National Australia Bank: AUSTRAC issue lingers over good result

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Former Senior Analyst
Date posted:
10 November 2021, 9:00 AM
Sectors Covered:

  • National Australia Bank (ASX:NAB) has announced cash earnings from continuing operations of $6,558m, 0.6% lower than our expectation. A final dividend of 67cps fully franked has been declared, better than our expectation of 64cps.
  • NAB is displaying good volume growth momentum and margin discipline going into FY22F, however, AUSTRAC’s enforcement investigation remains a source of concern.
  • Retain Hold recommendation.

Net interest income outcome pleases

It is pleasing to see 2.9% growth in Group net interest income – excluding Markets & Treasury – from 1H21 to 2H21. This was achieved with a stable Group NIM (excluding Markets & Treasury) and Group loan growth of 5% from Mar-21 to Sep-21.

At the divisional level, net interest income grew over the same period by 5.0% in Business and Private Banking, 0.5% in Personal Banking, and 5.3% in NZ Banking. Income from lending and deposits in the Corporate and Institutional Banking division was up 3.5% over the same period.

NIM outlook for FY22F not worrisome

We are forecasting NAB’s NIM to increase by 1bp from 2H21 to 1H22F. While NAB has neither disclosed its exit NIM for 2H21 nor provided NIM guidance, it appears that the key NIM headwind that NAB sees in FY22 is mortgage competition.

At the sector level, we see early signs indicating that borrower preference for fixed rate home loans has peaked. We expect a shift in mix back towards variable rate home loans – which are generally higher margin than fixed rate home loans – to be beneficial for sector NIMs.

Over the last couple of years, apart from mortgage competition, the other key NIM headwind that has been in place has been low interest rates. We believe this headwind has now largely played out at the sector level. NAB today has said that it expects the NIM impact of the replicating portfolio to be broadly neutral in FY22 before becoming a tailwind in FY23.

NAB also expects lower funding costs and deposit mix to be a moderating tailwind in FY22F.

As volatility returns to interest rate and foreign exchange markets, we expect Markets & Treasury income to be a beneficiary.

For those worried about the phase out of the RBA’s Committed Liquidity Facility (CLF), NAB has said that it expects a minimal NIM drag from this factor in FY22.

AUSTRAC issue remains a source of concern

NAB’s FY21 operating expenses of $7.82bn are in line with our expectations.

By way of outlook, NAB has said that it is targeting broadly flat costs in FY22F. NAB has also said that it continues to target FY23F-FY25F costs to be lower than $7.7bn pa.

This cost guidance excludes: the impact of large notable items; the impact of the proposed acquisition of Citigroup’s Australian consumer business; and, importantly, any potential non-recurring AML/KYC related costs including those incurred in addressing the issues subject to investigation by AUSTRAC, such as file remediation and other associated costs.

We continue to see the risk of AUSTRAC launching civil penalty proceedings against NAB as mentioned in our report titled Increased probability of AUSTRAC penalty. Due to the highly contingent nature of AUSTRAC-related issues, we are not yet building any penalty into our earnings forecasts.

However, we expect the uncertainty associated with this issue to continue to weigh on NAB’s share price. Since June 2021, we have been factoring this risk in our target price by allowing for $5bn worth of damage to NAB’s market capitalisation (equating to ~$1.50 per share) and this continues to be the case in setting our target price for NAB.

Investment view and changes to forecasts

We have increased our cash EPS forecasts by 1.9%/3.6% for FY22F/FY23F respectively, largely due to higher loan balance forecasts.

Our target price, based on our DDM valuation, is (login to view).

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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