DBRS Morningstar Confirms National Australia Bank’s Issuer Ratings 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 at AA and the Short-Term Issuer Rating 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 reflects the generally supportive regulatory framework and DBRS Morningstar’s expectation of timely systemic support, given NAB’s importance to the financial system in Australia. This results in a one notch uplift to the Issuer Rating from the IA. See a full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS
The confirmation of the ratings reflects NAB’s strong domestic franchise, particularly in business banking, as well as its resilient underlying earnings generation ability, robust capital levels and sound asset quality indicators. The ratings also incorporate a sound and improving funding profile, although DBRS Morningstar continues to note that usage of wholesale funding is still at the higher end of the peer group, despite a reduction in recent quarters due to the liquidity injected into the system through the Reserve Bank of Australia’s (RBA) funding programs, and the significant increase in deposits due to extraordinary government support packages and precautionary savings. The confirmation of the ratings also takes into consideration the Bank’s continued progress in addressing risk management issues. DBRS Morningstar also considers that the impact of the coronavirus (COVID-19) pandemic has negatively affected the Bank’s operating environment, and, as a result, revenue generation is likely to be weaker in 2021, and there is likely to be some deterioration in asset quality.

RATING DRIVERS
An upgrade of the ratings is unlikely in the near term, given the uncertain economic outlook. An upgrade of the ratings would require the Bank’s asset quality metrics to remain solid throughout the COVID-19 crisis, as well as consistently lower reliance on wholesale funding, very strong earnings and robust capital levels.

A downgrade of NAB’s ratings would likely be driven by either sustained lower profitability, a marked deterioration in asset quality or weaker capitalisation levels. In addition, a downgrade of the Long-Term Issuer Rating could occur if, in DBRS Morningstar’s opinion, the likelihood of timely systemic support were reduced.

RATING RATIONALE
NAB is a leading Australian bank with a strong franchise in its core markets of Australia and New Zealand, and a select presence in business banking in Asia. Domestically, the Bank's franchise lies predominantly in business banking (including a market share of 21.5% in Australia), with this complemented by a sound position in retail banking, including a market share of 14.6% in mortgage lending. NAB also has strong market shares in New Zealand, with a market share of 23.6% business lending and a 16.0% mortgage lending market share.

The financial year to end-September 2020 (FY20) marked the completion of NAB's three year transformation programme, which entailed the simplification of the Bank's business offering and the streamlining of its procedures and systems, along with the enhancement of its digital capabilities. DBRS Morningstar views this programme as having strengthened the Bank's position in the face of the challenging COVID-19 environment. Further simplification of the Bank's business offering is anticipated during FY21, once the announced sale of the Bank’s MLC Wealth business, which includes the Advice, Superannuation & Investment Platforms and Asset Management businesses, is completed.

NAB has been generating strong underlying earnings in recent years. Earnings in FY20 were impacted by the more challenging economic environment and the subsequent increase in provisions, as well as sizeable notable items. On a statutory basis, NAB reported net profit attributable to owners of AUD 2,559 million, or 47% lower than in FY19, while cash earnings (including the large notable items) were similarly down 37% to AUD 3,710 million. The decrease both on a statutory and underlying basis was mainly due to higher credit impairment charges as a result of the deterioration of the economic outlook due to the COVID-19 pandemic, but also due to circa AUD 1.0 billion of large notable items (on a post-tax basis) such as a change in NAB’s software capitalisation policy, customer and payroll remediation costs, and property-related asset impairments. The Bank’s statutory return on equity in FY20 was down to 4.4% from 9.1% in FY19, or 8.3% in FY20 excluding notable items. Nonetheless, DBRS Morningstar considers this performance as in line with many global peers in the challenging operating environment, although it is towards the lower end of the domestic peer group.

Cost control remains a key area of focus for NAB. The Bank's cost-income ratio from continuous operations (including the large notable items) was a sound 52.4% in FY20 (vs. 46.7% in FY19). NAB remains committed to containing its cost base in FY21 below the AUD 7.7 billion cost base in FY20 (excluding large notable items). DBRS Morningstar considers that actions taken to date, which have resulted in cumulative productivity savings of AUD 1.2 billion over the 2017-2020 period, will be supportive towards achieving this target.

Credit quality remains strong. The gross impaired assets ratio was 1.03% at end-FY20, partly reflecting the ongoing support provided by the Australian government during the pandemic. The overall quality of the Australian home loans portfolio remained strong and was supported by COVID-19 related payment deferrals in FY20, with 4.6% of this book, or AUD 14 billion, being under payment deferrals at October 23, 2020, as per DBRS Morningstar calculations. With regards to those sectors likely to be most impacted by COVID-19 (Retail Trade, Tourism, Hospitality and Entertainment, Air Travel, Office/Retail/Tourism/Leisure Commercial Real Estate), NAB’s combined exposure at default was AUD 81.8 billion, or 8.8% of the total exposure at default at end-September 2020. Regarding conduct issues over the past years, DBRS Morningstar considers that NAB is making steady progress in rectifying identified operational risk shortcomings.

NAB has an adequate funding profile. The Bank's net loan-to-deposit (LTD) ratio, as calculated by DBRS Morningstar, stood at 126% at end-FY20, which although improved from around 140% in the previous year remains at the higher end of NAB's domestic peer group. The improvement in the LTD ratio was on the back of a significant rise in deposits, which increased by about AUD 43.5 billion, or 10.3% YoY. This was partly driven by the liquidity injected into the market by the RBA to ensure that banks would be able to extend credit and support customers affected by the COVID-19 outbreak, through the establishment of the Term Funding Facility (TFF) in March 2020. Similar to its major Australian peers, the Bank has been relying to a higher degree than most of its global peers on overseas wholesale market funding. Wholesale funding accounted for 34% of total funding at end-FY20 (end-FY19: 39%), while short-term wholesale funding, which includes term funding maturing in less than 12 months, accounted for a sizeable 50% of it. The Bank’s liquidity position is sound, with a quarterly average Liquidity Coverage Ratio (LCR) of 139% in Q4 2020 and a Net Stable Funding Ratio (NSFR) ratio of 127% at end-September 2020.

DBRS Morningstar views NAB as having a robust capital position and being well-placed to address the challenging environment. The Bank reported an Australian Prudential Regulation Authority (APRA) Common Equity Tier 1 (CET1) ratio of 11.47% at end-FY20, up from 10.38% at end-FY19 largely due to the AUD 4.25 billion equity raise in April 2020 as well as organic capital generation that more than offset the impact of the dividend payment. NAB estimates that the sale of MLC Wealth, which is subject to certain conditions and pending regulatory approvals, will increase its CET1 ratio by 35 bps on completion to 11.85% on a pro-forma basis, at end-FY20. NAB’s CET1 ratio remains well above the minimum requirement of 8% and APRA’s requested benchmark of 10.5%. On an internationally comparable basis, NAB’s CET1 ratio was 15.8%.

ESG CONSIDERATIONS
DBRS Morningstar views the Business Ethics and Corporate Governance ESG subfactors as significant to the credit rating, and these are included in the Governance factor. In recent years operational risk and control deficiencies have been identified, however, NAB appears to be working towards improving controls and resolving these issues by strengthening its compliance function, and simplifying its business model.

NAB, along with the other three major Australia banks, has been part of various investigations with regards to a number of conduct issues over the past few years. The Bank continues to implement the recommendations of the Royal Commission, which investigated misconduct in the banking, superannuation and financial services industry, and whose recommendations were published in February 2019. In particular, NAB has stated that they have completed 7 of the Royal Commission’s recommendations, while 32 recommendations are being actioned.

Furthermore, DBRS Morningstar notes that following the Bank’s self-assessment into governance, culture and accountability, APRA imposed a capital add on of AUD 500 million in July 2019, which relates to identified weaknesses in non-financial risk management. Even though headline noise over past conduct issues appears to have abated, DBRS Morningstar will continue monitoring developments regarding regulatory and other state authorities, given DBRS Morningstar's limited tolerance on recurring conduct issues at NAB's rating level.

In recent years, we note NAB has simplified its business offering and streamlined its procedures and systems in part to address operational issues. Further simplification of the Bank's business offering is anticipated within FY21, following the announced agreement regarding the sale of its MLC Wealth business, which includes exiting its Advice, Superannuation & Investment Platforms and Asset Management businesses.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792

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

DBRS Morningstar notes that this Press Release was amended on 1 December 2020 to incorporate the disclosure regarding rating methodologies and Coronavirus Disease.

Notes:
All figures are in AUD unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020) - https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include NAB FY20 Annual Report, NAB FY20 Pillar 3 Disclosure, NAB FY20 Results Highlights, NAB FY20 Investor Presentation, NAB FY20 Results Transcript, Reserve Bank of Australia’s Financial Review, Australian Prudential Regulation Authority, 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.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

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 12-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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/370577

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

Lead Analyst: Vitaline Yeterian, Senior Vice President, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: January 25, 2005
Last Rating Date: November 29, 2019

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