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Morningstar | NAB Shuffles Senior Executive Ranks Again; FVE Unchanged at AUD 32. See Updated Analyst Note from 17 Sep 2018

Wide-moat National Australia Bank’s most recent senior executive reshuffle was no real surprise, with the news that head of consumer banking and wealth Andrew Hagger is departing. Hagger was National Australia Bank’s most senior and high-profile executive to front the Royal Commission and received considerable heat and reputational damage from the Commission’s blowtorch focus on shortcomings in the wealth and superannuation industries. We retain our AUD 32 fair value estimate, and currently the shares are undervalued, trading 13% below our valuation. We retain our fiscal 2018 forecast cash net profit after tax of AUD 6.45 billion and total fully franked dividend of AUD 1.98 per share. We still exclude the previously announced AUD 755 million restructuring charge from our cash NPAT forecast.

The most interesting development in the reshuffle is the move of star recruit and former NSW premier Mike Baird to head of retail banking from head of corporate and institutional banking. We see Baird as the logical successor for CEO Andrew Thorburn when Thorburn eventually steps down. Despite widespread criticism of the bank’s actions and/or inaction, revealed during the Royal Commission hearings, we do not believe Thorburn is under any pressure to resign any time soon. Hagger has taken responsibility for the bank’s poor showing in front of the Commission. Baird will be responsible for the rebuild of the bank’s reputation. Consumer banking is a key business, with fiscal 2017 cash earnings of AUD 804 million representing 24% of fiscal 2017 group profits. Baird will be responsible for more than 700 branches, 7,000 bankers, broker partnerships, direct banking, and the digital bank, UBank. In our view, Thorburn will judged on the success or otherwise of the multiyear major transformation project currently under way and the expected uplift in earnings the project is targeted to deliver. Thorburn was promoted to CEO in August 2014 and could possibly exit the bank sometime in 2020.

National Australia Bank recently appointed former CEO of Perpetual Limited Geoff Lloyd as head of the bank’s wealth businesses, MLC, with plans to plans to sell, demerge, or separate the business by the end of calendar 2019 under way. MLC reported a first-half fiscal 2018 pro forma cash NPAT of approximately AUD 102 million. The success of the MLC separation is also important for Thorburn’s reputation.

Former chief risk officer David Gall will move to head of corporate and institutional, while group treasurer Shaun Dooley will become chief risk officer. Rachel Slade is promoted to head of customer experience, marketing, digital, products, NAB Labs, and NAB Ventures. The executive changes are expected to complete by Oct. 1, 2018, subject to regulatory approval. In late August, National Australia Bank announced the departure of COO Antony Cahill.

The bank’s decision not to follow major bank peers and raise variable home loan interest rates to compensate for higher short-term wholesale funding costs came as a surprise. All banks are suffering from higher wholesale funding costs, with net interest margins affected. Westpac Banking Corporation went first with 14 basis points in late August, followed a week later by Australia and New Zealand Bank with 16 basis points and Commonwealth Bank of Australia with 15 basis points. Thorburn got on the front foot on Sept. 10, breaking ranks with major bank peers by announcing with much fanfare that the bank was holding rates unchanged, attempting to build trust with existing customers and potentially attract new customers.

We think decision to hold variable home loan interest rates will not make much difference to National Australia Bank’s 15.4% market share, with the major players in the mortgage market Commonwealth Bank and Westpac Bank holding market shares of 25.4% and 24.5%, respectively. ANZ Bank holds a 15.6% market share. ANZ Bank, Westpac Bank, and National Australia Bank market shares are broadly unchanged during the past 12 months, with Commonwealth Bank suffering a 40-basis-point decline during the same period. The collective market share of smaller banks, including Macquarie Group, increased 60 basis points to 11.9% during the 12 months to end July 2018.

If short-term wholesale interest rates remain elevated or increase further, we think National Australia Bank will need to increase variable home loan interest rates to support net interest margins. In the bank’s third-quarter trading update, released in August, higher funding costs and intense competition for new home loans were identified as culprits behind the slight decline in margins.

Ironically, margin pressure caused by higher short-term wholesale funding costs is easing modestly, with the latest 60-day bank bill swap, or BBSW, rate sitting just above 1.91%, following a slow and steady decline from end of June highs of 2.12%. If this trend continues and 90-day BBSW rates get back below 1.8%, then National Australia Bank’s decision to hold interest rates could be a winner.