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

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings of National Australia Bank Limited (NAB or the Bank), including the Long-Term Issuer Rating and the Long-Term Senior Debt rating at AA. The Short-Term Issuer Rating was confirmed at R-1 (high). The trend on all ratings is Stable. The Intrinsic Assessment (IA) of the Bank is AA (low) and the Support Assessment is SA2, which results in a one notch uplift to the final rating from the IA. The Support Assessment of SA2 reflects the generally supportive regulatory framework and DBRS Morningstar’s expectation of a timely systemic support, given NAB’s importance to the financial system in Australia. A full list of rating actions is included at the end of this press release.

KEY RATING CONSIDERATIONS
The confirmation of the long-term ratings reflects the Bank’s strong franchise in Australia and New Zealand, particularly in business banking, as well as the fact that the Bank’s solid capital levels, along with its resilient underlying earnings generation ability, should enable the Bank to meet increasing capital requirements.

It also takes into consideration NAB’s progress in addressing risk management issues, whilst asset quality remains good with a low level of impairment charges. The long-term ratings also incorporate NAB’s adequate funding profile, despite the fact that the Bank has a higher reliance on wholesale funding than most similarly rated domestic or international peers.

RATING DRIVERS
Upward rating pressure on the IA would require the Bank to (i) continue to address outstanding regulatory issues, and (ii) become less reliant on wholesale funding, while (iii) maintaining very strong earnings and sound capital management.

Negative pressure on the IA would arise (i) if the Bank had significantly larger than already identified operational risk issues given DBRS Morningstar’s limited tolerance of control issues at high rating levels, or (ii) if the proportion of wholesale funding were to increase significantly.

Furthermore, negative pressure on the long-term ratings would arise (i) if DBRS Morningstar were to change the Support Assessment to SA3, in case DBRS Morningstar’s expectation for timely systemic support were to reduce, or (ii) if the rating of Commonwealth of Australia was downgraded to the same level or lower than the Bank’s IA.

RATING RATIONALE
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. NAB is currently on the third and final year of its transformation programme. To date, the Bank has made good progress with the simplification of its business offering and the streamlining of its procedures and systems. NAB remains focused on reshaping its Wealth Management business, which includes exiting its Advice, Superannuation & Investment Platforms and Asset Management businesses, and further announcements are expected within FY20 .

NAB has consistently generated strong underlying earnings, albeit on a statutory basis the Bank’s results have been impacted by various one-offs in recent years. Statutory net profit attributable to owners of NAB decreased by 13.6% in FY19 to AUD 4,798 billion. Similarly, on a continuing operations basis (not excluding one-offs), NAB’s net profit was down 14.4% to AUD 5,087 million compared to FY18 as a result of higher operating expenses relating to elevated customer-remediation charges as well as a policy change in software capitalisation. On a statutory basis, the Bank’s cost-to-income ratio from continuing operations weakened to 54.8%, up from 51.9% according to DBRS Morningstar calculations. On a cash basis, NAB’s reported cost-to-income ratio was 52.3%, when including notable items, and 44.3% when excluding those, which indicates still strong efficiency levels. While increasing, credit impairment charges remained very low. In FY19, NAB reported a statutory return on equity of 9.1%, lower than in FY18 and FY17, but still in line with the Bank’s similarly rated international peers.

NAB’s credit risk performance is solid on the back of a benign macroeconomic environment in Australia. Credit quality remains very strong with a gross impaired loans ratio of 0.93% in FY19 albeit up from 0.71% in FY18 reflecting slight deteriorations in the Australian home and business loan book but also in the New Zealand dairy portfolio. The Bank’s corporate portfolio accounts for 43% of NAB’s total loan book at end-FY19, which represents a higher portion of total lending than its domestic peers, which is consistent with NAB’s focus on business lending.

DBRS Morningstar considers that addressing non-financial risks such as operational risk issues uncovered by the Royal Commission is an important challenge for NAB, along with its peers. Currently, NAB is in the process of actioning recommendations by the industry-wide Royal Commission and by APRA, following the conclusion of NAB’s Culture, Governance and Accountability (CGA)’s self-assessment. NAB has been reporting some progress on both fronts, however, DBRS Morningstar is expecting full implementation of the recommendations laid out by the Royal Commission and APRA will take time, in part because of the number of recommendations and given legislative changes can be required.

DBRS views NAB’s funding profile as adequate. Similar to its major Australian peers, the Bank relies to a higher degree than most of its similarly rated global peers on the wholesale market, and usage of wholesale funding remains significant. NAB’s net loan-to-deposit ratio was 140% at end-FY19 (flat on end-FY18), as per DBRS Morningstar calculations, and this is at the higher end of its domestic peer group. At the same time, the Bank maintains relatively good diversification in its wholesale funding profile in terms of product and currency, with issuances in AUD, USD and EUR and no significant refinancing concentration. In addition, the Bank reported a Liquidity Coverage Ratio of 126% (129% at end-FY18) and a Net Stable Funding Ratio of 113% (flat on end-FY18).

DBRS Morningstar views NAB as having a solid capital position and considers the Bank as able to manage the impact of ongoing developments in regulatory capital requirements in Australia and New Zealand, given the Bank’s solid track record in generating earnings, its flexibility in accessing markets and the recently announced capital initiatives that are expected to result in a share capital increase of approximately AUD 1.55 billion, as per NAB’s calculations. The Bank reported an APRA Common Equity Tier 1 (CET1) ratio of 10.4% at end-FY19, which albeit up from 10.2% at end-FY18, is below the APRA’s benchmark of 10.5% that is set for January 1, 2020. However, when taking into account the capital strengthening initiatives, NAB’s pro-forma CET1 ratio was 10.75% at end-FY19. In addition, DBRS Morningstar notes NAB’s CET1 ratio was 14.3% at end-FY19 on an internationally comparable basis according to the Bank’s calculations.

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

Notes:
All figures are in AUD unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019). This 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, the Reserve Bank of New Zealand and S&P Global Market Intelligence. DBRS Morningstar 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 Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar 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 Morningstar's outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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: Vitaline Yeterian, Vice President - Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of European FIG - Global FIG
Initial Rating Date: January 24, 2005
Last Rating Date: December 3, 2018

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