The National Australia Bank Ltd. (ASX: NAB) share price is being closely watched today, following the release of its half year financial report.
Here are the key takeaways:
- A $3.29 billion cash profit, up 2.3%
- An interim dividend of 99 cents per share, flat year over year, is payable in early July
- The all-important net interest margin (NIM) fell 0.11%
- The charge for bad debts rose 5.1% to $394 million
- Regulatory capital was 10.1%
Commentary
"This is another solid result and reflects improving momentum as we execute on our strategy," CEO Andrew Thorburn said. "There have been solid contributions across the business, in particular, our priority segments of small and medium business where we have maintained or grown our leading market shares."
Mr Thorburn noted that the risks to the Australian financial system are ever-present, but said that his bank remains confident of achieving profit growth in the remainder of the year, thanks to ongoing internal initiatives.
"The operating environment for banks remains challenging, including heightened regulatory change, digital disruption and increasing stakeholder expectations," he added. "But Australia's economic fundamentals provide a favourable backdrop including strong population growth and improving business conditions."
When asked by journalists on the state of the housing market, Mr Thorburn commented, "Households are becoming a little more stretched…but the household sector is still in reasonable shape".
NAB's results follow an update from Australia and New Zealand Banking Group (ASX: ANZ) earlier this week. Since then, the ANZ share price is down 4.3%.
Result Analysis
While the headline figure looks upbeat, there are a few things in the financial report that investors and shareholders should watch closely.
The first thing is the net interest margin (NIM). Basically, the NIM is the difference between interest received on loans and interest paid on deposits divided by the total amount of assets being lent to borrowers. A wider NIM is better.
NAB's NIM fell from an already slim 1.93% last year to 1.82% this year. That's a meaningful fall when you have lent $704 billion to borrowers. In fact, the effect of the drop means that although the bank was able to lend an extra 3% of capital on assets since last year, the net income from the entire portfolio has fallen more than 3.1%.
The bank said the NIM was squeezed by increasing competitive pressures and lower overall interest rates. A lower interest rate on loans means the bank does not have much wiggle room to make more profit.
Generally, a rising interest rate environment is best for bank profits.
That's because a bank can reprice its mortgages, which are long-term (e.g. 25 years), for example. And although the interest on term deposits increases, they are typically sold with less than five years to maturity, so the bank's can exploit the valuation mismatch between long-term mortgages and short-term deposits.
However, in addition to the narrowing NIM, it was concerning for the bank to see a rise in funding costs. Year over year, the price of debt has increased 0.06%. Once again, that might not sound like much, but it all counts. And on $704 billion, that's a $422 million difference.
On the cost front, the group's cost-to-income ratio fell slightly from 43.1% to 42.7% year over year, which is promising.
Pleasingly, the group's charge for bad debts rose only modestly from last year. For many years, analysts (including myself) have been concerned that bad debts would tick up when the housing market slowed.
However, with pockets of weakness in Western Australia and Queensland, the percentage of impaired loans 90 days past due increased from 0.78% to 0.85%. While that's not overly concerning right now, it can be a leading indicator of rising bad debt charges.
Finally, the market share of the bank was decent. NAB closed 11 branches in Australia and 12 in New Zealand over the year, but the total number of internet banking customers rose strongly. In Australia, the bank's share of business banking fell from 21.9% to 21.5%, with its household lending falling from 15.8% to 15.6%.
Falling market share is not always a bad thing, especially when markets are high. In fact, I prefer a bank that loses market share before the market peaks.
Foolish Takeaway
NAB's result appears upbeat. However, there may be a few issues starting to show their ugly heads. Therefore, it's important to remember that bank profits and share prices are heavily cyclical.
So if you are a long-term investor with a time horizon of, say, five years, you can afford to be patient.
In my opinion, NAB and Commonwealth Bank of Australia (ASX: CBA) shares are the two best retail banks on the ASX — but neither of them are a buy today, in my opinion.
