NAB delivered a tidy result considering the volatility of the economy due to lockdowns and restrictions. Its own financial position is very strong and has a stable and clean operating business ready to capitalise on the rebound in economic activity.
NAB's cash earnings of $6,558 billion in FY21 was a decent 38.6% recovery from last year's COVID-affected earnings. The Board declared a fully franked final dividend of 67cps taking the full year dividend to 127cps, a payout ratio of 63.7% of earnings. This is just below the group's target payout range of 65-75%. The previously announced $2.5 billion share buyback is underway with just $0.5 billion completed so far. NAB's CET1 capital ratio currently sits at 13.0% compared to the target range of 10.75-11.25% suggesting that the Board is keeping a very conservative capital position for now. The pro forma CET1 ratio is at 12.25% allowing for the sale of BNZ Life, the proposed acquisition of Citigroup's Australian consumer business and the remaining $2.0 billion of share buyback (approximately 48bp). This puts NAB in line with ANZ and WBC in this regard.
If there is a weak spot in NAB's business, it is net interest income which slipped to 1.71% in FY21. The low interest rate environment continues to pressure this factor along with competitive pressure on housing lending.
Compared to WBC especially, NAB's expense performance was very good, increasing by just 1.8% across the year as headcount declined slightly, helping the total cost to income ratio improve to 46.5% from 52.4% last year. This is the lowest among the retail banks with CBA at 47.0%, ANZ at 51.9% and WBC at 69.4%.
The New Zealand business delivered a bumper year as profits rebounded strongly to A$1,154 million or 17.6% of group cash earnings in FY21. NAB's NZ CEO earned 99% of her total potential bonus, topping her NAB peers, as the NZ business increased housing lending by 18.1%. The net interest margin in the NZ Business increased by 10bp in FY21 to 2.29% while the cost to income ratio at 37% is the most frugal in New Zealand.
Australian home buyers have enjoyed an extended period of low interest rates that has fuelled the housing market, but savers have been left to earn very little for their thrift. Of NAB's $285 billion of customer deposits, just $11.9 billion earns an interest rate above 1.0%. That is very cheap funding for the banks that has supported the most valuable part of the loan book – residential mortgages.
There is much press attention focused on bank lending to resource businesses and in particular, those with significant greenhouse gas issues. NAB seems to be taking a measured approach so that an outright ban on lending to such customers is not being imposed. Instead, NAB has a policy of working with its resource customers to assist in their own emissions reduction plans rather than simply withdrawing funding. At the same time, NAB is quickly increasing its lending to environmental financing opportunities and aims to lift its current $56 billion exposure to $70 billion by 2025. In contrast, NAB has total lending of $9.15 billion to resource sector companies. That level of lending is almost immaterial in the context of NAB's $629 billion of gross loans and acceptances. NAB has now capped its oil and gas industry exposure to US$2.4 billion and will grind its thermal coal mining exposure to zero by September 2026.
NAB sees housing credit growth in Australia remaining at elevated levels for the next two years above 5% with business credit growth at 4.5% over the same time frame. NAB is expecting GDP growth to be 4.0% in CY22f before easing back to 2.3% in CY23f. Across the many factors measuring the Australian economy, it appears the pandemic has not caused any long term permanent damage with most indicators anticipating or already demonstrating a rebound effect. NAB's own business survey is expecting a rapid rebound as lockdowns become a thing of the past. Business confidence is highest in NSW and lowest in Tasmania.
NAB is expecting to see an increase in the RBA's cash rate by mid-calendar 2023 from its current very low position at 0.10%.
Investment view
The Australian economy is in good shape considering the volatility caused by the pandemic over the last two years. Importantly, NAB's business in also in good shape and poised to accelerate its business and housing lending. NAB's cost control has been arguably the best of the four retail banks throughout this period and that should give it a headstart on generating better cash eps growth than its peers.
Like the other retail banks, its capital position is pristine and ready to respond to any regulatory changes. The FY21 dividend payout was at the low end of its target range so there is room to lift shareholder returns.
NAB's point of difference among the large retail banks is its Business and Private Banking emphasis, ahead of residential mortgages. NAB excels in the business segment and is no slug in housing lending either, so we see its portfolio as nicely set to benefit from the economic recovery.
If regulatory changes become more onerous or NAB failed to maintain market share in key lending areas of its portfolio, then earnings growth might be affected.
With a gross dividend yield at 6.3% and a PE ratio of 14.7x FY22 cash eps, NAB is decidedly cheaper than CBA and a better quality bank exposure than WBC or ANZ. NAB has quickly improved its business performance this year. Based on this view, we upgrade our recommendation to Buy.
