DBRS Confirms National Australia Bank at AA; Trend Stable. Sub Debt Under Review Negative

DBRS Ratings Limited (DBRS) has today confirmed the ratings of National Australia Bank (NAB or the Bank) including the AA Deposits and Senior Debt ratings and the R-1 (high) Commercial Paper rating. The trend is Stable. NAB’s ratings reflect an intrinsic assessment (IA) of AA (low), combined with a support assessment of SA-2, which results in a one notch uplift to the final rating from the IA. The SA-2 reflects the systemic importance of NAB to the financial system in Australia, and the generally supportive regulatory framework. Concurrently the Bank’s AA (low) subordinated debt ratings have been placed Under Review with Negative Implications.

The confirmation reflects the strong Australian and New Zealand franchises, and the predictable earnings streams that these generate. It also incorporates the strong capital levels and relatively low risk profile, although these strengths are mitigated to a certain degree by the weaker than peers liquidity profile with regard to coverage of short-term funding. The Stable trend reflects DBRS’s expectation that the Bank will continue to generate strong earnings from its Australian and New Zealand franchises, maintain its strong asset quality and its solid capitalisation. The ratings are unlikely to see upward pressure in the medium term, given the already high level of the ratings, and the current funding and liquidity profile. Any upward pressure would, however, require a reduction in the level of wholesale funding, whilst maintaining low levels of credit losses, solid and predictable earnings and continued sound capital management. Downward pressure on the ratings would be likely if the proportion of wholesale funding, especially short-term wholesale funding, were to increase, or if the Bank’s asset quality were to deteriorate substantially.

NAB has a strong franchise across Australia, including a leading position in business banking and strong positions in other areas such as retail banking and wealth management, as well as a strong position in New Zealand. It is also looking to exit its operations in the USA and UK. DBRS views the potential exit from the USA and UK positively given its view that these operations are sub-scale within those markets. The Bank also has limited operations in Asia, focused on relationships with Australian Business Banking customers with interests in Asia.

Overall NAB has solid and consistent earnings generation, however in recent years, especially 2014, this has come under some pressure as a result of UK-related ‘conduct costs’. Despite this, in 2014, NAB reported income before provisions and taxes (IBPT) of AUD 8.8 billion (including the UK conduct charge provisions), down 12% YoY and net profit of AUD 5.3 billion. The ability of NAB to consistently generate strong and resilient earnings, despite these issues, is a key rating consideration and is a key factor in the overall high rating.

NAB’s funding position has improved in recent years, with strong deposit growth helping to reduce the Bank’s dependence on wholesale funding. Since end-September 2011, customer deposits have increased 22% to AUD 391.1 billion at end-September 2014 however the Bank’s reliance on wholesale funding remains significant, as evidenced by a DBRS calculated gross loan-to-deposit (LTD) ratio of 139% at end-September 2014. Despite improvements, NAB’s reliance on offshore funding, similar to other Australian banks, remains significant, accounting for 60% of the AUD 28.2 billion term funding raised in 2014. In addition, NAB’s use of short-term funding remains considerable. Whilst DBRS views positively NAB’s diversified mix of funding sources, by type, maturity, currency and market, it will continue to monitor closely the Bank’s use of offshore wholesale and short-term funding. Any further increase in the use of short-term wholesale funding would be viewed negatively. Although the Bank’s liquidity profile has also improved in recent years, covering 85% of the Bank’s total short-term funding, including long term debt with a residual maturity of less than one year at end-September 2014, this is weaker than peers. DBRS does, however, positively note, that at end-September 2014, the Bank reported an internal calculation of the Liquidity Coverage Ratio (LCR) of over 100%, in excess of APRA’s (Australian Prudential Regulatory Authority) minimum LCR requirement of 100%, which comes into effect from 1 January 2015. As a result of the shortage of AUD denominated High Quality Liquid Assets (HQLA) the RBA (Reserve Bank of Australia) is providing a Committed Liquidity Facility (CLF) to the Australian banks, which DBRS views as a positive development for the banking system.

DBRS views NAB’s risk profile as relatively conservative, although in recent years it has been hampered by the poorly performing UK commercial real estate (CRE) portfolio. Impairment charges were down in 2014, reflecting lower charges in Australian Banking and NAB UK CRE, and as a result, the total charge for bad and doubtful debts reduced to only 0.17% of gross loans and acceptances. Lower levels of new impaired assets across Australian Banking, UK Banking and NAB UK CRE, and the run-off and repayments within the NAB UK CRE portfolio, including the sale in July 2014 of GBP 625 million of impaired loans led to the total gross impaired loan ratio improving to 0.76% at end-September 2014, with a coverage ratio of 99%. Even with loans 90+ days past due included, the Bank’s problem loans as a percentage of gross loans & acceptances remains low at 1.19%. Positively the Bank’s UK CRE portfolio has now reduced to GBP 2.2 billion, down from a peak of GBP 7.7 billion in 2009.

DBRS views NAB as having solid capitalisation. At end-September 2014, the Bank reported an APRA Basel 3 Common Equity Tier 1 (CET1) ratio of 8.6%, an increase of 20 bps YoY. This is already in excess of APRA’s 8% minimum requirement by 1 January 2016, which comprises a minimum CET1 ratio of 4.5% (effective from 1 January 2013), and then an additional CET1 capital conservation buffer of 3.5%, inclusive of a Domestic Systemically Important Bank (DSIB) requirement of 1%.

DBRS notes the publication of the Australian Financial System Inquiry’s (FSI) final report on December 7, 2014. The higher capital requirements and higher mortgage risk weights for banks using the internal ratings based (IRB) approach for calculating regulatory capital, which are recommended in the report, are viewed positively by DBRS as these should help to further improve the resilience of the banking system. DBRS also notes that the FSI has recommended that Australia implements a framework for minimum loss absorbing and recapitalisation capacity, in line with emerging international practice. DBRS will continue to monitor how this evolves in Australia and the potential impact on systemic support.

Concurrently DBRS has placed NAB’s AA (low) Subordinated Debt rating Under Review with Negative Implications. Since the financial crisis, in many jurisdictions, the approach of regulators and authorities in dealing with struggling banks has evolved to the extent that subordinated debt may now be required to be “bailed-in” outside of a bankruptcy or resolution. Whilst we acknowledge that the Australian authorities are yet to endorse bail-in and burden sharing policies for senior debt, the regulator already has some powers to transfer assets, which, in certain circumstances, could be used to achieve a similar economic effect to a bail-in. DBRS also notes that the FSI final report recommends the introduction of a bail-in framework. As a result of these developments DBRS views that the probability of subordinated debt being treated adversely in a stress scenario has increased. Consequently, DBRS will review whether to notch these instruments from the bank’s Intrinsic Assessment (IA), rather than from the senior debt rating, in line with the criteria “Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities” published in December 2013. As a result rating downgrades are expected to be limited to one notch.

Separately, DBRS has also withdrawn the AAA ratings on debt guaranteed by the Australian government as this debt has been repaid.

Notes:
All figures are in AUD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other methodologies used include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013). These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance

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Lead Analyst: Ross Abercromby
Rating Committee Chair: Alan G. Reid
Initial Rating Date: January 24, 2005
Most Recent Rating Update: July 17, 2013

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