrid models than it was with the point-in-time model.

Thank you, Chris. I think another one for you, I'm afraid, Chris. Can you give a bit more comfort on the risk profile of buy-to-let in the context of rising rates?

Yes. So we've given you the chart. Interestingly, you might note, there is no expected credit loss addition from that piece of analysis, largely because of the LTV profile of the book. If you look at that chart, you'll see current pay rates are 2.5%. And whilst it's fair to say, a 5-year fixed rate at the moment is 5.5%. We see those -- that fixed rate going below 5% in the not too distant future. The reason why I tell you all that is I'm now going to tell you that if I look at the interest coverage ratio owned -- and strike the number of 200%, consistent with it being able to afford the mortgage at that kind of higher rate, like only 3% of the buy-to-let book has an ICR below 200% and an LTV above 6% (sic) [ 60% ]. So a tiny proportion of the book is potentially exposed to rate shock. And that's why the ECL adjustment is 0, but you've got all the data in that slide.

Above 60%.

Above 60%. I know it's going to get out the way.

Yes.

Try and get the signs in the right way. Let's repeat that. Only 3% of the book has an ICR below 200% and an LTV above 60%. Got it the right way around. Thank you.

Moving on to the deposit side of the balance sheet. Has the 60% deposit pass-through being consistent across the rate increases? Or has it risen as rates have moved higher? And how do you expect deposit pass-through to evolve? And following on from that, is there an upper level beyond which you will not let the net interest margin rise above, i.e., where you give a 100% pass-through of higher rates to depositors?

So let's start at the beginning of that. Yes, as we have progressed through base rate rises, the overall deposit pass-through rate has increased. But on average, it's now 60% as we caught that up. Our assumption going forward is it's broadly 60% of base rate rises will get pass-through to retail variable savers. I think the important context though is -- actually that's an assumption. The way we manage the book is the other way around is to look at total market flows, competitive position, we aim for the product set to be delivering value to the members. And therefore, the margin is effectively a solve to on the basis of retaining a very competitive deposit book that meets the needs of funding the balance sheet.

Thank you, Chris. When assuming the severe downside scenario plays out with large house price declines, what percentage of the current book is at risk of moving into negative equity?

We'd have to get the calculators out for that. I mean at the moment, the negative equity in the book is GBP 8 million. We will revert on the detailed calculation. It's not compared to previous scenarios, a very significant number, but I will have to get the calculator, I'm afraid.