- National Australia Bank (NAB) announced unaudited cash earnings of $1.65bn for the three months to 31 December 2017, broadly in line with our expectation for 1H18F after allowing for the restructuring provision which is expected to be taken in 2Q18. No restructuring position was taken in 1Q18.
- Revenue came in softer than our expectation, the impact of which in earnings was offset by the credit impairment charge being less than we expected.
- NAB continues to offer the highest dividend yield of the major banks and we do not expect any cuts to NAB's nominal dividend over our forecast period. Subdued loan growth is providing support to NAB's capital position and further strengthening the dividend outlook.
Subdued non-home lending growth weighs on revenue
Growth in the revenue run-rate from 2H17 to 1Q18 was 1%, softer than our expectation. While the update is scant on detail, we infer from the trading update and Pillar 3 Report that revenue softness was largely the result of Markets & Treasury and contraction in combined institutional and SME lending. This is also consistent with APRA data showing that NAB's loans to non-financial corporations contracted by 0.1% over the three months to 31/12/2017.
The net interest margin (NIM) contracted from 2H17 to 1Q18. However, excluding Markets & Treasury, the NIM was broadly stable over this period.
Cost guidance reiterated despite Royal Commission
The operating expense run-rate increased 4% from 2H17 to 1Q18 due to higher investment spend and personnel costs. NAB continues to expect FY18 expenses to grow 5-8% in FY18 and then remain broadly flat over FY19-FY20. It is pleasing to see this reiteration of guidance despite the announcement of the Royal Commission, enforcing our view that the major banks should generally be able to absorb the cost of dealing with the Royal Commission process within existing budgets.
Asset quality improving and CET1 strengthening
The credit impairment charge for 1Q18 was $160m, which on a run-rate basis is lower than our previous 1H18 forecast of $455m. NAB has said that asset quality improved with the ratio of 90+ days past due and gross impaired assets to gross loans and acceptances down from 0.70% at Sep-17 to 0.67% at Dec-17. Another positive in the update was strengthening in the CET1 ratio to 10.2% at Dec-17 from 10.1% at Sep-17. CET1 ratio strengthening is partly the result of subdued loan growth.
We are now forecasting only one more discounted Dividend Reinvestment Plan (DRP), down from our previous forecast of two.
Investment view and changes to forecasts
We have not made material changes to our cash EPS forecasts, with the impact of lower loan growth forecasts being offset by lower credit impairment change forecasts and removal of one discounted DRP. Our share price target remains unchanged. Key downside risks include increased funding costs and greater-than-expected asset quality deterioration.
We retain our Add recommendation.
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