Unimpressed with NAB

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The general sentiment amongst brokers is that NAB carries the highest risk of the four major banks, most notably because of the ill fated investment into Britain. Right on cue, NAB’s UK banks did disappoint, but overall the performance was held to have enough positives to at least sustain neutral recommendations.

With a prospective dividend yield above 7% — given that dividend yield will be very much the market’s focus, at least in the short term — the pricing may be competitive. But the elephant in the room, the cost of wholesale funding, remains. And it is hard to see how Australia’s banking sector will escape what is now a global deleveraging.

Macquarie states the pros and cons:

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Cash profit in-line with our expectations but below consensus with margins down due to higher funding costs and UK BDDs up – Unaudited cash profit of cA$1.4bn was in line with our expectations (A$1.38b). Strong revenue growth in the Wholesale banking division and good cost control were unfortunately offset by a decline in margins (down 9bp) due to higher funding costs and higher BDDs in the UK (partially due to a reduction in UK commercial property collateral values).

 There is a case for improvement around margins via repricing and mean reversion around short-term funding costs – Given the funding pressure being experienced (c6bp) there is a clear case for repricing of both business and mortgage lending. This, along with a mean reversion of the BBSW/OIS spread, could see NAB naturally claw back some, or all, of the additional margin decline, although this is likely to be a 2H12 story at best.

 However there is a stronger case for structural headwinds particularly in the UK and to a lesser degree domestically – More concerning is the continued underperformance of the UK, which is now subject to a strategic review culminating in an announcement to market in May. While it would be tempting to consider the recent rise in BDDs as an aberration, there is a good chance that further hits to profitability are on the horizon (as shown by the deterioration in the UK 90 days past due up 10bp). In addition, while repricing may relieve some funding pressure, we note that NAB has at least some margin decline “baked in” due to the structure of its broker origination model.

NAB could sell the two UK banks, which will be considered in the strategic review in May. There are signs of increasing strategic skill: reasonable revenue and volume growth, a sustainable cost base and capital management. The eventual exit from the off-balance sheet conduit credit exposures will be a positive.

UBS has a buy and a price target of $25.50. Macquarie has a neutral and a price target of $26.70. Merrill’s price objective is only $24.50 and it sees signs of danger for the sector:

While NAB’s poor margin result was partly driven by company specific issues, we believe there is a negative read across for the sector, particularly around higher funding costs and levels of liquidity. This was a key reason for the downgrade in our sector view in December. We continue to believe consensus margin forecasts are vulnerable to downgrades. Today’s stable RBA decision adds further weight.

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Merrill has moved NAB to its number three pick of the big four.

UBS – Wed[1]