Banking blues; NAB reveals notable items  

Banking stocks are facing a tuff time as COVID-19 has grappled countries. Since the start of the calendar year, three of the four banks, excluding Commonwealth Bank of Australia (ASX: CBA), are down by over 30% year.

As per the Australian Banking Association, there are around 187k bank employees in the country. Australia has around 18 million banking customers and 3 million shareholders.

Of late, the banking and financial services industry had been running in troubled waters due to the outcomes of the Haynes Royal Commission. This calendar year, the banking industry is facing challenges due to a range of factors.

Market participants are expecting banks to report heavy impairment provisions due to the COVID-19 pandemic. As businesses have seen a sudden stop in cash flows, the risk of defaults has been increasing.

While banks have introduced a long list of measures to provide relief to customers in distress due to COVID-19, the banking industry has rolled out a moratorium on interest payments as well as principal repayments.

Some of the measures include:

  • a six-month deferral on loan repayments by small businesses in distress due to COVID-19,
  • banks are offering new loans at a very low-interest rate,
  • deferral is applicable for home loan customers as well,
  • banks are helping credit card and personal loan customers,
  • loan deferral was extended for loans up to $10 million, which include large businesses,
  • there are provisions for commercial landlords as well.

With so much deferral, cash flows of the banking industry are likely to face challenges over the near term, which may also result in higher provisioning of the expected credit losses by the banks.

At the same time, the economy is facing a contraction and unemployment is likely to hit 10%, as per the Australian Treasury estimates.

Although the JobKeeper and JobSeeker payments by the Government would provide some floor for Australians, the key will remain at the pace of recovery. And, supporting employers and businesses appear necessary to make a floor for a smooth and quick recovery.

The Reserve Bank of Australia has taken the policy interest rate to a record low level, which makes it harder for the Australian banks to generate income on the balances held by them. Of late, the credit spreads have widened as investors have started to price the default risks by the weaker pockets of corporates.

A recovery in the economy is likely to bring recovery in the banking sector, primarily driven by an increase in business confidence, improvement in employment, relaxation of public health, resumption of economic activity, improvement in the major Australian commodities’ prices, wage growth, a pick-up in global demand, etc.

NAB notes over $1 billion profit hit

National Australia Bank Limited (ASX:NAB) has dropped the items impacting its profit that would impact the dividend paying capability of the bank as well. Repercussions of Haynes Royal Commission are still causing dips to the profitability of the banking and financial services industry.

  • NAB has reported that customer-related remediation issues to cost $268 million (before tax) or $188 million (after tax);
  • Earnings will have an impact of $1.05 billion (pre-tax) or $742 million (post-tax) due to a change in software capitalisation policy;
  • Besides, an impairment of $214 million (before and after tax) in the bank’s stake in MLC Life.

Although the software capitalisation cost and MLC Life impairment would not impact the group’s CET1 ratio, the net impact of $188 million related to customer-related remediation is expected to lower the CET1 ratio by six basis points.

During the half year results, the bank is going to provide updates on COVID-19 impact, including provisions, capital and dividend outcomes. Starting from 1H20, the bank would report MLC Wealth as a separate business and not under consumer banking. First half results would also include individual divisional reviews for consumer banking as well as MLC Wealth.

Customer related remediation

NAB noted that the $188 million net impacts include the cost and benefits associated with continuing and discontinued operations, respectively. The pre-tax impact from the continuing operation is around $418 million, of which 69% is related to wealth-related matters, 23% to banking and 8% to New Zealand.

Additional provisions were made due to:

  • a higher refund rate for the adviser fees charged by Financial Planning.
  • a higher wealth related remediation program cost and banking-related matters.
  • newly identified issues mainly related to workplace superannuation.

It was also noted that reassessment of the provisions in relation to the MLC Life business is expected to improve the earnings by $150 million from discontinued operations. Meanwhile, there is an uncertainty on the total costs associated with customer remediation unless the process is completed.

Software Capitalisation Policy

As a result of reviews into software capitalisation policy, the minimum threshold for software capitalisation was changed to $5 million from $2 million and would be applied to current and future software balances, thereby lowering the bank’s capitalised software balance by $1.05 billion (pre-tax) as on 31 March 2020.

National Australia Bank has a forecast of $154 million for amortisation saving in the second half, which is likely to be offset by investment expenditure (previously capitalised).

MLC Impairment

NAB’s carrying value of 20% investment in MLC Life has been reduced due to challenges in the operating environment of the life insurance industry. As a result, there is an impairment loss of $214 million; it reflects a 37% reduction in the carrying value of the investment.

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