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 Group) including the AA Deposits and Senior Debt ratings. 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 of the ratings reflect the Group’s strong Australian and New Zealand franchises. The ratings also incorporate the Group’s completion of all major legacy asset disposals continued progress in exiting non-core assets, with the full divestment of the UK-domiciled CYBG plc (CYBG – the ultimate holding company of Clydesdale Bank plc) through a demerger and Initial Public Offering (IPO), and the sale of 80% of NAB Wealth’s life insurance business, along with the Group’s solid capital levels, resilient profitability, conservative risk profile, and improving funding and liquidity profile.

The Group’s profitability, on an underlying cash earnings basis (which excludes one-off items, such as the loss on sale of CYBG and 80% of NAB Wealth’s life insurance business, along with other non-cash items, and fair value and hedge ineffectiveness), continued to improve in FY16, supported by a strong performance across the Group’s Australian and New Zealand Banking divisions.

DBRS views NAB’s risk profile as generally conservative, evidenced by its good quality loan book, solid diversification by industry and low cost of risk. Whilst credit quality has deteriorated year-on-year (YoY) in FY16, most notably in New Zealand as a result of difficulties in the dairy sector, the performance of NAB’s overall loan portfolio remains strong, with gross impaired loans and loans over 90+ days past due (DPD) accounting for only 0.85% of gross loans and acceptances at end-FY16. The coverage ratio also remains strong at 118% of gross impaired loans, or 67% of gross impaired loans and loan over 90+ DPD. DBRS also notes that the outlook for New Zealand dairy has improved, while only 1% of the Group’s exposure was classified as unsecured at end-FY16. The Group’s lending exposure to sectors that are currently more susceptible to increased volatility also appears well managed. Direct exposure to the Resources sector (i.e. mining, and oil & gas extraction) accounts for only approximately 1% of the Group’s exposure at default (EAD); only 0.74% of the Group’s Agriculture, Forestry & Fishing EAD is classified as impaired or over 90+ DPD; and, only 0.23% of the Group’s AUD 61.5 billion commercial real estate (CRE) gross loans and acceptances is classified as impaired at end-FY16.

NAB has also made improvements to its funding profile in recent years, with further growth in customer deposits helping to reduce the Group’s loan-to-deposit ratio to 139% at end-FY16. NAB’s reliance on wholesale funding does, however, remain significant, at AUD 284 billion at end-FY16 (including AUD 35 billion of repo liabilities), leaving the Group exposed to potentially more volatile wholesale markets. The Group’s use of offshore and short-term funding also remains sizeable, although DBRS notes positively the Group’s recent reduction in offshore short-term wholesale funding, down to 8% of total funding at end-FY16, from 16% in 2011. DBRS also views NAB’s liquidity position as solid, with total eligible regulatory liquidity, measured in High-Quality Liquid Assets (HQLA), Committed Liquidity Facility (CLF) eligible assets and retained residential mortgage backed securities (RMBS), of AUD 154 billion at end-FY16, which compares to short-term funding, including term funding with a maturity of less than one year, of AUD 129 billion. Liquid assets that qualify for inclusion in the Group’s liquidity coverage ratio (LCR) were on average AUD 147 billion in 4Q16, which compares to average net cash outflows of AUD 121 billion, and results in the Group reporting a quarterly average LCR of 121% in 4Q16, up 6 percentage points YoY.

DBRS views NAB’s capital position as strong, with the Group reporting an APRA Basel 3 Common Equity Tier 1 (CET1) ratio of 9.77%, down 47 basis points YoY, as the impact of the Clydesdale demerger and IPO, along with mortgage risk-weight changes, more than offset cash earnings and the sale of the life insurance business. Despite the YoY decrease, DBRS notes that the Group continues to surpass APRA’s additional capital buffer requirements, which result in a minimum CET 1 ratio of 8% by January 1, 2016, and in advance of the Group’s target range CET1 ratio of between 8.75% - 9.25%. The Group’s leverage ratio, calculated on an APRA basis as Tier 1 capital % of Total Exposure, was 5.7% at end-FY16. On an internationally comparable basis (as calculated per the 2015 APRA study), NAB reported a CET1 ratio of 14.0%, and a leverage ratio of 6.2% at end-FY16, leaving the Group well placed compared to global peers.

Concurrently, DBRS has withdrawn its Commercial Paper rating on NAB and assigned an R-1 (high) Short-Term Instruments rating to NAB, which reflects DBRS’s view of the Group’s short-term debt and deposit liabilities (i.e. maturing within 1 year).

RATING DRIVERS
Upward pressure on the rating is unlikely in the medium term given the already high rating level. Any upward pressure would 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.

Notes:
All figures are in AUD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2016). Other applicable methodologies include the DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016). 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, the Reserve Bank of Australia, the Australian Prudential Regulation Authority, Reserve Bank of New Zealand and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Ross Abercromby, Senior Vice President - Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer - Global FIG and Sovereign Ratings
Initial Rating Date: January 24, 2005
Most Recent Rating Update: December 17, 2015

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