National Australia Bank: A comforting update thematically
About the author:
- Author name:
- By Azib Khan
- Job title:
- Senior Analyst
- Date posted:
- 16 August 2019, 4:00 PM
- Sectors Covered:
- NAB has announced unaudited cash earnings of $1.65bn for 3Q19, slightly softer than we had expected for 2H19F on a run-rate basis.
- 3Q19 revenue was ~0.9% less than we had expected for 2H19F on a run-rate basis. While the trading update is scant on detail, we suspect this softness was the result of contraction of the Corporate & Institutional loan book as well as fee income softness as a result of NAB simplifying and reducing fees.
Achieving revenue growth
Revenue was up 1% (excluding customer-related remediation) from 1H19 to 3Q19 on a run-rate basis.
The company has said this reflects growth in SME lending and a slightly higher group margin. The NIM increased primarily due to lower short-term wholesale funding costs. This NIM outcome appears in line with our expectations and our NIM forecasts remain unchanged.
Nonetheless, the revenue outcome was a little softer than we expected.
While the trading update is scant on detail, we suspect the softer outcome was the result of the following two factors: it appears the Corporate & Institutional loan book contracted over 3Q19; and our guess is that the initiative launched by NAB in February to simplify and reduce fees (with 67 fees removed by the end of June) has resulted in fee income softness.
We have reduced our revenue forecasts accordingly.
Expense outcome acceptable
Operating expenses were flat (excluding customer-related remediation) from 1H19 to 3Q19 on a run-rate basis.
The Company has said that ongoing productivity savings from the transformation program have been offset by higher risk and compliance costs.
We believe there is a risk that the risk and compliance spend run-rate will increase once the new CEO commences.
Some of the finer thematic points on capital are worth noting
Given the significant contraction in CBA's institutional loan book over 2H19 as well as our suspicion that NAB's Corporate and Institutional loan book contracted over 3Q19, it appears that the major banks generally remain strongly focused on risk-adjusted returns in the institutional space; we believe this bodes well for sector ROTEs as well as CET1 ratios.
Putting the CBA result and NAB's trading update together also shows a theme of continued downtrend in risk weighted assets (RWA) for Interest Rate Risk in the Banking Book (IRRBB).
We suspect this downtrend is largely the result of lower domestic and offshore interest rates.
We expect further declines in IRRBB RWA upon further declines in domestic and offshore interest rates, a factor which would be supportive of CET1 ratios.
Investment view and changes to forecasts
We have reduced our cash EPS forecasts by 1.2%/2.2%/2.1% for FY19F/FY20F/FY21F respectively, largely due to lower revenue forecasts and higher credit impairment charge forecasts.
We retain a Hold recommendation. Our target price, based on our DDM valuation, is unchanged (Morgans clients can login to see detailed reports and target prices). Key downside risks include a material increase in funding costs and greater-than-expected asset quality deterioration.
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