National Australia Bank: AUSTRAC sword hangs over impressive momentum
About the author:
- Author name:
- By Azib Khan
- Job title:
- Former Senior Analyst
- Date posted:
- 11 February 2022, 10:30 AM
- Sectors Covered:
- National Australia Bank (ASX:NAB) has released an impressive 1Q22 trading update with unaudited cash earnings of $1.80bn for the quarter being ~8% better than our expectation.
- Pre-provision profit is ~4% better than our expectation largely due to better-than-expected Markets & Treasury revenue.
- While NAB’s operational momentum looks impressive relative to peers, we remain mindful of the risk of an AUSTRAC-related civil penalty. Retain Hold recommendation.
Strong Markets & Treasury performance
We were expecting the Market & Treasury (M&T) revenue run-rate to be flat from 2H21 to 1Q22, however, there has been notable improvement in this revenue over this period. We estimate that M&T revenue was $430m in 1Q22, a significant improvement from $580m in 2H21.
The key question is whether this M&T performance can be sustained for the rest of FY22. We believe that a steepening yield curve and increasing volatility in interest rate and foreign exchange markets assisted M&T revenue in 1Q22. With rising inflation and increased prospects of rate rises, we assume volatility will continue to be seen for the remainder of FY22.
We are also of the view that M&T revenue in 2H21 was softer than normal and that the 1Q22 performance is more of a normalisation. We are therefore now assuming that the 1Q22 M&T revenue run-rate will be maintained for the remainder of FY22 and our EPS forecasts have increased as a result of this factor.
Revenue in line after excluding M&T
Revenue, excluding M&T, is broadly in line with our expectation. Within this, the 1Q22 NIM is ~5bps softer than we expected, however volume growth is stronger than expected.
Whilst NAB’s NIM contracted 5bps from 1.69% in 2H21 to 1.64% in 1H22, it is an impressive outcome relative to peers. It is particularly impressive bearing in mind the significant increase in swap rates in the Dec-21 quarter and the corresponding potential adverse impact on the spread generated on new fixed rate home loans.
After excluding a modest negative impact from M&T and higher liquids, the NIM movement looks even more impressive relative to peers, being down only 2bps.
The NIM outcome is also impressive in the context of the strong lending volume growth that NAB is achieving. In Australia, over the three months to December 2021, home lending grew 2.6% and SME business lending increased 3.4%. New Zealand loan growth was also strong at 2.2% over the same period.
Sticking with flat cost guidance
Operating expenses increased 2% on a run-rate basis from 2H21 to 1Q22. This is higher than our expectation of 1% growth. NAB has said that it continues to target broadly flat expenses in FY22.
We continue to forecast 1% cost growth in FY22.
Credit quality metrics sound
NAB has said that it is seeing improving asset quality across both housing and business lending and continued low specific provision charges.
There was a credit impairment benefit of $35m in 1Q22. The ratio of collective provisions to credit risk weighted assets reduced 6bps to 1.29% from Sep-21 to Dec-21.
Risk of AUSTRAC-related penalty eating into surplus capital position
NAB has reported a CET1 ratio of 12.4% as at Dec-21. We are forecasting NAB to have a CET1 ratio of 11.9% at end-FY22, and expect this to equate to surplus CET1 capital of ~$4bn above a CET1 ratio of 11.0%. A potential AUSTRAC-related penalty poses downside risk to our surplus capital forecast.
Investment view and changes to forecasts
Cash EPS forecasts increased by 4-5.5% for reasons mentioned inside this report.
Our target price, based on our DDM valuation, is (login to view).
Retain Hold recommendation.
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