Company Reports

National Australia Bank’s third-quarter cash profit of AUD 1.75 billion was broadly as expected, flat on the average quarterly profit of the first half. Net interest margin remained steady at the 1.72% reported in the first half. Competitive lending rates and bank customers switching to more costly term deposit and saving accounts are a drag on margin. However, higher returns on deposit and capital hedges provided an offset. We expect a modest improvement in fiscal 2025 due to more favorable pricing on loans and deposits. Some banks that used high refinancing levels and cheap funding to try and aggressively grab market share are expected to be more focused on preserving margins. Operating expenses appear to be tracking marginally better than we anticipated, as operating productivity benefits help offset wage growth and technology spending. Guidance for expense growth below last year’s 5% rate is unchanged. Bad debt expenses remain very low, although nonperforming exposures are rising. We expect that the depletion of savings, rising unemployment, and less rapid house price appreciation will contribute to higher loan losses in fiscal 2025. Hoever, we forecast below long-term average levels in the short term as the bank releases bad debt provisions.

National Australia Bank is one of four major banks operating in oligopolistic Australia and New Zealand markets. It is Australia's biggest business bank, offering a full range of banking and financial services to the consumer, small business, and corporate sectors, with significant operations in New Zealand.

On a weighted average basis, major bank share prices increased 28% in the 12 months to June 30, 2024, outperforming the 8% increase in the Morningstar Australia Index. It is hard to pinpoint a single specific driver for the turnaround in bank sentiment. On the earnings front, signs of repricing loans and deposits to protect margins and low loan losses, are positives. But global funds increasing ownership and inflows into passive funds has likely also supported prices.

Largely as expected, National Australia Bank’s first-half fiscal 2024 cash profit eased 3% from second-half fiscal 2023 to AUD 3.5 billion. After being squeezed in second half fiscal 2023, net interest margin firmed 1 basis point to 1.72%. Competitive lending rates and bank customers switching to more costly term deposits and saving accounts weighed on margins, but higher returns on deposit and capital hedges provided an offset. We expect these trends to continue into the second half, with a modest improvement in fiscal 2025 due to more favorable pricing on new loans and deposits.

National Australia Bank is one of four major banks operating in oligopolistic Australia and New Zealand markets. It is Australia's biggest business bank, offering a full range of banking and financial services to the consumer, small business, and corporate sectors, with significant operations in New Zealand.

After reasonably uneventful earnings updates, it is hard to pinpoint a single specific driver for the turnaround in bank sentiment. Still, we think part of it is that a likely lower cash rate eases housing fears and provides banks an opportunity to reprice loans and deposits to protect margins. Major bank share prices increased 23% since November 2023, outperforming the 16% increase in the Morningstar Australia Index over the same period. The major banks' weighted average price/fair value estimate is 1.14, up from 1.05 in the last quarter. Nonmajor banks trade at a price/fair value of 0.85.

Despite headwinds to net interest margins, National Australia Bank’s first-quarter cash profit of AUD 1.8 billion is solid and is on track to meet our full-year forecasts. Profit in the quarter is 3% lower than the quarterly average for the second half of fiscal 2023. The 17% fall in profit from the previous corresponding period sounds alarming. Still, it shouldn’t surprise, as it reflects the downward NIM trajectory and bad debt expenses rising from very low levels, similar to the second half of last year.

National Australia Bank is one of four major banks operating in oligopolistic Australia and New Zealand markets. It is Australia's biggest business bank, offering a full range of banking and financial services to the consumer, small business, and corporate sectors, with significant operations in New Zealand.

Australian banks face low credit growth, softer net interest margins, and an increase in loan losses in the short term. Industry returns on equity will be suppressed in fiscal 2024. However, we expect loan and deposit pricing changes in the medium term to lift margins to a level that allows wide-moat-rated major banks to generate maintainable returns above our 9% cost of equity.

We increase our fair value estimate on wide-moat-rated National Australia Bank by 3% to AUD 31 fair after a largely-expected fiscal 2023 result. The positive fair value uplift, given the time value of money, is partially offset by a modest reduction in our short-term profit forecasts, driven by a lower net interest margin and higher operating expenses. Fiscal 2023 cash profit increased 9% to AUD 7.7 billion, with the second half down around 10% on the first half as competition eroded the margin benefit of rapid cash rate increases. Shares currently trade at a modest discount to our fair value estimate, on a fully franked dividend yield of 5.8% and a P/E of 12.

National Australia Bank is one of four major banks operating in oligopolistic Australia and New Zealand markets. It is Australia's biggest business bank, offering a full range of banking and financial services to the consumer, small business, and corporate sectors, with significant operations in New Zealand.

The short-term outlook for Australian banks is challenging with margins under pressure, loan losses expected to rise, and inflationary cost pressures unable to be offset by cost-cutting initiatives. Industry returns on equity are suppressed, hence we expect loan and deposit-pricing changes in the medium term to lift margins to a level that allows wide-moat-rated major banks to generate returns above our 9% cost of equity.

With interest margins softening and bad debts likely to rise, at least investors could take comfort in the banks sitting on surplus capital. With an average common equity Tier 1 ratio of 12.1%, all Australian major banks comfortably exceed the regulatory requirement of 10.25%. The Australian Prudential Regulation Authority does expect banks to maintain a buffer though, hence major banks have set their own targets of 11%-11.5%. This surplus capital position could be under threat if APRA sees fit to shake up the hybrid market.

Australian wide-moat major banks are comfortably meeting regulatory capital requirements, sitting on an aggregate excess capital of nearly AUD 15 billion as of Sept. 30, 2022. COVID-19 induced conservatism saw major banks cut dividends, tighten lending standards, divest assets, and in the case of Westpac and National Australia Bank, raise equity. Because of this, the majors are entering a downturn both well-capitalised and having enjoyed historically low loan losses given the accommodative monetary policy and fiscal stimulus in response to the pandemic. As at Sept. 30, 2022 on average, the four major banks had impaired and past due loans as a proportion of total loans of 46 basis points compared with 64 basis points as at Sept. 30, 2019.

The Australian major banks expectedly reported improvements in net interest margins, or NIMs, in the fourth quarter of fiscal 2022.

The increases in the Reserve Bank of Australia cash rate to arrest inflation will have an impact on key earnings drivers for the banks. With the cash rate currently at 2.35%, and likely north of 3% by year-end, the increases from just 0.1% in April 2022 have been swift. It is expected to slow credit growth, with less borrowing capacity and confidence (a complete turnaround from the fear-of-missing-out environment of recent years). However, we think bank sector revenue growth will be buoyed by higher net interest margins, with the spread between lending rates and the cost of customer deposits widening.

Given strict regulatory requirements, banks usually have sound balance sheets, making decisions around investment strategy (including loan growth and quality) and distributions more important in determining shareholder returns. On balance sheet strength and distribution strategies it’s a level playing field across the major banks in our opinion, but we think Commonwealth Bank has edged its peers on strategy and execution. We assign a Standard capital allocation rating across the banks, but we think the pendulum is swinging close to an exemplary rating for Commonwealth Bank, while Westpac and National Australia Bank are closer to Poor. We make no other changes to our earnings forecasts or fair value estimates.

We make no change to our forecasts or AUD 26 fair value estimate for National Australia Bank following the announcement AUSTRAC has begun formal enforcement investigations into breaches of anti-money laundering and counter-terrorism financing, or AML/CTF, rules.

National Australia Bank’s first-half fiscal 2021 cash profit of AUD 3.3 billion jumped 48% on second-half fiscal 2020, and was pleasingly void of large nonrecurring costs for the first time in a long time. The turnaround attributable to AUD 128 million in loan impairment provisions written back this half, compared to a AUD 1.6 billion expense in the previous half. Mediocre loan growth and modest expense growth were as expected, with full-year cost growth guidance of 0-2% reaffirmed. Home loan growth has returned closer to system after service levels in the broker channel were rectified and lending restrictions put in place during COVID were eased. The bank noted a growing business lending pipeline with momentum building in March and April. The firm has added 490 new bankers. While weighing on business lending profits now, it leaves them well placed as activity lifts.

Environmental, social and governance, or ESG, factors can have a material bearing on the cash flow and valuation of firms. In the past, issues such as James Hardie’s asbestos liability or AMP’s management of its conflicts of interest have had a material impact on the valuation of those firms. Identifying and assessing ESG risks is critical to any thorough assessment of a company’s cash flow and earnings potential. At Morningstar, we incorporate ESG into our long-term-oriented methodology by focusing on issues with the highest risk, defined by likelihood and materiality to a company’s intrinsic value.