Morningstar DBRS Confirms National Australia Bank's LT Issuer Rating at AA, Stable Trend

DBRS Ratings Limited (Morningstar DBRS) confirmed the credit ratings of National Australia Bank Limited (NAB or the Group), including the Long-Term Issuer Rating at AA and the Short-Term Issuer Rating at R-1 (high). The trend on all credit 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 Morningstar DBRS' 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 credit ratings at the end of this press release.

KEY CREDIT RATING CONSIDERATIONS

CREDIT RATING DRIVERS
The confirmation of NAB's credit ratings reflects the Group's strong banking franchise in Australia and New Zealand, where it has meaningful market shares for business, housing loans and customer deposits, its solid capitalization, supported by a sound and resilient earnings. The ratings also incorporate Morningstar DBRS view that the Group continued to make good progress in improving its operational risk management but expects further improvement to its Anti Money Laundering counter-terrorism (AML/CTF) financing programs. The credit ratings also take into account that NAB, similar to domestic peers, makes more use of wholesale funding compared to many international and domestic peers and that although asset quality remains strong, impaired loans have increased (albeit from very low levels) due to the higher interest rate environment.

CREDIT RATING RATIONALE
An upgrade of the credit ratings would require a longer track record of improved profitability, a lower reliance on wholesale funding and sound asset quality and capital.

A downgrade of the credit ratings could be driven by a sustained material deterioration of profitability and asset quality. Furthermore, a downgrade of the long-term ratings would occur if, in Morningstar DBRS's opinion, the likelihood of timely systemic support were reduced.

CREDIT RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Very Strong/Strong

With total assets of AUD 1,071 billion at end-March 2024 (end-H1 24), NAB is a leading Australian bank that has strong franchises in Australia and New Zealand. In business banking, the Group enjoys market shares of 22% and 14.6% in home lending in Australia respectively as well as a 26.7% market share in credit cards in Australia. Additionally, in New Zealand, NAB's subsidiary BNZ has also strong market shares of 22.4% in business lending and 16.3% in housing lending. The Group has limited activities in business banking in Asia, where it mainly serves Australia business customers with interests in the region. Since April 2024, NAB has a new Group Chief Executive Officer, Andrew Irvine, who announced some top management changes in April 2024. Nevertheless, Morningstar DBRS expects NAB's strategy to remain unchanged as the new CEO was already part of NAB's Executive management involved in the current strategy.

Earnings Combined Building Block (BB) Assessment: Strong/Good

NAB `s profitability is sound supported by a solid and resilient revenue generation, that has recently benefitted from the higher interest rate environment, as well as good cost discipline and generally low levels of loan loss provisions. On a statutory basis, NAB's statutory net profit attributable to owners was AUD 3,494 million, down 11.9% year-on-year (YOY) from AUD 3,967 million. Statutory Return on Equity (ROE) was 11.5% in H1 2024, down from 13.3% in H1 2023 and 13.3% in FY23 and similar to the 11.3% in FY22. On a cash basis, that excludes one offs items, the ROE was 11.7% in H1 2024 . Net interest income remained resilient and was only down 0.9% YOY in H1 2024, driven by margin compression as strong mortgage competition and higher customer deposit funding costs were partly offset by higher revenues from lending volume growth. The net interest margin (NIM), however, remained pressured and was down to 1.72% on a statutory basis in H1 2024, down slightly from 1.77% in H1 2023 and 1.71% in FY23. Moreover, NAB generally maintains a good cost discipline. In H1 2024, statutory operating expenses grew 5.3% YOY in H1 2024, largely reflecting salary inflation and higher investments in IT. As a result, NAB's cost-income ratio on a statutory basis declined to 47.4% in H1 2024 from 43.3% in H1 2023 and 45.4% in FY23 although it continues to compare well with most international and domestic peers. NAB's cost of risk was a low 10 bps in H1 2024 (as calculated by Morningstar DBRS), broadly stable from 12 bps in H1 2023 and FY23 .

Risk Combined Building Block (BB) Assessment: Strong

NAB has a generally conservative credit risk, partly supported by sound asset quality with low levels of impaired loans despite some deterioration as a result of the higher interest rate environment and inflation. The higher interest rate environment is adding some pressure to asset quality although Stage 3 loans remain at low levels. At end-H1 2024, Stage 3 loans grew 8.1% from end-FY23 to AUD 8,255 million (AUD 7,636 million at end-FY23), largely driven by higher arrears in mortgage and business loans in Australia. The Stage 3 loan ratio increased to 1.14% at end-H1 2024, slightly up from 1.08% at end-FY23 and 0.89% at end-FY22. Stage 2 loans, which are loans that are performing but where there has been an increase in credit risk, represented 22% of total gross loans at end-H1 2024. The commercial real estate (CRE) portfolio amounted to AUD 71.5 billion at end-H1 2024 or 10% of total gross loans. The CRE portfolio has slightly deteriorated, although from low levels, and the gross impaired ratio (incl. 90+ DPD) was 0.55% at end-H1 2024 up from 0.37% at end-FY23 compares to 0.22% at end-FY22.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong/Good

NAB's funding is sound backed by a strong customer deposit base in its home markets. Customer deposits including certificates of deposits (CDs), totalled AUD 663.5 billion at end-H1 2024, up around 2% from end-FY23, and the Group's net loan-to-deposit (LTD) ratio, as calculated by Morningstar DBRS and including CDs, was 108% at end-H1 2024, in line with end-FY23 but gradually improved since 2019 supported by sound customer deposit growth. Wholesale funding sources are well diversified by instrument, maturity and currency. However, Morningstar DBRS considers NAB to have a relatively high reliance on wholesale funding, as the total proportion of wholesale funding to total non-equity funding was 26% of total non-equity funding at end-H1 2024, which is higher than most domestic and international peers, although it has gradually improved from 33% in FY19. NAB has a strong liquidity position with the Group's quarterly average Liquidity Coverage Ratio (LCR) of 137% and a Net Stable Funding Ratio (NSFR) ratio of 116% at end-Q3 2024.

Capitalisation Combined Building Block (BB) Assessment: Strong/Good

NAB's capital position is solid on the back of strong earnings generation and access to capital markets. At end-H1 2024, NAB reported an APRA Common Equity Tier 1 (CET1) ratio of 12.15% broadly stable from 12.2% at end-FY23 as the capital generated through earnings (80 bps) was fully offset by shareholder distribution (83 bps) and higher risk weighted assets from new mortgage and business lending volume growth as well some asset quality deterioration in the Australian retail loan portfolio, mostly from mortgages. The removal of the operational risk capital add-on also translated into +17 bps of CET1 in H1 2024 and the CET1 also benefitted from lower IRRBB risk weighted assets (+23 bps). The CET1 improved at end-Q3 2024 to 12.6% largely reflecting retained earnings. Considering the AUD 1.5 billion share buy-back still to be completed, the pro-forma APRA CET1 ratio was 11.75% at end-H1 2024 and 12.3% at end-Q3 2024. The CET1 ratio remains comfortably above the APRA's minimum requirement of 10.25%. The leverage ratio, calculated on an APRA basis as Tier 1 Capital as a percentage of total exposure, was solid at 5.1% at end-H1 2024.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/439696.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

The subfactor 'corporate governance' is relevant to the credit rating of NAB but does not affect the overall credit rating or trend assigned to the Group. This is reflected in the Risk grid building block. Morningstar DBRS considers that NAB has improved its operational risk framework after significant weaknesses were identified in the 2018 Self-Assessment report and from the industry-wide Royal Commission investigation in 2019 and which resulted in a capital-add on of AUD 500 million. On 12th March 2024, APRA announced the removal of the capital-add of AUD 500 million capital add-on as the operational risk framework has improved to APRA's satisfaction. However, Morningstar DBRS considers that additional remedial actions are still needed in relation to AML/CTF. In April 2022, NAB accepted an `enforceable undertaking' (EU) after AUSTRAC had identified several weaknesses with NAB's compliance with AML/CTF. The EU requires NAB to implement a detailed Remedial Action Plan detailing the Group's plans to improve its compliance systems, controls and record-keeping. The EU will end when the AML/CTF related remediations made by NAB are completed to AUSTRAC's satisfaction.

There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781

Notes:
All figures are in Australian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (4 June 2024) https://dbrs.morningstar.com/research/433881 In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings, https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Morningstar Inc. and company documents, National Australia Bank (NAB) H1 2024 report, NAB H1 2024 Investor Presentation, NAB Q3 2024 trading update, NAB Climate Report 2023. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were 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

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS's outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/439695.

These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Maria Rivas, Senior Vice President, Sector Lead - European Financial Institution Ratings
Rating Committee Chair: William Schwartz, Senior Vice President - Global Fundamental Ratings, Credit Practices
Initial Rating Date: January 24, 2005
Last Rating Date: November 22, 2023

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