Shares in Value Logo
Product Review Img Vertical

Date : 08/05/2023

National Australia Bank

ASX :

NAB

Market Cap : $83.42B Billion

Dividend Per Share : $1.61

Dividend Yield : 6.05 %

Buy

52 Week Range : $25.43 - $32.83

Share Price : $26.58

We see the expected weakness in Nab's profitability as temporary. We maintain a 'Buy.'

Company Analysis

Nab’s share price tumbled by more than 6 per cent despite a strong 1HY23 result on the back of rising interest rates. The strong results were, however, widely expected by the market. What came as a surprise was the company’s bearish outlook for the second half of the financial year. The big bank mentioned its expectation of a slowdown in the Australian economy’s growth and a further c. 4% fall in house prices in the calendar year (CY) 2023. Nab also said it expects robust employment conditions for the remainder of the year, but also mentioned a softening in business confidence levels.

For a detailed read of National Australia Bank’s business units and operations, use this link to our previous report about Nab.

Customers rolling off fixed-rate loans en-masse in the next 12 months

About 88% of Nab’s $94b Fixed Rate (FR) loan book rolls to Variable Rate (VR) loan over the next two years. This is basically the result of many customers taking on fixed-rate loans during the COVID to take advantage of the near-zero interest rate environment. Now those FR loans are expiring at a time when interest rates have rapidly soared to 10-year high levels in a matter of a year, a scenario that very few of those customers could’ve considered when taking on large mortgages to compete to overpay for houses that have dropped in value since then, and are expected to drop by a further c. 4% in the rest of the CY23 for a total of c.12% peak to trough decline.

Source: Nab

Source: Forexfactory

Inflationary cost pressures make higher mortgage repayment even more difficult

An analysis of full pass-through of cash rate increases to current customer rates by Nab shows forecast mortgage repayments at a 3.85% cash rate to increase average monthly repayments for VR loans by 37% and for FR loans expiring by March 24 by 59%. The massive increase in loan repayments comes when household budgets are already under pressure from rising costs of living, while the employment landscape is deteriorating as the economy’s growth is slowing down.

Source: Nab

Nab is focused on business lending rather than home lending

Nab has reported fierce competition amongst creditors for home lending as refinancing activity has elevated amongst home loan customers, and new loan applications are decreasing. This situation has resulted in a decline in the bank’s Net Interest Margin (NIM), and has encouraged it to lean even more towards its area of strength in business lending. Nab is a leader in SMEs (small and medium enterprises) lending, and further increased its market share in small business lending in the last several months. At the same time, it is fair to say that Nab is losing its share of the home lending market as it has reported a retention ratio of c. 85% of FR loans rolling to VR loans. Our take from this is that the other 15% are refinancing their home loans with other credit providers, and therefore Nab’s market share of home lending is declining. While steering away from writing unprofitable home loans makes sense, increasing exposure to small business lending can prove very risky in the current uncertain economic times.

Nab’s operating environment is deteriorating, but not forever

Some economists refer to the current state of the global economy as stagflation, which is defined by a combination of high inflation and slow economic growth. Stagflation is normally caused when a sudden supply shock reduces an economy’s productive capacity. Supply chain issues created by the Covid-related restrictions during the pandemic, and the international sanctions on the Russian economy after its invasion of Ukraine in February 2022 caused the sudden supply shock to the global economy that led to the current stagflation situation.

The solution for stagflation is hardly with central banks. Monetary policies are more effective in manipulating the demand on economies and do very little to change their output capacity. However, there are reasons to believe the current stagflation is nearing its end.

The supply chain issues are increasingly improving after the reopening of China’s economy in late 2022. In addition, commodity prices are moderating as the world has been increasingly finding alternatives to the Russian export of energy and mineral resources. The ease down in demand for consumer durable goods that soared during the COVID is also helping with lowering demand for commodities and, therefore, the commodity prices.

Investment thesis

Nab’s profit for the six months to 31 March 2023 showed an 18.8% improvement to the previous period, reflecting growth from all business units. Gross loans advances and deposits rose by 6.2% and 8.4%, respectively. Net Interest Margin (NIM) increased by 14 basis points during the period and stood at 1.77%. Although the reported increase in NIM in the half year looks promising, a further look into the details shows declining NIM prospects. Nab’s NIM peaked in the December quarter at 1.79%, and dropped to 1.77% in the March quarter, reflecting an increasing cost of capital and intense competition in the home loan business.

Given that Nab’s FR home loan customers are going to roll to VR loans in the next 12 months en-masse, and the fact that Nab’s strategy is not to retain customers at a loss, we can only see the company’s home loan book declining from here. In addition, the continuing fierce competition in the sector is also pointing to a further decline in the bank’s NIM, at least in the short to medium term.

Nab, however, has a rock-solid balance sheet, equipping it well to weather through the temporary unfavourable operating environment. The bank’s capital ratios remain above the target range of 11-11.5%, with the group’s Common Equity Tier 1 (CET1) capital at 12.21% as of 31 March 2023. And as you can see in the charts below, the percentage of Nab’s home loans with negative equity is sitting well below pre-pandemic levels. Nab’s small business lending is also well-secured, with 75% of the loans to SMEs fully secured and 20% partially secured, with the share of discretionary spend related loans at only 10% of the bank’s SME loan book.

Source: Nab

Source: Nab

Recommendation

Given the size of Nab and its exposure to different economic sectors, the company’s performance basically reflects that of the overall economy, as we see it. So, with our view of an improving outlook for the Australian and global economy in the medium to long term, we think it’s just a matter of time before Nab returns to its business-as-usual days. Thus, we retain our “buy” recommendation on Nab.

Given our expectation of a decline in Nab’s earnings in the short to medium term, we see further weakness in the stock’s price to the support level of $25 as a likely scenario (the green line on the chart). As such, we think prices near $25 are attractive for new buyers.

National Australia Bank, Weekly Chart in Semi-log Scale (Source: Metastock)

 

Scroll to Top

Login

By submitting this form, I agree to the TERMS AND CONDITIONS and PRIVATE POLICY