Thursday, August 8th, 2019
NAB shares are at 11-month highs after the appointment of Ross McEwan as CEO to start by April 2020. Formerly head of Commonwealth Bank’s retail bank, Ross left Australia to become CEO of Royal Bank of Scotland after missing out on CBA’s CEO role to Ian Narev in 2012.
This choice of NAB CEO is the best-case outcome in our view. CBA’s retail bank performed well under Ross’s management and he was our preferred candidate for CBA CEO. He brings valuable experience from turning around RBS in the UK, where he navigated ultra-low interest rates, intense mortgage competition, open banking, fintech disruption, executive accountability regimes and generally heightened regulation and government focus. Notable achievements were dealing with legacy conduct matters and migrating customers from branches to digital banking.
Acting CEO Phil Chronican will become NAB’s Chair in November. In his earlier executive career, Phil built a strong reputation as head of ANZ’s Australia division, Westpac’s institutional bank and as Westpac’s Chief Financial Officer. The new CEO-Chair duo will be one of the best leadership teams in Australian banking and increases our confidence in the stock. The good news follows the earlier welcome decision to cut the interim dividend, which supported the share price by derisking NAB’s capital position. Within Clime’s investment process NAB is becoming a higher-quality investment for these reasons and as it gradually exits the riskier, more volatile businesses which undermined its performance over the last 20 years. The stock should now be a more reliable payer of fully franked dividends.
We expect Ross McEwan will eventually re-invigorate the turnaround of NAB’s core banking businesses, particularly by using his retail banking expertise and automating more currently manual processes – a source of cost savings NAB is already pursuing. The opportunity is to take costs out of processes and systems while making it easier for customers to bank digitally with NAB such that fewer branches are needed. Delivery of former CEO Andrew Thorburn’s productivity and upskilling program was going well and we hope this continues.
Cultural change is also required. This will take time and be assisted by the regulator APRA’s new remuneration policy (currently under consultation), which will require banks to limit the proportion of remuneration linked to financial performance metrics to 50 per cent. The non-financial measures to drive the remaining half include operating risk management, customer satisfaction, brand and reputation, culture and diversity. NAB has not always done well at some of these measures, as the Royal Commission and the resignation of the former CEO and current chair revealed.
Other problems awaiting the new CEO are strategic (the delayed divestment of wealth management business MLC), credit quality (higher arrears for interest-only mortgage borrowers transitioning to principal and interest), regulatory (tighter assessment of loan applicants’ household expenses), competitive (fee pressures in retail banking), shareholder value (dilution from the discounted, partly underwritten dividend reinvestment plan), and remediation costs (for customers of NAB’s aligned advisers). APRA also this month required NAB to hold an extra $500 million of operational risk capital until it strengthens operational, compliance and conduct risk management. Resolution of these matters should gradually justify a higher rating in the share market.
NAB is performing well in business banking, institutional banking and New Zealand but we would like to see a stronger retail banking franchise with more pricing power. Last year’s deferral of mortgage repricing to restore customer trust reduced interest margins but seems to have had few benefits. It might not have been thought necessary had customers held the retail bank in better regard.
Downside risks from the appointment of the new CEO are the potential for extra provisions and writedowns of the kind new CEOs normally make, and slippage in revenue momentum while NAB lacks a permanent CEO. NAB needs to navigate the pressure on interest margins from RBA rate cuts, any uptick in unemployment and stabilisation of home lending growth as house prices bottom and property transaction volumes recover.
The Clime Direct Model Portfolio increased its position in NAB before and after the May federal election to become one of the largest in the portfolio. Currently, the shares are pricing in most of the near-term upside in a market where income investors are demanding stocks with dividend yields at a premium to fixed interest yields. We think NAB is worth $28.65, around today’s share price, and are comfortable with our position.
Clime Group owns shares in NAB.