Company overview - National Australia Bank Limited is a business bank engaged in providing personal banking and business banking services. The Company's segments include Business & Private Banking, Corporate & Institutional Banking (CIB), Consumer Banking & Wealth Management, Customer Products & Services and NZ Banking. The Company’s Business & Private Banking focus on medium enterprises (SME) customers, which include NAB business franchise with specialized agriculture, health, Government, education and community services along with private banking and small business segment. CIB includes corporate and institutional banking businesses, fixed Income, currencies and commodities (FICC), capital financing businesses, asset servicing and international branches. Customer Products & Services include banking & wealth products, strategy, digital, NAB labs/ventures, marketing and corporate affairs. Consumer Banking & Wealth Management includes the distribution components of wealth management.

NAB Details

Post the recent federal budget, a major bank levy was introduced on Authorized deposit taking institutions (ADI) with licensed entity liabilities of at least $100 billion. This levy will be applicable to NAB as well. Based on what the Government has announced in recent budget, the tax could cost NAB approximately $350 million annually, or $245 million post tax. However, the actual cost will not be known until the final legislation for the tax has been passed and bank can fully assess its impact on NAB’s business. Recently, Moody’s has downgraded the long-term ratings of NAB to Aa3 from Aa2 and the outlook was revised to stable from negative.  For H1FY17, NAB reported a 2.3% increase in cash earnings on the back of lending and trading income, while there was a 0.8% rise in costs owing to higher redundancy and general expenses (technology depreciation costs). The total bad debt increased by $19 million to $394 million and included an increase in provision overlays of $89 million for potential risks relating to the commercial real estate portfolio. Further, net interest margin fell by 11 basis points.  Banks Common Equity Tier 1 (CET1) ratio stood at 10.1% as at 31 March 2017, an increase of 42 basis points in H1FY16.  The statutory net profit was $2.5 billion against the loss of $1.7 billion for the first half of fiscal 2016, led by reduced losses from discontinued operations. The consumer bank earnings maintained stability while there was a boost in earnings growth from the corporate and institutional bank (cash earnings surged 18%) driven by increased operating income. There was also a rise in customer deposits by 6.1% over prior corresponding period.


Group financial performance; (Source: Company reports)

Improving performance in Corporate & Institutional Banking: Business & Private Banking cash earnings grew by 2.5% to $1,368 million reflecting sound revenue growth and tight cost management, partly offset by higher B&DD charges. NIM improved and lending growth in specialized businesses such as Health and Agribusiness was strong. Consumer Banking & Wealth cash earnings were stable at $764 million impacted by higher funding costs, increased competition in home lending, and reduced Wealth income. NIM stabilized compared to the September 2016 half year and more recent home lending market share trends are improving. Corporate & Institutional Banking (CIB) cash earnings rose 17.9% to $791 million, and strong result underpinned by a disciplined focus on returns. Over the year to March 2017 CIB delivered strong revenue growth with lower B&DD charges and a $15 billion reduction in risk weighted assets.


Segment wise earnings contribution; (Source: Company reports)

Costs and credit quality: However, there has been a rise in costs for the half year by 0.8% owing to higher redundancy and general expenses (technology depreciation costs). Further, total bad debt charge of $394 million has been announced and this is up $19 million on the prior corresponding period and includes an increase in provision overlays of $89 million for potential risks relating to the commercial real estate portfolio. The Group maintains a well-diversified funding profile and raised $18.8 billion of term wholesale funding in the March 2017 half year across a range of markets. The weighted average term to maturity of the funds raised by the Group over the March 2017 half year was 5.4 years, while the net stable funding ratio (NSFR) was 108% at 31 March 2017. The Group’s leverage ratio as at 31 March 2017 was 5.5% on an APRA basis and 5.9% on an internationally comparable basis.


Group provisions; (Source: Company reports)
 
Decline in charges for bad and doubtful debts: During Q1FY17, National Australia Bank reported 1% yoy growth in revenue driven by growth in lending and higher trading income while the net interest margin (NIM) was broadly stable. However, cash earnings declined by 1% yoy to ~$1.6 billion due to higher operating expenses during the quarter mainly owing to related salary increases combined with higher project related costs including regulatory spend, and increased depreciation and amortization. Notably, the charge for bad and doubtful debts for the quarter declined 23% to $164 million driven by non-repeat of the increase in the collective provision overlay for mining, mining related and agricultural sectors. During the same period, specific provision coverage of gross impaired assets increased from 38.3% to 43.0%. The Group’s Common Equity Tier 1 (CET1) ratio declined by 30bps to 9.5% qoq due to the impact of the final 2016 dividend declaration. Further, as part of NAB’s ongoing commitment to maintain a strong and efficient capital position, NAB has considered issuance of a new ASX-listed Subordinated Tier 2 Capital security. Although, the operating environment is challenging as funding costs remaining elevated levels and intense competition, the bank seems to be on track to deliver more than $200 million in productivity savings.

FY16 driven by increased volumes in housing and business lending: During FY16, on a statutory basis, net profit of NAB decreased by $5,986 million or 94.4% compared to 2015, mainly driven by the increased loss on discontinued operations during 2016. Net interest income increased by $468 million or 3.8% compared to 2015. Excluding foreign exchange rate movements, net interest income increased by $450 million or 3.6%, includes a decrease of $107 million which was offset by movements in economic hedges in other operating income. The underlying increase largely reflected increased volumes in housing and business lending and deposits combined with benefits received from the repricing of lending and deposits. However, these were partially offset by higher funding costs and competitive pressure on housing and business lending margins. The Group’s net interest margin fell two basis points from 1.90% to 1.88% in 2016 mainly due to higher funding and liquidity costs, due to higher wholesale funding costs, partially offset by benefits received from repricing.


FY16 financial performance; (Source: Company reports)
 
Net investment and insurance income decreased by $54 million or 7.7% due to the impact of the Successor Fund Merger on 1 July 2016, declining margins driven by MySuper plan transitions and a change in business mix to lower margin wholesale and institutional products, consistent with broader industry. Total other income decreased by $729 million or 13.8% compared to 2015. Excluding foreign exchange rate movements, other income decreased by $737 million or 14.0%. This result includes an increase of $107 million due to movements in economic hedges, offset in net interest income. The underlying decrease was driven by lower trading performance and sales of risk management products to the Group's customers, movements in fair value and hedge ineffectiveness and one-offs in the September 2015 full year relating to the settlement of a long standing legal dispute, combined with the sale of loans in NAB UK CRE and assets in Australian Banking, that were not repeated in the September 2016 full year. Importantly, FY16 has been a milestone year for the Group with the completion of major divestments including the demerger of CYBG and the sale of 80% of NAB Wealth's life insurance business to Nippon Life.


Cash earnings and underlying profit growth in FY16 v FY15
 
Recommendation: The stock has moved up 17.5% in last one year, while it is down 8.2% in the last three months (as on July 17, 2017), owing to recent headwinds for the sector. Given the stable net interest margins and robust balance sheet and liquidity position, we believe NAB can navigate well through diversified business portfolios. We give a “Buy” recommendation on the stock at the current price of $29.94


NAB Daily chart; (Source: Thomson Reuters)

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