EUR 850.00 For Business Accounts Only

Morningstar | Confusion Reigns Supreme at NAB with Resignation of Both Chairman and CEO. FVE AUD 30 Unchanged. See Updated Analyst Note from 07 Feb 2019

We were not surprised by the announced departures of National Australia Bank’s Chairman, Dr Ken Henry and CEO Andrew Thorburn. As soon as the government released the Royal Commission, or RC, final report on Feb. 4, it was clear they had to go. Their positions were untenable, and we were surprised it took three days for the resignation announcement. The next 12 months will be a period of elevated uncertainty for Australia’s fourth-largest major bank. Nonetheless, we view the management and board change as a positive and in the best long-term interest of shareholders. We are confident in the underlying business and at this stage our earnings forecasts, positive view and AUD 30 fair value estimate are unchanged. The stock is undervalued, trading 17% below our valuation.

We do not doubt the principles and integrity of both departing executives, but clearly, they had misread the seriousness of Commissioner Hayne’s direct and stinging criticism and the profound change in community expectations for the leadership of Australia’s biggest financial institutions. The outgoing chairman indicated he would retire once a permanent CEO has been appointed. Board renewal is also needed with outgoing chairman Henry stating new nonexecutive directors are being targeted “this year to increase diversity of thinking and experience for the challenges ahead.”

Andrew Thorburn departs Feb. 28, 2019 with nonexecutive director, Phil Chronican appointed acting CEO effective March 1. Chronican is a good appointment due to his executive leadership roles at Australia and New Zealand Banking Group and Westpac Bank. He is highly regarded in the market and is a potential replacement for the Chairman’s role, but an external appointment is more likely. We don’t think Chronican would be considered for the permanent CEO role as an outsider is needed to restart the turnaround and realise the considerable potential in the bank’s profitable Australia and New Zealand banking businesses.

Once again, National Australia Bank finds itself in a serious mess seeking a new CEO and a new Chairman at the same time as dealing with the RC fallout, a slowing housing market, below-trend GDP growth and a potential change of government in May--to name a few. Despite acting CEO Chronican professing confidence in outgoing CEO Thorburn’s existing strategy and major restructuring program, we believe the permanent CEO when appointed will have free rein to change and/or refine the current strategy, potentially planning a new course for the embattled bank.

We don’t think it appropriate Chairman Henry leads the selection process for the new CEO. A new Chairperson, appointed externally or potentially Mr Chronican, should be making the critical appointment, particularly as the reputation of the bank is at stake.

Separately to the departure announcement, the bank released a reasonably impressive first-quarter trading update for fiscal 2019. The unaudited cash profit of AUD 1.65 billion is in line with our expectation and our we retain our full-year forecast profit of AUD 6.6 billion. The first-quarter profit is modestly higher than the average of the two previous quarters, up 2%, and modestly lower than previous corresponding period, or pcp, down 3%. No surprises in the unaudited statutory profit of AUD 1.7 billion. Good volume growth offset by weaker net interest margins and lower markets and treasury income resulted in broadly stable revenue in the quarter.

We liked the strong asset quality with ratio of 90-plus day arrears and gross impaired assets to gross loans broadly stable at just 0.72%. Despite high household debt level, weak wages growth, and soft economic conditions there are no signs yet of any deterioration in loan quality. Loan losses declined for the fourth quarter in a row to just AUD 193 million. This was a strong outcome considering an additional AUD 62 million was recognised for drought-related provisions in the quarter.

The annualised loss rate 13 basis points was close to our fiscal 2019 forecast of 14 basis points. No change to our fiscal 2019 bad debt expense of AID 804 million.
The balance sheet remains in good shape with leverage, funding and liquidity measures above regulatory minimum requirements. The common equity Tier 1 capital ratio of 10% decline from 10.2% at end September 2018 due to the declaration of the fiscal 2018 final dividend detracting a net 48 basis points of common equity Tier 1. We expect the bank to achieve APRA’s 10.5% common equity Tier 1 benchmark in an orderly manner by the Jan. 1, 2020 deadline from organic capital generation and offering a 1.5% discount on the dividend DRP during calendar 2019.

As expected, net interest margins were not specified, but declined on the second-half fiscal 2018 quarterly average of 1.84% due to pressures in housing lending and lower markets and treasury income. This is consistent with Commonwealth Bank of Australia’s margin for the six months to Dec. 31, 2018. Margins should improve during the remainder of fiscal 2019 due to the eventual repricing of variable home loan rates by 15 basis points in January. Based on the AUD 70 million “cost” in delaying the repricing approximately four months, we see a potential uplift of AUD 190 million for fiscal 2019. We maintain our full-year margin forecast of 1.86%, in line with fiscal 2018.

Expenses were well managed declining 3% on the quarterly average for second half fiscal 2018 due to improved productivity and lower RC and marketing spend. Despite the strong quarterly performance operating expenses could increase more than expected due to ongoing customer remediation costs and regulatory compliance investigations.

Plans to exit the MLC wealth management business have been delayed to fiscal 2020 from the previous timing of before the end of calendar 2019. Disposal options include a public markets exit and/or a trade sale. Following a key recommendation of the RC to not forcibly split integrated wealth management business, it appears National Australia Bank is less motivated to dispose of MLC as investor appetite for wealth management businesses is softening. The bank said it “will take a disciplined approach to the exit of MLC” and “the proposed exit remains subject to market conditions, regulatory and other approvals.” We continue to include MLC in our earnings forecast and valuation for National Australia Bank.