DBRS Confirms NAB at AA / R-1 (high), Stable Trend

DBRS Ratings Limited (DBRS) has confirmed the ratings of National Australia Bank Limited (NAB or the Group), including the AA Long-Term Issuer Rating and Long-Term Senior Debt. 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 one notch of uplift to the final rating from the IA. The Support Assessment of SA2 reflects the systemic importance of NAB to the financial system in Australia, and the generally supportive regulatory framework.

The confirmation of the ratings reflects the Group’s strong franchise in Australia and New Zealand along with its resilient earnings generation ability, its conservative risk profile, its solid capital levels and its improving funding profile, despite its reliance on wholesale funding.

NAB has a strong franchise in its core markets of Australia and New Zealand, which is complemented by limited activities in business banking in Asia, where NAB mainly serves Australia business customers with interests in the region. DBRS views positively the Group’s renewed focus on its core markets, which have consistently generated higher returns.

The Group’s profitability improved further in FY17 and on an underlying cash earnings basis, which excludes extraordinary items along with other non-cash items and fair value and hedge ineffectiveness, NAB reported cash earnings of AUD 6.6 billion, up 2.5% on FY16. This improvement primarily reflected improved net interest income and trading income performance, which mitigated a 2.6% increase in operating expenses, and relatively stable credit impairments. The Group has given guidance that in FY18 operating expenses will most likely increase by 5%-8%, due to the impact of upgrading NAB’s digital offering and other costs associated with its acceleration strategy, including an estimated AUD 1.5 billion increase in investment over the next three years.

DBRS views NAB’s risk profile as relatively conservative, given the good quality loan book, the diversification by industry sector and the low cost of risk. Credit quality improved year-on-year in FY17, as a result of successful strategies in dealing with customer facing difficulties in the Australian portfolio and the improvement in the New Zealand dairy industry, and overall remains strong with a ratio of 90+ days past due (DPD) and gross impaired assets to gross loans and acceptances of 0.70% at end-FY17. The coverage ratio remains strong at 187% of gross impaired loans, or 81% including the loans over 90+ DPD. DBRS notes that the outlook for New Zealand dairy has improved further while the Group’s lending exposure towards more pressured sectors, such as commercial real estate and resources, remains low and appears to be well-managed. The Group’s commercial real estate portfolio totalled AUD 61.5 billion, or 10.9% of total gross loans & acceptances, with only 0.22% of it classified as impaired. DBRS notes that in October 2017 NAB and the Australian Securities and Investment Commission (ASIC) reached an agreement over bank trading and the Bank Bill Swap Rate; as part of the resolution, NAB has agreed to pay a penalty of AUD 50 million.

NAB has also improved its funding profile in recent years with further growth in customer deposits that helped to marginally reduce the (DBRS calculated) loan-to-deposit ratio to 138% at end-FY17. Reliance on wholesale funding, however, remains significant at AUD 293.3 billion (including repurchase agreements of AUD 23.5 billion), leaving the Group exposed to potential volatility in wholesale markets. DBRS notes positively that usage of offshore short-term wholesale funding has come down in recent years and at end –FY17 accounted for 7.3% of total funding liabilities and equity, compared to 10.8% at end-FY13 and 15.5% at end-FY11. DBRS views NAB’s liquidity as solid with the average liquid asset portfolio of AUD 136 billion in 4Q17. This comprises of High Quality Liquid Assets (HQLA), including internal Residential Mortgage Backed Securities (RMBS) and the Committed Liquidity Facility (CLF), and compares to short-term funding of AUD 120 billion at end-FY17. The Group reported an average LCR of 123% in 4Q17, up from 121% in 4Q16. The Group’s Net Stable Funding Ratio (NSFR) stood at 108% at end-FY17, which is above the minimum 100% requirement to be introduced as of January 1, 2018.

DBRS views NAB’s capital position as solid with the Group reporting an APRA Basel III Common Equity Tier 1 (CET1) ratio of 10.1% at end-FY17, up from 9.8% at end-FY16, as a result of accumulated earnings and despite the impact of higher risk weights due to mortgage model changes. The Group is on target to reach APRA’s ‘unquestionably strong’ benchmark that requires a minimum CET1 ratio of 10.5% by January 1, 2020 through internal capital generation. The Group’s leverage ratio, calculated on an APRA basis as Tier 1 Capital % of Total Exposure was 5.5% at end-FY17, down from 5.7% at end-FY16. On an internationally comparable basis, NAB reported higher ratios with a CET1 ratio of 14.5% and a leverage ratio of 5.9%.

RATING DRIVERS
Any upward pressure would require a reduction in the extent of the reliance on 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.

The Grid Summary Grades for NAB are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Very Strong/Strong; Risk Profile – Very Strong/Strong; Funding & Liquidity – Strong/Good; Capitalisation – Very Strong.

Notes:
All figures are in AUD unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017). This can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial, company reports, the Reserve Bank of Australia, the Australian Prudential Regulation Authority and the Reserve Bank of New Zealand. 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 and US 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
Last Rating Date: July 14, 2017

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