DBRS Confirms NAB at AA / R-1 (high) with a 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 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.

KEY RATING CONSIDERATIONS
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 adequate funding profile.

RATING DRIVERS
Any upward pressure would require (i) a reduction in the extent of the reliance on wholesale funding, (ii) whilst addressing current regulatory issues, and (iii) maintaining solid recurring earnings and continued sound capital management.

Downward pressure on the ratings would be likely if (i) the proportion of wholesale funding were to increase materially, or if (ii) the Group had larger than expected conducts issues or fines. iii) Additionally, negative pressure could also arise if the Group’s asset quality metrics were to significantly deteriorate potentially due to a significant stress in property market.

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, 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.

NAB has consistently generated strong underlying earnings supported by the strong economic environment of Australia. In FY18, 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 6.5 billion, down 2% on FY17. This is excluding restructuring related costs amounted to AUD 530 million after tax and customer-related remediation costs totalled AUD 261 million after tax. At the same time, the Group net interest margin was flat at 1.85% in FY18 in spite of increased funding costs in 2H18. In this context, the Group’s cost-to-income ratio weakened to 44.6% from 42.7%. DBRS notes expense growth (+6.4%) was consistent with the Group’s guidance of 5-8% planning for ongoing investments in technology. Credit impairment charges remained very low.

With regards to credit risk, the Group’s largest exposure remains towards residential mortgages, which accounted for AUD 340.0 billion at end-FY18, or 58% of the total gross loans and acceptances. DBRS notes the Australian housing market has slowed down in 2018, in particular in Sydney and Melbourne. However, DBRS views NAB as well positioned to absorb a deterioration given that the Group’s dynamic loan-to-value ratio (LVR) stood at 43.3% with 66.1% of the customers being at least one month in advance of their repayment schedule at end-FY18 - providing a buffer in case of a significant correction in house prices. Overall, the quality of the home loans portfolio remains very strong with a loss rate of 0.02%.

Operational risk control and risk management have been apparent in recent months. NAB, along with the other major Australian banks, is part of the Royal Commission in the banking, superannuation and financial services industry that was initiated in December 2017 and will produce its final report in February 2019. To date, the financial implications for NAB have been small, and the potential consequences of reputational damage remains unclear. DBRS will continue to monitor this area closely.

DBRS views NAB’s funding profile as adequate. Similar to its major Australian peers, though, the Group relies to a higher degree than most of its global peers on the wholesale market, and usage of wholesale funding remains significant. DBRS notes that NAB’s (DBRS calculated) net loan-to-deposit ratio was up to 142% at end-FY18 (138% at end-FY17). At the same time, the Group maintains relatively good diversification in its wholesale funding profile in terms of product and currency, with issuances in AUD, USD and EUR with no significant refinancing concentration. In addition, the Group reported an improved Liquidity Coverage Ratio of 129% (123% at end-FY17), and DBRS anticipates that the usage of short-term funding will remain contained. The Group’s Net Stable Funding Ratio was 113% (108% at end-FY17).

DBRS considers that NAB has a robust capital position, which benefits from very good earnings generation ability. The Group reported an APRA Common Equity Tier 1 (CET1) ratio of 10.2% at end-FY18, up from 10.06% on end-FY17. On an internationally comparable basis, NAB reported a CET1 ratio of 14.6% at end-FY18. DBRS notes that in November 2018, APRA released a consultation paper with regards to implementing a framework for increasing the loss-absorbing capacity of Authorised Deposit-taking Institutions to support orderly resolution. Under this proposal, NAB will need to increase its total capital requirements by four to five percentage points of RWA, mainly through the issuance of additional Tier 2 capital. DBRS notes this is equivalent to approximately AUD 15.6-19.5 billion for NAB based on the current capital framework in DBRS estimates.

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 (July 2018). 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 documents, 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: Vitaline Yeterian, 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: November 30, 2017

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