Departure of CEO and Chairman a negative development
National Australia Bank (NAB) has announced that CEO Andrew Thorburn and Chairman Ken Henry will be leaving the bank. Mr Thorburn will finish at NAB later this month. We view this as a negative development for the following reasons:
- While the Board has said that it is committed to the transformation program underway at NAB and is committed to the corresponding targets announced in November 2017, we believe the departures create significant potential to disrupt and even reset the transformation strategy.
- We believe there is increased risk that the dividend policy may be reset by a rejigged Board which may result in a dividend cut.
- We believe there is increased risk of more remediation charges to come from NAB.
- We see increased risk of greater compliance and regulatory spend as part of a potential cultural reset by a rejigged Board.
Trading update released earlier than scheduled
NAB's trading update was released earlier than expected in the aftermath of the announced leadership changes. Cash earnings of $1.65bn have been announced for the Dec-18 quarter, which is approximately 1% lower than we expected. Revenue was the key area of softness relative to our expectation, with the key drag here appearing to be lower markets and treasury income.
Looking ahead, we expect the quarterly run-rate of revenue and cash earnings to improve as a result of increases to standard variable rates which became effective on 31/1/2019. While it is positive to see that expenses decreased 3% on a run-rate basis from 2H18 to 1Q19, we now see increased risk of greater regulatory/compliance spend for NAB going forward as mentioned above.
The 1Q19 credit impairment charge of $193m is a little better than we expected; asset quality looks to have remained broadly stable from 2H18 to 1Q19.
Increased risk of dividend cut
The CET1 ratio was 10.0% at Dec-18. This is weaker than we expected, with one of the main reasons an increase in Risk-Weighted Assets (RWA) due to higher overlay adjustments reflecting a change in the recognition and exposure measurement of certain off-balance sheet facilities.
We now expect the next dividend to be accompanied by a 1.5% discounted Dividend Re-investment Plan (DRP). Given the weaker-than-expected capital position and the leadership changes, we see increased risk of a dividend cut over our forecast period.
We have reduced our cash EPS forecasts by 1-4% for each of the forecast years. Our share price target, based on our DDM valuation is reduced as a result of factoring in a higher cost of equity capital to reflect the increased risks mentioned above.
NAB is now our least preferred major bank. We downgrade our recommendation from Add to Hold.
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