DBRS Confirms National Australia Bank at AA / R-1 (high); Trend Stable

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 on all ratings is Stable. NAB’s ratings reflect an intrinsic assessment (IA) of AA (low), combined with a support assessment of SA2, which results in a one notch uplift to the final rating from the IA. The SA2 reflects the systemic importance of NAB to the financial system in Australia, and the generally supportive regulatory framework.

The confirmation reflects the strong Australian and New Zealand franchises, the predictable earnings streams and the progress that the Bank has made in reducing its legacy and low return assets. It also incorporates the strong capital levels and relatively low risk profile, although these strengths are mitigated to a certain degree by the weaker liquidity profile, compared to many AA-range rated global peers, 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 domestic franchise across both Australia and New Zealand, including estimated market shares in business and household deposits in Australia of 20.6% and 14.7% respectively as well as a strong position in New Zealand. This strong position in its core markets, which DBRS views as a key strength underpinning the ratings, is supplemented by limited activities in Asia, focused on relationships with Australian Business Banking customers with interests in the region.

In 2015, the Bank has made substantial progress in exiting its legacy and low returning assets, including the finalisation of its exit from the USA, a further reduction in the UK commercial real estate (CRE) portfolio, and the closure of the Specialised Group Assets (SGA) operation following liquidations in 2015. Alongside the announcement of its full year 2015 results, NAB also announced an agreement to sell 80% of the Bank’s life insurance business to Nippon Life and that the planned exit of the UK Banking business (Clydesdale), through a demerger and IPO, is now expected to be completed in early February 2016. NAB will, however, retain ownership of its Investments business, which includes superannuation and asset management, and announced further substantial investment in the division over the next four years. In addition, NAB will also enter into a 20 year distribution agreement with Nippon Life thereby allowing the Bank to continue to introduce life insurance products to its customer base. DBRS views these transactions positively as they should allow management to further concentrate resources on the Bank’s core Australia and New Zealand businesses, although execution risk still exists with regard to the UK exit. DBRS further notes, however, that the structure of the exit from Clydesdale will cap the Bank’s exposure to any potential future legacy conduct costs not covered by existing provisions.

NAB continues to generate solid and consistent earnings. In 2015, NAB reported income before provisions and taxes (IBPT) of AUD 9.9 billion, up 15% year-on-year (YoY) with the Bank’s domestic franchise generating the bulk of this.

DBRS considers NAB’s funding position as adequate, given the high rating level. Although the Bank benefits from a diversified funding mix, and has reduced its use of offshore short-term wholesale funding in recent years, the dependence on wholesale funding remains significant, as evidenced by a DBRS calculated net loan-to-deposit ratio of 138% at end-September 2015. In addition, the Bank’s use of short-term funding, including long term debt with a residual maturity of less than one year, remains high, at 59% of total wholesale funding at end-September 2015, albeit this is down from 62% at end-September 2014. Despite improvements, the Bank’s liquidity profile remains weaker than many AA-range rated global peers, with total liquid assets, including internal RMBS but excluding contingent liquidity, covering 95% of the Bank’s short-term funding. DBRS, however, positively notes that at end-September 2015, the Bank reported a quarterly average Liquidity Coverage Ratio (LCR) of 115%, in excess of the Australian Prudential Regulation Authority’s (APRA) regulatory minimum of 100%, with LCR eligible assets of AUD 150 billion, including AUD 93 billion of High Quality Liquid Assets (HQLA).

DBRS views NAB’s risk profile as relatively conservative, although in recent years it has been hampered by the poorly performing UK CRE portfolio. However, the Bank’s asset quality has continued to improve, with 90+ days past due and gross impaired loans reducing by AUD 2.2 billion to AUD 4.2 billion at end-FY15, resulting in a 90+ days past due and gross impaired loans ratio of 0.71%, down from 1.19% at end-FY14. The improvement was driven principally by improvements in the Bank’s business lending portfolio and the sale of GBP 430 million of NAB UK impaired CRE assets. As a result of the sale, DBRS positively notes that the Bank now only has approximately GBP 500 million of UK CRE left on the balance sheet, of which 93% is performing at end-FY15. Although NAB has suffered a financial and reputational impact from conduct risk issues in recent years, mainly through its UK operation, the planned exit from this business in February 2016 should reduce this in the future.

DBRS views NAB as having solid capitalisation, with an APRA Basel III Common Equity Tier 1 (CET1) ratio of 10.24% at end-September 2015. This is already in excess of APRA’s 8% minimum requirement by 1 January 2016. DBRS also notes that the Bank expects its CET1 ratio to remain well in excess of APRA’s minimum requirement, at approximately 9.4% after adjusting for estimated FY16 impacts, which include the implementation of the increase in average credit risk weights in its Australian mortgage portfolio to 25%, which takes effect from 1 July 2016, the sale of the life insurance business and the demerger and IPO of Clydesdale. At end-September 2015, NAB also reported an APRA leverage ratio of 5.5%. DBRS notes that APRA is yet to set a minimum leverage ratio requirement.

Notes:
All figures are in AUD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2015). Other methodologies used include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (March 2015) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2015). 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, APRA 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: Elisabeth Rudman
Initial Rating Date: January 24, 2005
Most Recent Rating Update: March 26, 2015

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